October 6th, 2016 | by Solomon Teague | euromoney.com
RMB joins the SDR basket

The renminbi's inclusion in special drawing rights (SDR) is 'the biggest structural event in FX since the creation of the euro'.

The RMB became the first emerging market (EM) currency to be included in the IMF's SDR basket on Saturday.

The move had been well flagged, and was seen by many to be a technical issue of principally symbolic significance, with the market barely registering the event. However, while little has changed in the short term, the longer-term implications are significant.

The RMB becomes the fifth currency in the basket for SDR — the currency in which the IMF makes loans, joining USD, EUR, GBP and JPY. It starts with a weighting of 11%, with the IMF reviewing the weightings every five years, and if China makes more progress liberalizing its capital account, in time it might see its weighting increase.

The market's response was muted.

Alicia García Herrero, chief economist for Asia Pacific at Natixis and senior research fellow at Bruegel, a think tank, says: "We saw RMB appreciate on October 1, but we believe that was due to state intervention to celebrate the event — given how thin liquidity was, it didn't take much to move the market."

However, David Clark, chairman of the Wholesale Markets Brokers' Association (WMBA), believes the event will come to be seen as far more significant than many have given it credit for. "The composition of reserve assets tends to reflect relatively closely their weightings in the SDR basket," he says. "It won't happen overnight, but over time RMB allocations can be expected to rise markedly, from around 1% now, to around 11%, likely at the expense of sterling, yen and euros." This might not mean huge purchases of RMB assets in the market. More likely, institutions will hold on to their RMB earnings, he adds. "The inclusion of the RMB in the SDR is a significant structural event, which is rare in currency markets, and quite unlike other big events such as Brexit, the SNB crisis or political developments that move markets," says Clark. "You could argue it is the biggest structural event since the creation of the euro, the reunification of the East and West mark in 1990, and even the collapse of the Bretton Woods fixed exchange-rate system in the 1970s. This is less spectacular, but has similar long-term consequences. It is the advent of a new era." Of particular significance is the IMF's tacit acknowledgement that the old order, in which the global economy was dominated by a small number of developed economies, is no longer relevant.

Tiecheng Yang, partner at Clifford Chance in Beijing, says: "It is significant that the RMB has become the first developing economy currency to be included in the SDR basket, which makes the SDR more diversified."

The development can, therefore, be seen as a win for EMs everywhere, and could be the first step in a more comprehensive reorganization of the SDR. Herrero at Natixis says: ":I would not be surprised to see the RMB weighting increased in 10 years, and it could also be joined by other EM currencies. The Indian rupee is very liquid and could be a candidate, as could the Brazilian real. The Russian rouble is also a possibility, though this is less likely because its bond market is much smaller." For now, RMB's new role is a clear acknowledgement of China's unique status, and its remarkable growth in recent years. According to the Bank for International Settlements' 2016 FX survey, the Chinese renminbi is the most actively traded EM currency, having overtaken the Mexican peso, and is ranked eighth overall. Dan Marcus, CEO of ParFX, says: "This is an enormous achievement for a currency that wasn't easily accessible to mainstream investors a decade ago."

For Marcus, it is RMB's growth, rather than the technical change to the SDR composition, that represents the real seismic shift. "The renminbi's role in foreign-exchange trading and cross-border payments has surged to such an extent that its growth is now considered by many to be the most significant development in currency markets since the introduction of the euro in 1999," he says. What is clear is there will be no sudden change in demand for RMB. "It will be difficult for central banks to justify increasing their allocations to RMB in the short term because the general expectation is that the currency will be depreciating going forward," says Herrero. "In the long term, of course, they will, but before they hold more RMB bonds they will want to see greater liquidity in the market."