October 26, 2015 / 4:31 PM / 5 years ago

China's SDR inclusion may lead to $500 bln reserve demand for yuan

LONDON, Oct 26 (Reuters) - Including the Chinese yuan in the International Monetary Fund’s benchmark currency basket would give it an official seal of approval, eventually leading to global demand worth more than $500 billion in coming years, currency analysts say.

Inclusion of the yuan in the holdings of foreign exchange reserve managers would be a gradual process, subject to external factors with high degrees of uncertainty. But the yuan eventually might comprise nearly 5 percent of global reserves.

The IMF’s executive board is scheduled to decide in November on the yuan’s inclusion and is expected to give the green light, although approval could be early next year, sources familiar with the discussions told Reuters.

Being able to buy and sell the yuan will require further liberalisation of China’s exchange-rate controls, a process that has been years in the making and may take many more.

Still, demand for yuan from reserve managers could counter the capital outflows from China. Those outflows have accelerated recently to record levels as the economy has slowed and markets have fallen.

Based on its inclusion in the IMF’s Special Drawing Rights (SDR) basket, a virtual currency that values IMF reserves and emergency payouts to members, the yuan’s share of the world’s FX reserves could eventually reach around 5 percent, analysts estimate.

That would place the yuan, or renminbi, ahead of the Canadian and Australian dollars (each almost 2 percent of reserves, according to the latest IMF data) and near sterling (4.7 percent), but still well behind the euro (20.5 percent).

The U.S. dollar remains the world’s pre-eminent reserve currency, accounting for nearly two-thirds of all holdings.

In the SDR itself, there are only four currencies - the dollar, euro, sterling and Japanese yen. The Canadian and Australian dollars are not part of it. The yuan would be the fifth.

“You don’t have to be in the SDR to be a reserve currency. It helps, but it doesn’t particularly matter,” said Simon Derrick, global head of currency strategy at Bank of New York Mellon in London.

“It’s a guessing game, but within a few years the yuan would probably be of similar size to the Canadian dollar, and well within the next decade not hugely dissimilar to sterling,” he said.

World FX reserves stand at around $11.46 trillion, of which the composition of $6.666 trillion is known. It is assumed the remainder is along similar lines.

The total value of SDRs is only around $280 billion. Its composition, which factors in currency use in international trade flows, is rather different. Last set in 2010, it is 41.9 percent dollar, 37.4 percent euro, 11.3 percent sterling and 9.4 percent yen.


Earlier this year, analysts at Citi conducted a “very informal” survey of 12 reserves managers with more than $2 trillion of FX reserves under management, asking whether the yuan’s SDR inclusion would make them more inclined to add it to their FX reserves. The response was that it would.

“SDR inclusion makes the RMB, by definition, a ‘reserve asset’, and this should catalyse capital inflows to China, but by how much, it’s hard to say,” said David Lubin, head of emerging market economics at Citi in London.

“And since China should expect to see gross capital outflows for the foreseeable future, it’s not even clear that SDR inclusion will lead to a net capital inflow to China,” he said.

Li-Gang Liu of Washington-based Peterson Institute for International Economics argued in an opinion piece earlier this year that SDR inclusion would not automatically grant it reserve currency status.

That will be determined by financial markets, based on “risk, return, liquidity, ease of hedging, and other market efficiency criteria,” he said.

Based on current methodology, the yuan’s SDR composition could be around 14 percent, according to HSBC. But it will be lower if the IMF factors in its use in financial transactions, “the RMB’s weak point,” the bank said in a recent note.

They argue that market-friendly FX and other reforms being undertaken by Beijing in the face of serious economic challenges override the “symbolic” benefits offered by SDR status.

Against a backdrop of easing monetary policy and narrowing growth differentials with the rest of the world, continued capital outflows should weaken the yuan over the next year to 6.60 per dollar from 6.35 currently, they said.

Barclays are even more bearish, calling for the dollar to hit 6.90 by the middle of next year, and possibly higher.

Still, the yuan is now the fourth most-used world payment currency, accounting for a record high market share of 2.79 percent in global payments, according to global transaction services organization SWIFT.

Reserve managers looking to build up their renminbi holdings will want to do so gradually and in a manner that increases their portfolio diversification. That would likely see them trim their dollar and euro holdings, BONY Mellon’s Derrick said. (Reporting by Jamie McGeever, editing by Larry King)

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