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The IMF’s Executive Board has formally announced that the RMB will join its Special Drawing Right (SDR), which will be effective on 1 October 2016. This is a key milestone for RMB internationalization. The RMB’s weight in the SDR has been set at 10.92% with a new methodology being announced. Expectations have already been riding high that the board would formally announce the RMB’s inclusion. This implies that a lot of the near-term expectations should already be factored into the RMB from this announcement alone. With the SDR outcome now behind us, we expect the RMB’s focus to shift to the coming ECB and Fed rate decisions.
Today’s outcome 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 (See Qu Hongbin’s, 'Getting Bold: Why Beijing is so determined to push for full RMB convertibility', 20 April 2015). These need to progress further in order to boost the RMB’s growing appeal as a reserve currency (see 'The rise of the redback III: The world's next reserve currency', March 2014).
What has been announced?
The IMF’s Lagarde announced earlier today that the Executive Board voted in favour of the RMB joining the SDR.
The key points include:
• As of 1 October 2016, the RMB will have a weight of 10.92% in the SDR basket
• To compensate for the RMB’s inclusion, the other currencies’ weights will change
o The USD’s weight reduced to 41.73% from 41.90%
o The EUR’s weight declined to 30.93% from 37.40%
o The JPY’s weight will be 8.33% from 9.40%
o GBP’s will be 8.09% from 11.30%
• The IMF also adopted a new formula for determining currency weights in the SDR basket to address long-recognized issues with the formula that had been in place since 1978
• This explains why the RMB's weight of 10.92% is lower than what the previous methodology implied (roughly 14%).
• The new formula endorsed by the Board is one of the two alternatives presented in the 2010 Review and expands the share and representativeness of the financial variables. It is based on:
o The value of the issuers’ exports
o The financial indicator comprises, in equal shares, 1) official reserves denominated in the member’s (or monetary union’s) currency that are held by other monetary authorities that are not issuers of the relevant currency, 2) foreign exchange turnover in the currency, and 3) the sum of outstanding international bank liabilities and international debt securities denominated in the currency.
• The new formula is meant to overcome the stock (reserves) versus flow (export) inconsistency that was evident in the previous methodology and to incorporate a financial variable
• The IMF said exports and the composite financial variable are given equal weight (Read Report)
1) China Financial Daily - IMF Approves Adding China’s Yuan to SDR Reserve-Currency Basket by Deutsche Bank Markets Research, published on 1st December 2015
2) OCBC China Insights - RMB: The road to a freely usable currency by OCBC Investmnet Research, published on 1st December 2015
Source : HSBC Global Research