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China's renminbi has a long way to go despite official reserve status

In China, October first is a holiday marking the anniversary of the Communist takeover of the country. But this year the first day of the month will be another historic day for China. Its currency, the renminbi (RMB), will join the US dollar, the Japanese yen, the British pound, and the euro as a reserve currency for the IMF.

However, one expert doesn’t think too much should be expected from the currency any time soon, despite its new status.

“It’s happening before the RMB actually becomes a major reserve currency,” said Eswad Presad, professor at Cornell and former head of the IMF’s China division. “It seems like the IMF is getting a little ahead of the game. But part of the reason the IMF is doing this is to bring China into the fold, so to speak, and took acknowledge that China has become a great economic power. The currency still has a long way to go, though.”

Presad, author of a new book chronicling the history money in China called “Gaining Currency: The Rise of the Renminbi,” notes that the RMB remains under tight government control, unlike the other reserve currencies. Although China is the world’s second-largest economy, it is estimated that the renminbi is just around 1% of global foreign exchange reserves.

“Traditional attributes of a reserve currency—open capital account, flexible exchange rate—are not there for China yet,” he said. “It’s become a reserve currency just because China is so important in terms of world GDP and world trade … It accounts for about 13% of the world trade and it’s been the biggest contributor to global growth. So it’s largely size that’s driving this as if now.”

The US dollar won’t be dethroned by the Chinese renminbi any time soon, Presad said, though it may have some sway in a few regions.

“If China doesn’t stumble in terms of growth, if they continue with their economic and financial market reforms, make the currency more market determined, open up the capital account, it could very well rival the Japanese yen, the pound sterling, and perhaps even erode the euro share to a significant extent,” he said. “It will start playing a significant role in the Asian region and perhaps another region such as Africa and Latin America, which are very tied in to trade with China.”

Another factor holding back renminbi from top status is that the country’s financial markets and institutions aren’t as transparent as those of other major currencies, argues Prasad.

“China’s not there yet in terms of its financial market development and in terms of its data and government transparency,” he said. “So I think that is a long way to go even for the renminbi.”