The IMF is about to include the Chinese currency in its SDR currency basket - here's why it matters

Chinese President Xi Jinping enjoying a glass of red. China is x. Photo: Greg Bowker – Pool/ Getty.

China joined the world trade organisation in 2001. Since then its economy, development, and growth rate haven’t looked back.

Sure, the rate of growth has started to slow, but the economy has gone from barely registering on the global economic growth scale to the second biggest economy in the world. At the same time, China has taken emerging Asia along with it and over the past few years this combination has been the primary driver of global growth while developed market growth rates languished.

China and US GDP (tradingeconomics.com)

The axes on the chart above are different — the growth in the Chinese economy, relative to the globe and the United States, the world largest economy, are clear.

Which is why news over the weekend that Christine Lagarde, managing director of the IMF, and her staff are going to be recommending the inclusion of the Chinese currency, the CNY or RMB, in the IMF’s basket for special drawing rights (SDR), is so important.

The IMF announcement said:

IMF staff assesses that the RMB meets the requirements to be a “freely usable” currency and, accordingly, the staff proposes that the Executive Board determine the RMB to be freely usable and include it in the SDR basket as a fifth currency, along with the British pound, euro, Japanese yen, and the U.S. dollar.

Now as arcane an instrument as SDR’s are (IMF fact sheet here) this decision, which is expected to be ratified by the IMF’s executive board November 30, is just as momentous event in the evolution of China’s modern day economic history as joining the WTO.

Paul Mackel, head of global emerging market FX research at HSBC, and his team in Hong Kong said in a note to clients today that in the near term the RMB will strengthen but that this will be temporary.

Longer term, the move toward making the RMB a major global currency will be support by inclusion in the SDR, Mackel said. That’s because of the “stringent requirements for a currency to be included”.

“This serves as a sign of quality assurance for global users that the currency in question is very liquid and is stable as a store of value. SDR inclusion would also encourage China to stay on the reform track, which is important for investors’ confidence,” HSBC said.

Beyond the flows, Mackel and his team highlighted that inclusion in the SDR basket will:

… encourage China to stick to a much needed financial and capital account liberalization. These would over time increase financial sophistication and improve the efficiency of capital allocation, which would facilitate the economy to be more consumption and service driven. It should give China confidence in making its exchange change rate even more market driven, which would free up its monetary policy.

In other words the RMB inclusion matters for two reason. It supports President Xi’s moves to fight corruption and reorientate the economy away from property and exports to an economy more in keeping with the next stage of China’s economic evolution. But, in reinforcing that Xi and his plans are on track we also see the danger that the growth slowdown that is a part of this economic transition continues for some period.

That might trouble marekts even if the long run outcome will be a clear positive for China and the global economy.

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