Currency gain

Yi: “no more yuan depreciation”

This week shareholders at the International Monetary Fund voted to include the yuan, also known as the renminbi, as the fifth currency in the IMF’s special drawing rights (SDR) currency basket alongside the US dollar, the Japanese yen, sterling and the euro.

The announcement is no great surprise. Christine Lagarde, the IMF’s managing director, flagged that it was recommending the move a few weeks ago. Now the executive board has approved it, with Reuters reporting that the vote in favour was unanimous.

Created in 1969 as an alternative store of value for central banks, SDRs can be exchanged for “freely usable” currencies. The goal is to improve financial liquidity: holders of the currency can exchange it between themselves, and the IMF sometimes designates countries in better financial shape to purchase it from those in worse condition.

Under the changes the yuan will take on an 11% weighting in the basket from October next year – leapfrogging sterling and the yen, which will be reduced to 8% each. The euro is the biggest loser in percentage terms, dropping six points to 31%, while the dollar’s share remains broadly unchanged at 42%.

Real-world usage of SDRs is minimal (one of the exceptions noted by The Economist this week: the billing of transit fees for ships passing through the Suez Canal). That means that companies won’t be rushing out to buy renminbi to hedge their exposure. The immediate impact on yuan-denominated investment is likely to be limited as well, with investors waiting to see whether China dismantles more of the controls relating to funds moving in and out of its economy.

But in the longer run the changes are going to increase the demand for renminbi at central banks.

This process is still in its early stages. An IMF survey of its 188 member countries last year found that just 38 held any of their foreign currency reserves in renminbi, according to the Financial Times. That was about 1.1% of the world’s assets.

Nonetheless, the IMF’s decision is an important symbolic step, confirming that the yuan is a liquid asset in which governments can safely park their wealth. Thus the state news agency Xinhua noted approvingly that the currency had “ascended to the heart of global finance”, highlighting the changes as more evidence of China’s newfound status on the global stage.

“Without the inclusion of the yuan, the representativeness of the SDR and the legitimacy of the IMF would have been questioned,” it warned. “By allowing an emerging-market currency into the SDR basket for the first time, the IMF showed its willingness and ability to adapt to global economic reality.”

Critics of the decision snipe that the IMF has succumbed to political pressure and question whether the renminbi can be classed as “freely usable” until it is left more to the determination of the market.

Plenty of institutional investors are still furious at Beijing’s massive intervention in the Chinese stock markets over the summer too (there were periods in which they were blocked from selling shares).

But the IMF’s definition of “freely usable” currencies relates more to how they are made available and traded internationally, rather than a purer focus on whether they are freely floating.

To meet these yardsticks Beijing has pushed through a series of reforms, including wider access for foreigners to the domestic currency markets, more frequent issuance of debt and an increase in trading hours.

In another key step this summer, policymakers tied the yuan’s opening exchange rate to its previous day’s close. Previously the starting quote of the new trading day had been set by the central bank (see WiC292).

The IMF has given China “a big hug for its painstaking and determined financial reform”, Xinhua argues. But the IMF also expects that the Chinese will do more to free up their currency. “It’s a milestone in a journey that will include certainly more reforms,” Lagarde told reporters after this week’s announcement.

Yi Gang, China’s deputy central bank governor, said “the decision has made us very happy” and on Tuesday ruled out another bout of yuan depreciation.

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