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ollowing the earlier announcement in November that the renminbi (RMB) meets the International Monetary Fund'€™s (IMF'€™s) criteria as a '€˜'€˜freely usable'€™'€™ currency, the IMF Executive Board has now formally decided to include the RMB in its Special Drawing Rights (SDR) basket of currencies from Oct. 1 next year.

This came as no surprise to those who have followed China'€™s unprecedented steps to open up its capital markets.

A monumental milestone for the RMB, this event will trigger significant and gradual inflows of funds into RMB '€“ changing the global currency landscape forever, as central banks, sovereign wealth funds (SWFs) and multilateral institutions recalibrate their balance sheets.

Many won'€™t wait until next year before taking action '€” indeed as many as 70 central banks have already invested part of their reserves in RMB, either onshore or offshore.

The reforms made by China to qualify for SDR inclusion have been so radical that '€” to public sector investors '€” RMB has become fully convertible with no restrictions on access or size of investment in the China interbank bond market (CIBM), something which has largely gone unnoticed in the focus on China'€™s slowing growth.

Six out of the world'€™s ten largest central banks have so far refrained from investing in CIBM. However, because of China'€™s recent reforms, these and many other public sector investors are now reviewing their stance, and we are likely to see a significant, gradual increase in their investment.

Eventually, we should expect to see RMB reach a double-digit share of global reserves '€” inflows in the order of US$800 billion to over $1 trillion '€” though this will likely take a number of years.

Even a conservative estimate of reallocation of about 1 percent of global reserves each year would mean about $80 billion inflows annually '€“ no mean sum.
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The World Bank and Asian Development Bank will also be affected ...

Added to the moves by central banks there will of course be investment by sovereign wealth funds of some magnitude.

Though this is harder to make generalized predictions on, looking at Norway'€™s SWF for example '€” whose fixed income benchmark is GDP weighted '€” the allocation to the CIBM could be to the tune of over $40 billion.

The implementation of RMB'€™s inclusion to the SDR basket 10 months from now will also inevitably trigger a significant rebalancing or hedging demand for RMB, though this, too, is likely to occur gradually.

Against common perception '€”given that the aggregate SDR holdings/assets of the central banks in the IMF member states (around $280 billion) have an equal amount of SDR allocations/liabilities '€”RMB'€™s addition to the SDR basket won'€™t actually trigger a system-wide hedging demand, though some countries that are long or short on SDR may hedge their positions.

Instead, by far the most significant direct effect from the RMB'€™s inclusion on currency flows will come from multilateral institutions.

IMF'€™s own investment account and investment by its Poverty Reduction and Growth Trust would need to be rebalanced to include RMB.

Likewise, institutions such as the Bank of International Settlements, the African Development Bank, the Islamic Development Bank, the Arab Monetary Fund and the International Fund for Agricultural Development have SDR-denominated balance sheets, which will need to be rebalanced.

 The World Bank and Asian Development Bank will also be affected as some of their facilities for the world'€™s poorest countries are denominated in SDR.

The combined size of these multilateral institutions'€™ affected balance sheets is over $600 billion, so the resulting RMB flows could be over $60 billion.

 Private sector investors are yet to enjoy the same unfettered access to RMB investment as their public sector counterparts, but the sheer speed and extent of China'€™s reforms in the past year strongly signals China'€™s intent to accelerate the full opening of its capital account.

This may happen a lot faster now than people currently expect.

The '€˜'€˜ifs'€™'€™ and '€˜'€˜buts'€™'€™ for the RMB are over. For those who are yet to formulate an RMB strategy, now is the time.
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The writer, Managing Director and Head of Central Banks and Sovereign Wealth Funds, Standard Chartered Bank. He previously worked for the IMF and central banks of New Zealand and Finland.