Yuan's inclusion in SDR both a boon and bane for China

THE renminbi's inclusion in the Special Drawing Rights (SDR) basket approved by the International Monetary Fund's board last week is only a small step in China's quest for a major reserve-currency status. Historically, the international monetary system has operated with multiple reserve currencies. China faces considerable challenges as the renminbi seeks gradually to attain this role. The speed with which this happens is directly linked to the pace and credibility of China's macroeconomic reforms.

This is the first time a middle-income nation has become a candidate for the reserve-currency status. When West Germany and Japan were moving towards that role in the 1970s (a transition about which both countries had strong qualms), their GDP (gross domestic product) per capita on a purchasing power parity basis was 85 per cent and 65 per cent of US levels respectively. By contrast, China's GDP per capita is estimated at only 25 per cent of the US equivalent. Countries do not take on this position lightly. Reserve currencies - held in significant quantities by governments and institutions as part of their foreign-exchange reserves - are generally characterised by broad and deep capital markets, floating exchange rates, scale, credible policy frameworks, voluntary private holdings of the currency and liquidity. This list brings considerable responsibilities and potential burdens, as well as benefits. It is worthwhile spelling these out.

The first important benefit is better financing through ability to borrow in a country's own currency both domestically and internationally. China's public and private sectors can issue most of their debt in renminbi, removing an exchange-rate risk that could suddenly trigger a balance-of-payments crisis. Second, a reserve-currency country gains seigniorage: income earned by issuing currency that others wish to hold. This phenomenon, frequently termed a positive "carry" for governments, should not be exaggerated. For the United States, the annual benefit is estimated at around 0.1 per cent of GDP.