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China’s RMB joins currency elite club

On Monday, the International Monetary Fund (IMF) announced to include Chinese yuan(Chinese currency name RMB) in its Special Drawings Rights Basket (SDR) along with the US dollar, the euro, the Japanese yen, and the British pound.

The SDR is a basket of currencies used by the IMF almost like an universal currency by which all international currencies can be measured against and facilitate international trade and finance.

The elite club of international currencies that make up the SDR basket are the US dollar, the euro, the British pound and the Japanese yen, China’s yuan will now join them on 21st October 2016.

The SDR “basket” is made up of different proportions (called “weighting”) of the 5 currencies depending on how important they are. When the yuan joins the SDR next year it will have a weighting of 10.92% behind US dollar’s 41.73% and the euro’s 30.93%, while the Japanese yen will be weighted at 8.33% and 8.09% for the British pound.

To join the SDR, a nation must not only be a large exporter - a criteria China achieved a long time ago - but a considerable amount of the foreign trade must take place in the currency.

"They [China] have more trade than any other country in the world,” says Stephen Leeb, Research Chairman of the Leeb Group. He also added how important trade in the yuan has become. “They now have a benchmark oil contract that they're trading in yuan or RMB. They're doing a lot of trading in the east in yuan and the east is only getting larger and their power within the east is only going to get greater."

A second IMF criteria is having a currency that is "freely usable." Over the past several years, China has executed many reforms to make this happen like putting more yuan in global circulation.

China has ‘swap lines’ where other countries can access China's currency as well as China being able to access other countries' currency. There are about 25 different countries that can use these ‘swap lines’. “It [the yuan] has gone from practically nothing in terms of world trade to being maybe the fourth or fifth most important currency," says Marc Chandler, Global Head of Currency Strategy, Brown Brothers Harriman.

For the past 16 years, there hasn’t been any currencies to join this elite club, says CCTV correspondent Shraysi Tandon, the euro joined in 1999 when it came into existence replacing the French franc and the German mark. The question remains however as to what the effect be both globally and nationally for China now it has joined this elite club.

“There are political and economic benefits to China, which includes greater usage for the RMB and more demand for the currency. Many of the economists have been talking about that in the next few year we are going to see central banks, international organizations and governments having greater quantities of China’s currency in their foreign exchange reserves”, says Shraysi.

Managing Director of IMF, Christine Lagarde says that the inclusion of the RMB into the SDR basket is an “important milestone” of the Chinese economy into the global financial system.

Praising the policies the Chinese government has undertaken to free up China’s currency, Lagarde says that the decision it’s also a recognition of the progress that the Chinese authorities have made in the past years in reforming China’s monetary and financial systems.

The IMF says that the inclusion of the RMB will enhance the attractiveness of the SDR by diversifying the basket and making it more representative of the world’s major currencies. The hope is it will also make it more resilient against global shocks.

International media have all commented on the IMF’s decision to include the yuan in the SDR basket:

The NY Times says that the fact the IMF made the decision because it considers the currency to be “safe” and “reliable.”

The BBC’s business correspondent Karishma Vaswani says that the inclusion means it is the start of a whole new world order as they quote Nomura Securities predicting RMB will be one of the top three major international currencies by 2030.

Responding to the decision, China’s central bank PBOC says the RMB will help boost the representation of the SDR and improve the current international currency system. And China will speed up the promotion of financial reform and opening up procedure.

As with all economic decision the consequences of such an event will remain unclear for some time. What is not in doubt however is everyone recognizes that the event is an historic one.