Get ready for yuan in IMF basket

Internationalization of Chinese currency picks up pace with clearing centers around the world

It came as no surprise recently to read that the Chinese yuan, or renminbi, as it is also widely known, is set to replace the Japanese yen to become the fourth international currency within two years.

Such is the rise of the yuan that eclipsing the yen in the short term is an absolute inevitability.

Indeed, since November last year the yuan overtook both the Canadian and Australian dollars to rank as the world's fifth-largest payment currency worldwide.

Breaking into the top five world payment currencies is a key milestone and signifies an unstoppable internationalization momentum. This confirms the yuan's transition from an "emerging" to a "business as usual" payment currency.

European industry should be aware of the rapid rise of the yuan and be more prepared than ever to do business in this currency, and not just when dealing and trading directly with Chinese companies.

The global rise of the yuan has been happening for years. Since last year a total of eight new offshore renminbi clearing centers have been established, fueling further international growth.

The almost exponential rise in the internationalization of the yuan can be appreciated by the whopping 321 percent leap in the value of yuan-denominated payments since December 2012. During this time payment growth denominated in all other currencies on the top 10 list grew by less than 50 percent.

But later this year we may well see another major milestone in the internationalization of the Chinese currency. That is when the International Monetary Fund is to complete its customary five-year review of its Special Drawing Rights currency basket. The likelihood of the yuan being added to the currencies already included is high.

If the IMF takes this step and adds the yuan to its SDR currency basket, it will signify the biggest step yet in the internationalization of the Chinese currency, and the entire Chinese economy, for that matter.

European businesses need to be aware of this "new kid on the currency block" and ensure that systems and strategies are in place that accommodate this change in the balance of currency power.

In order to cater to the inevitable growth in demand for the yuan, China's central government has in recent times appointed a grand total of no fewer than 15 clearing banks worldwide outside of the Chinese mainland to accommodate the rapidly rising popularity of its currency. The locations are Hong Kong, Macao, Taipei, Singapore, Seoul, London, Paris, Frankfurt, Switzerland, Luxembourg, Malaysia, Bangkok, Sydney, Toronto and Dubai.

But just how significant would SDR inclusion really prove to be?

In order to answer this question it is important to look briefly at the the role of the IMF generally and the use of its SDR around the world.

The IMF, founded in 1944 and headquartered in Washingtons DC, remains a key cog in the global economy with the sole aim of securing financial stability across the world and in so doing, facilitating sustainable global economic growth. The IMF represents an impressive total of 188 countries.

The SDR, created by the IMF as long ago as 1969 in order to supplement member countries' official currency reserves, is widely recognized as a major global reserve asset. As a result, it is only the most prominent and stable, global currencies that are included in the SDR currency basket: the US dollar, the euro, the British pound and the Japanese yen.

Clearly, inclusion in the IMF's SDR currency basket provides a tangible badge of recognition.

So, while the overall likelihood of yuan inclusion in the IMF's SDR by the end of this year is high, are there any signs or even hints that this may actually take place ?

Yes, plenty.

Most notably, it is recent economic reform plans put forward by China's central government that, in effect, have paved the way for SDR inclusion. Specifically, the opening-up of China's capital account and the deepening of its financial markets will certainly have been met with firm approval by the IMF as it mulls over yuan inclusion.

Furthermore, earlier this year, IMF head Christine Lagarde stated publicly that it was a question of "when" and not "if" the yuan will be included in the SDR currency basket.

The IMF's formal five-year SDR review period ends in the autumn this year and at this time a simple majority vote would be sufficient to bring into effect any change in the current SDR currency basket.

Perhaps the only potential obstacle at this present time is the IMF's "freely usable" criterion, which is usually interpreted as full currency convertibility.

But even the IMF appears to be appreciative of China's efforts to allow for and encourage greater use of its currency worldwide, both for trade and investment.

The full convertibility interpretation, therefore, may well be diluted to accommodate the yuan.

The IMF should also understand that any rush to full convertibility of the yuan could undermine the carefully managed transitionary state of the Chinese economy. Moving from an economy based on low-cost production to one driven by investment in high technology, high quality and premium brand building does not happen overnight. During this transition it would be dangerous in the extreme to expose the Chinese currency totally to market forces.

However, in order to expedite this transition and fuel further the internationalization of the Chinese economy, the IMF is also well aware of the boost that SDR inclusion would undoubtedly bring.

It is, therefore, quite possible that the IMF might tinker with its rules for SDR inclusion, with the yuan in mind. But any rule change would then require a 70 to 85 percent majority on the 24-member IMF executive board.

Despite positive signs and public statements, it may actually be the dire state of the global economy and the eurozone, in particular, that determines IMF decision-making on the SDR currency basket.

The IMF is all too aware of the crucial supporting role Chinese investment has played across Europe and beyond over recent years and the growth potential. Promoting the yuan to its SDR currency basket will only add fuel to this investment drive and provide further support to the still beleaguered European economy and, at best, a sluggish US economy.

European businesses should, therefore, be following developments and any public rhetoric on this issue extremely closely and should be preparing for a "yes" to yuan's inclusion in the IMF's SDR currency basket, effective from January 2016.

The author is a visiting professor at the University of International Business and Economics in Beijing and a senior lecturer on marketing at Southampton Solent University's School of Buiness. The views do not necessarily reflect those of China Daily.