IMF gives China’s currency prized reserve asset status

30 Nov 2015 | Author: | No comments yet »

Chinese yuan to join elite global currency club.

PASSING through the Suez Canal became easier earlier this year, thanks to an expansion completed in August. The Executive Board of the International Monetary Fund (IMF) today completed the regular five-yearly review of the basket of currencies that make up the Special Drawing Right (SDR).

Shareholders in the Washington-based IMF voted to include the yuan, also known as the renminbi, as the fifth member of its special drawing rights (SDR) currency basket alongside the dollar, the Japanese yen, sterling and the euro. To meet the IMF’s criteria, Beijing has undertaken a flurry of reforms in recent months, including better access for foreigners to Chinese currency markets, more frequent debt issuance and expanded yuan trading hours. “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,” she said in a statement. If lots of things were priced in SDRs, the IMF’s decision would have forced companies around the world to buy yuan-denominated assets as soon as possible, to hedge their exposure.

A vote by representatives of the IMF’s member countries to support the move marks a significant milestone for Beijing as it seeks to put the yuan on a par with the US dollar and play a growing role in global markets. The inclusion of the RMB will enhance the attractiveness of the SDR by diversifying the basket and making it more representative of the world’s major currencies.

Instead, admission to the currency club is significant mainly for its symbolism: the IMF is lending its imprimatur to the yuan as a reserve currency—a safe, liquid asset in which governments can park their wealth. The SDR interest rate will continue to be determined as a weighted average of the interest rates on short-term financial instruments in the markets of the currencies in the SDR basket. This is a large leap of faith in a currency which is still heavily managed, so before coming to this decision, the IMF asked China to make changes to its currency regime. The addition is likely to fuel demand for China’s currency and for renminbi-denominated assets as central banks and foreign fund managers adjust their portfolios to reflect the yuan’s new status.

Most importantly, China has now tied the yuan’s exchange rate at the start of daily trading to its previous day’s close; in the past the starting quote was effectively set at the whim of the PBOC, creating a big gap with its actual traded value. Currency analysts estimate the IMF seal of approval could fuel demand worth more than $500 billion in coming years and take the yuan’s share of global reserve holdings to around 5 percent, overtaking the Canadian and Australian dollars. “I think that it’s going to be very beneficial to the Chinese financial system as they develop a short-term treasury market to really accommodate reserve managers and their holdings of the yuan. Though still far from being a free-floating currency—the central bank has intervened since August to prop the yuan up—the cost of such intervention is now higher.

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