Risks ahead for traders after RMB added to the IMF’s reserve basket of currencies
Now that the Renminbi is to be added to the IMF’s reserve basket of currencies, there are a number of potential results any currency trader should be aware of. Demand could increase, stemming from the Renminbi becoming recognised as a credible currency for institutions to keep in their reserves. This credibility will also further attract traders, along with the facts that Renminbi will subjected to more market forces and less state meddling as well as increased liquidity both decreasing the currencies volatility.
By joining the small club of special currencies – the US dollar, euro, Japanese yen and British pound – which compose the IMF’s Special Drawing Rights currency basket, demand from financial institutions will increase. It can be expected that Central Banks will increase their demand for the currency in order to make use of it as a reserve currency asset. However, the impact of this increase in demand will perhaps only be minimal. In a June 2015 report by FX Watch expressed their belief that the slightly bearish nature of the Renminbi on exchange markets will not majorly alter demand. SDR quotas, as part of Central Bank reserves, are relatively small. According to FX Watch they account for, in total, “less than 3 percent of total global reserves.” Therefore, although there will be an increase in demand from Central Banks, it will be small and gradual and will not be enough to be materially felt on markets in the near future.
The inclusion of the currency in the SDR should also give it increased credibility. In general, traders have been reluctant to expose themselves too much to the Renminbi. There is perhaps no bigger stamp of credibility approval than inclusion of a currency in the IMF’s SDR basket, making traders more comfortable including the Renminbi in their portfolio. In many ways, the inclusion of the Euro as an SDR at the turn of the century helped to solidify its position as a serious global currency.
Becoming a reserve currency is set to make the Renminbi a more attractive currency for traders in other ways too. In the past the Renminbi has been subject to controls by the Chinese government: the Renminbi’s ascension to reserve status will increase the access traders have to the Renminbi in exchange markets. This increased market access will result in more frequent trading and increased liquidity, which should make the exchange price of the Renminbi more stable in the long term and reduce volatility. Likewise, the Renminbi will become less volatile by being subject to market forces once it becomes a reserve currency as well as being less prone to manipulation by the Chinese government.
While markets, by definition, are unstable, the movement of market forces is easier to anticipate than government action. Currency traders, then, taking into account these tendencies to make the Renminbi more stable on exchange markets, should be expected to start to consider including the Renminbi in their longer term investment strategies once it joins the elite club of IMF reserve currencies.