Later this year, the International Monetary Fund will decide whether to include the renminbi in its Special Drawing Rights – a "virtual currency" made up of a basket of other currencies.
If this happens, RMB use around the world is set to soar. Automatically, all central banks would become holders of RMB exposure through their SDR assets, and official reserve currency status would spur those central banks that have not already done so to invest part of their reserves in RMB.
There would be significant RMB hedging activity by some international institutions such as the African Development Bank and Bank of International Settlements, whose balance sheets of over $300 billion combined are denominated in SDR.
The final decision on the currency's inclusion in the SDR will, to a large extent, be political, and, judging by recent noises, it now seems significantly more likely that it will go in the RMB's favour.
In Europe – whose member governments have the largest combined share of the vote at the IMF – the atmosphere is turning increasingly favourable, with Germany declaring officially last month that it supports the RMB's inclusion in the SDR.
By our estimates, more than $100 billion of central bank reserves are now invested in RMB, considerably more than in the Swiss Franc, roughly on par with the known amounts of Australian and Canadian dollar investments, and fast catching up with the yen and the pound.
Even the European Central Bank is now considering adding the RMB to its reserves, according to media reports. This – along with the rapid growth in the use of RMB for trade and financial transactions – lends significant weight to the argument in favour of the currency's inclusion in the SDR later this year.
How the United States will play its cards will be interesting – so far, the official statements from Washington have been lukewarm at best. However, it is worth noting that, whereas most big IMF decisions require an 85 percent majority, effectively giving the US a veto, the SDR decision can be made with only 70 percent of the vote, if there's no significant change to the methodology.
If not now, the next SDR review is not till 2020. The IMF can theoretically conduct a review outside of those times, but this would be ill-advised and at odds with the IMF's stated aim to promote broader use of the SDR. Adding additional uncertainty about the timing of an SDR review would seriously hamper the SDR's prospects of becoming anything more than it is today.
By contrast, including the RMB this year would instantly make the SDR more reflective of the realities of the new world economy in which China is the largest exporter and has the second-largest GDP. By reducing reliance on the dollar, it would have the added benefit of making the international monetary system more stable.