CHINA’S YUAN ENTRY INTO THE ELITE IMF CLUB
1 October 2016. China’s long-held desire to provide an alternative to the US dollar dominance has been given a boost when the yuan, also known as the remminbi, enters the International Monetary Fund (IMF) basket of reserve currencies placing it alongside the US dollar, the Yen, the Euro and the British Pound in the IMF’s special drawing right (SDR) basket. The announcement came on the day the Communist party celebrates the founding of the People’s Republic of China in 1949. Remarkable indeed for the Chinese and a milestone forward for the government’s campaign to be recognised as a global economic power. It also marks the first time a new currency has been added since the Euro was launched in 1999.
To the Chinese, the inclusion of the yuan marks a significant achievement in the internationalisation of its currency and an affirmation of the success of China’s economic reform and the opening of its financial sector. It is now for China to take this opportunity to further deepen its economic reforms and open up sectors to promote global growth. This is important as the elevation in the SDR basket will bring about billions of investments into China and it will also prompt central banks and sovereign funds to buy more Chinese assets.
The inclusion of the yuan however, has not made, and is not expected to make, an immediate impact to the world’s financial market. That is still a long way to go. While it may be the biggest trading nation, the yuan has not been widely used in the international market to settle trade and thus it has not commanded a market share. The currency also faces structural and institutional obstacles in its internationalisation process. The yuan until now cannot win full trust in the international community unlike other currencies in the IMF’s global basket because it remains controlled and cannot be exchanged freely with flexible exchange rates. Hence, it will not be considered a safe haven currency unless it wins the trust of foreign investors.
Before meeting the market requirements for its capital account, the yuan had taken advantage of China’s large share in the world’s trade to be included in the SDR basket. This is a breakthrough but on the other hand, a beginning of a different path of the yuan’s internationalisation process. This coupled with the fact that Beijing is still opaque over its economic foreign exchange policy will now place China in the international spotlight as some central bank may add the yuan assets to their official reserve.
While some may have said that the move to include the yuan is largely symbolic as the currency may not be ready for prime business as it does not have the traditional attributes of a reserve currency. The Chinese government will now have to keep its perspectives. Under the current framework, Beijing has no alternatives but to strengthen its financial system, address excess credit and deal with bad debt troubles facing Chinese banks which have gone beyond government’s limit, reduce opacity and loosen capital account. Having an open and transparent form of domestic government that has checks and balance in place, an independent central bank and a good legal framework would also be of vital important.
Amid all the hype about the hegemony, it is important for China to understand that the real hard work has just began. It is now up to Beijing to focus on its reform in order to remain relevant as a strong representative to the global economy. It is now up to the market to determine how significant a reserve currency yuan will be.
The ambition that the yuan will someday become an alternative currency to the US dominance will take some time.
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© October 2016. This article is contributed by Acutus Advisory Pte Ltd. All rights reserved.