|Agence France-Presse: Getty Images|
On November 30, the International Monetary Fund (IMF) announced that the Chinese renminbi (currency code RMB) would be added as a special drawing rights (SDR) currency. Designation as an SDR makes the renminbi a reserve currency, a symbol of China's economic power.
Although this designation was predicted to occur, it was a major undertaking on China's behalf. They liberalized interest rates, developed the domestic bond market, and set the US dollar to RMB exchange rate to the previous day's close: all ways of lifting government regulations on the currency.
Previously, the US dollar, euro, Japanese yen, and British pound sterling made up the SDR basket. On October 1, 2016, the SDR market basket will consist of the following percentages:
- US dollar: 41.73%
- Euro: 30.93%
- Chinese renminbi: 10.92%
- Japanese yen: 8.33%
- Pound sterling: 8.09%
While the percentage for the US dollar remained around the same, the introduction of the Chinese renminbi led to a decrease in percentage for the euro, Japanese yen, and British pound sterling. Since the value of the renminbi is loosely tied to the US dollar, some argue that this designation will increase US influence of financial institutions. Due to a surging dollar, China has had to spend billions in order to maintain the value of its currency. In fact, China's spent $100 billion in August alone to prop up the renminbi. This signals trouble for China as the renminbi is used more extensively around the world.
But what are the implications for the US? The rise of a major economic competitor's currency in the world financial markets means that sanctions that the US wishes to impose on other countries, including for security reasons, will have less power than they currently hold. This could have adverse effects in sanctions that pressure other countries to do what the US wants- there is now more of a Chinese alternative to offer them.
Overall, the renminbi's designation as a reserve currency will not change global financial markets overnight. However, the structural reforms necessary for China to effectively provide a reserve currency will have lasting effects on their domestic economy. Stagnating growth in China may become worse. The renminbi might also depreciate, and the Chinese government will need to accept this after a gain in a public symbol as an economic power.