China's RMB joins IMF's elite currency club, tough journey ahead

Betterment of global monetary system

At the Group of 20 summit held in Antalya of Turkey this month, Chinese President Xi Jinping said the inclusion of the yuan will help increase the representation and attraction of the SDR, improve the international monetary system and safeguard global financial stability.

Chang Jian, chief China economist of Barclays Capital, an investment bank, said the global demand for safe reserve assets is rising, but the US dollar and the euro are getting harder and harder to supply adequate "safe havens."

"Only China is able to provide such safe reserve assets in order to ease the supply strains," she said.

The IMF is also facing challenges on all sides, as Europe has drawn the 188-member multilateral organization into the debt crisis from time to time and IMF's long-awaited quota and governance reform has been blocked by the US Congress for years.

"The international system of economic governance is at a turning point," Harold James, professor of History and International Affairs at Princeton University, and Domenico Lombardi, director of the Global Economy Program at the Centre for International Governance Innovation in Canada, wrote in a recent article published on the Project Syndicate website, one of the world's leading op-ed websites.

One solution for the IMF to reprise its role as a guardian of international financial stability could be adding the yuan into the SDR basket, they said.

Eswar Prasad, the former head of the IMF's China Division, said IMF wants to avoid another knock on its legitimacy, already tainted by the lack of progress on giving emerging markets their rightful voting shares.

"Excluding the yuan from the SDR could crystallize the concerns of policy makers in emerging markets that the IMF remains an institution run by and for the benefit of advanced economies," he noted.

"If the IMF is to remain relevant at a time of rapid economic transformation, it must adapt. By adding the Chinese renminbi and perhaps other emerging-market currencies -- to the SDR basket, it would demonstrate its willingness and ability to do just that," concluded Harold James, the professor from Princeton University, and Domenico Lombardi from the Centre for International Governance Innovation in Canada.

Lundsager, the former US executive director at the IMF, also argued that she would rather view the yuan's inclusion as a "fact-based move which features a currency from a large economy with an increasing role in the global market that is included."

"What is important is the data. I expected the IMF board will agree with the IMF Managing Director and staff that the yuan is qualified to be included in terms of data and fact," she said.

Tough journey ahead

China started promoting RMB's internationalization since 2009, which has grown at a pretty brisk pace over the past two years, President and CEO of Bank of China USA Chen Xu told Xinhua.

The internationalization of a country's currency usually involves three phrases: being used as an international trade settlement currency, turning into an investment currency, being treated as a reserve currency.

"The inclusion of RMB into the SDR basket shows that the internationalization of the currency has entered into the third phrase, and the process is expected to pick up pace," he added.

Gaining the status of a reserve currency will prompt central banks to increase their holdings of the yuan in the reserve currency portfolio. Private sectors will also be encouraged to gradually buy more yuan-denominated assets.

The global reserve currency status, however, will not automatically turn the yuan into a major global reserve currency, which is a choice of the market.

Lardy, the senior researcher with the Washington-based Peterson Institute of International Economics, said there are a few central banks that hold their reserves in proportion to the weight in the SDR basket. They tend to be very conservative and would adjust their portfolio in a very gradual manner.

"If yuan wants to gain the trust and confidence of the market, China needs to become an economy and a financial system that can accept large and free movement of inflows and outflows and has depth and breadth with a variety of financial instruments," Lundsager said. "So it's very important to keep China on path of reform. It's tough that everything you do is closely scrutinized by the market. But China can't backtrack in a major way. Inclusion will re-enforce the trend."