SINGAPORE - China scored an economic milestone with the International Monetary Fund's decision on Monday to include China's yuan, or renminbi (People's currency), in its Special Drawing Rights (SDR) basket.
Aimed at accelerating greater liberalisation of the world's second-biggest economy, the yuan will be officially included on Oct 1, 2016, and has a strong weighting above those of the Japanese yen and British pound. Under the new makeup, the dollar will be strongest, at 41.7 per cent. The euro will be 30.9 per cent, the yuan 10.9 per cent, the yen 8.3 per cent, and the pound 8.1 per cent.
The SDR, or Special Drawing Right, plays an influential role in global finance, helping governments protect their financial reserves against global currency fluctuations. It is also used as the basis of loans from the IMF's crucial crisis-lending facilities.
The inclusion of the yuan alongside the dollar, euro, yen and pound is the first change in the SDR basket's composition since 1999 - when the new euro replaced the deutschemark and French franc.
Here's what analysts have to say:
1. Paul Mackel, head of HSBC Global Emerging Markets FX Research: A Major Milestone
This should give China further confidence to let the exchange rate become more market-driven. In our view, this is more important than the SDR outcome itself and gauging whether FX policy is relaxing will be critical. We see USD-RMB ending 2015 at 6.50 and expect further RMB weakness with greater two way volatility next year.
In the longer-run, the currency's inclusion should promote further exchange rate and capital account reforms. These need to progress further in order to boost the RMB's growing appeal as a reserve currency.
2. Craig Chan, Nomura Global Markets Research analyst: New entrant
With market expectation of inclusion already very high prior to this announcement, we expect some, but limited, further positive impact on RMB sentiment in the near term. A rapid near-term increase in capital inflows is also unlikely in our view as SDR is just a potential claim on the freely usable currencies of IMF members, and any transactions would be done between central banks and not through the open market. In addition, the size of the SDR is still relatively small at around US$280 billion (equivalent as of 10 September 2015) and with China's 10.92 per cent weighting would imply only around a US$30.6 billion reallocation to RMB.
We also believe that reserve managers and sovereign wealth funds may exercise a certain amount of caution before investing in RMB assets because of concerns over China's economy and financial market valuations stemming from the Chinese government's multi-market intervention. However, we believe the indirect positive impacts on RMB from China's entry into the IMF's SDR basket could be significant over the long term given that foreign financial entities are broadly "underinvested" in RMB assets.
3. Roy Teo, Senior FX Strategist, ABN AMRO Private Banking: Mild depreciation
We expect mild depreciation of the Chinese currency versus US dollar in 2016. Over the coming year, we expect the Chinese authorities to maintain their current policy of allowing a gradual currency depreciation to support exports and re-inflate the economy. We also expect the Chinese central bank to reduce volatility in the yuan and narrow large discrepancies between the onshore and offshore yuan. In our view, the effect on additional demand from central banks for the yuan as a reserve currency will be limited (the SDR quota represent less than 3 per cent of total global FX reserves) and the role of the renminbi as a reserve currency will rise only gradually. We expect the renminbi to weaken versus the US dollar next year, reaching 6.55 by year-end.
4. Andrew Colquhoun, Senior Director, Sovereigns, Fitch (Hong Kong): Yuan Reserve Status Still a Way Off despite SDR entry
Being a part of the SDR basket is not a sufficient condition for the renminbi to be considered a reserve currency, nor will it necessarily result in a sudden spike in the allocation of reserves to renminbi assets. Notably, other currencies such as the Canadian dollar and Australian dollar are currently held more widely as central bank reserve assets without being a part of the SDR basket. Furthermore, renminbi-denominated assets do not currently qualify as foreign reserves according to the IMF - despite the inclusion of the renminbi in the SDR weighting - because of China's capital controls.
Inclusion in the SDR basket is neither a quick fix nor an alternative to the broader structural reform agenda. The speed at which the renminbi develops into a global reserve currency will depend on the extent to which central banks and sovereign wealth funds begin to see the currency as a viable store of liquidity and value to rival that of the US dollar. Such a shift is only likely to be gradual. It is especially unlikely in the short term so long as doubts persist over China's prospects for a smooth and orderly macroeconomic rebalancing.