IMF Approves Reserve Currency Status for China’s Yuan

30 Nov 2015 | Author: | No comments yet »

IMF Approves Reserve-Currency Status for China’s Yuan.

The decision — which marks another step in China’s global economic emergence — came after the IMF evaluated the Asian nation’s standing as an exporter and the yuan’s role as a “freely usable” currency.The IMF will add the yuan to its basket of reserve currencies, an international stamp of approval of the progress China has made integrating into a global economic system dominated for decades by the U.S., Europe and Japan.

Shareholders in the Washington-based International Monetary Fund are widely expected to vote to admit the yuan, also known as the renminbi, as the fifth member of its special drawing rights (SDR) currency basket alongside the US dollar, the Japanese yen, sterling and the euro. In a statement, IMF Managing Director Christine Lagarde noted the yuan’s inclusion is a “clear representation of the reforms” taking place in China. “The continuation and deepening of these efforts will bring about a more robust international monetary and financial system, which in turn will support the growth and stability of China and the global economy,” Lagarde said. Many China watchers say the IMF’s decision is in large part a political one designed to encourage stronger economic overhauls in the world’s No. 2 economy. Currency strategists at RBC Capital Markets think that the inclusion of the yuan would mean more politically than financially. “More than anything, it is a symbolic and political milestone in China’s long path to renminbi internationalisation,” they wrote in a research note. A host of other factors will determine the yuan’s fate as an actual global reserve currency, which is a reliable and well-used foreign exchange asset that central banks stock to buffer against crises.

This requires massive cultural and procedural changes.” “A country participating in this system [Bretton Woods] needed official reserves— government or central bank holdings of gold and widely accepted foreign currencies — that could be used to purchase the domestic currency in foreign exchange markets, as required to maintain its exchange rate. “But the international supply of two key reserve assets—gold and the US dollar—proved inadequate for supporting the expansion of world trade and financial development that was taking place. The pace of Beijing’s move to establish a market-determined currency; to deepen its financial system; to strengthen its economic institutions; and to secure healthier long-term growth will be the prime determinants for whether central banks—and investors—trust in the yuan enough to stock up their reserves with China’s currency. Therefore, the international community decided to create a new international reserve asset under the auspices of the IMF.” Not long after the creation of the SDR, the Bretton Woods system collapsed and the major currencies shifted to a floating exchange rate regime. Over the past year Beijing has rolled out a series of policies—including freer interest rates and easier foreign investor access—to meet the IMF’s criteria for yuan inclusion in the IMF’s so-called Special Drawing Right lending basket.

But the SDR system has become more important again recently by supplementing member countries’ official reserves during the credit crunch and global financial crisis. The IMF uses the SDR to denominate its crisis lending as member countries currently borrow dollars, euros, pounds or yen to keep their economies afloat. The SDR’s value is based on the basket of the four international currencies and SDRs can be exchanged for “freely usable” currencies, the Fund says. They can either arrange exchanges between members or the IMF can designate members with strong external positions – those with big current account surpluses – to purchase SDRs from members with weak external positions.

The SDR basket is typically reviewed every five years by the IMF’s executive board to ensure that it “reflects the relative importance of currencies in the global trading and financial systems”. While U.S. officials still privately question the yuan’s ripeness for reserve-currency status, they also see it as aiding efforts by reformers within the People’s Bank of China to liberalize the country’s economy. Awarding Beijing currency-reserve status is designed in part to encourage China’s government to greater international political and economic responsibility. Failure to win IMF reserve-currency status would have also been an embarrassment for China’s leadership as it takes over the rotating presidency of the Group of 20 largest economies next year. Some economists say that if the country failed to secure the IMF label, it could have made it even more difficult for those in China seeking to open up the economy.

Still, Standard Charted estimates the yuan’s new status could lead to a 1% annual shift in reserves into yuan-denominated assets over the next five years, totaling about $1 trillion. In other words, it must be a currency that is widely used to make payments for international transactions and widely traded in the main exchange markets. The IMF’s experts think so and Fund emphasises that “freely usable” relates to the actual international use and trading of currencies, and is different from whether a currency is freely floating.

Chinese authorities have announced a raft of changes to liberalise the country’s financial markets, moves seen as also helping the yuan meet the freely usable rule.

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