Yuan elevated to elite club of currencies

The inclusion of the renminbi among the elite reserve currencies of the International Monetary Fund over the weekend will push ahead reforms linked to the currency’s internalization and marketization, according to economists. They also discounted speculation it would prompt a sharp depreciation of the currency.

The IMF approved the yuan as the fifth elite currency to join the special drawing rights basket, which is a foreign exchange reserve asset that includes the US dollar, euro, yen and the British pound.

“The expansion of the SDR basket is an important and historic milestone for the SDR, the Fund, China and the international monetary system. It is a significant change for the Fund, because it is the first time since the adoption of the euro that a currency is added to the basket,” IMF Managing Director Christine Lagarde told reporters at the IMF headquarters in Washington on Friday.

“The renminbi inclusion reflects the progress made in reforming China’s monetary, foreign exchange, and financial systems, and acknowledges the advances made in liberalizing and improving the infrastructure of its financial markets,” Lagarde said.

“The continuation and deepening of these efforts, with appropriate safeguards, 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.

“The RMB’s acquisition of SDR status marks a milestone, which is equivalent to that of China’s entry into the World Trade Organization in 2001,” said He Zhicheng, former senior economist with the Agricultural Bank of China.

“But it only marks the beginning on its journey to become a global reserve currency,” He said. “It would prompt the government to move ahead with reforms in the financial sector.”

The renminbi has leapfrogged other currencies to occupy the thirdlargest share of the new SDR basket at 10.92 percent, following the US dollar’s 41.73 percent and the euro’s 30.93 percent.

Rising demand for yuan assets brought by inclusion in the SDR basket will push China to deepen reform and the internationalization of yuan, at a time when China is becoming more integrated into the global market, according to Zhao Xueqing, an economist with the Institute of International Finance, a think tank affiliated with the Bank of China.

The renminbi has been the fifthmost-used currency for global payments for the second consecutive month, according to SWIFT, the global transaction service.

Yuan-dominated direct investment saw rapid growth from January to August, when the total reached 1.62 trillion yuan ($242 billion), up 61.7 percent year-on-year.

Over the past decade, the world has witnessed the rapid rise of the Chinese currency.

But the SDR inclusion’s impact on the government’s tightening of controls over the yuan’s exchange rate will be rather minimal, according to Sun Lijian, an economics professor with Shanghai-based Fudan University.

Sun played down speculation that the central bank would allow a sharp depreciation right after the yuan’s inclusion.

While the yuan does face a certain level of depreciation pressure against the US dollar, mainly driven by a potential US interest rate hike in December, it “does not face long-term depreciation pressure”, he said.

“The RMB’s inclusion into the SDR basket, with its rising status as global currency, can be a hedge against the pressure of depreciation, if anything,” he said, referring to the fact that capital inflows brought by increasing demand for yuan assets would help stabilize the exchange rate.

Lian Ping, chief economist with Bank of Communications, shared similar views and said that the yuan’s exchange rate depends more on the fundamentals of the economy and market expectations.

“Inclusion of the RMB in the SDR is an important signal that China has made a lot of progress with financial reform and the RMB has become an international currency,” said David Dollar, a senior fellow at the John L. Thornton China Center of the Brookings Institution in Washington.

He said in order to be a major reserve currency, China needs to continue reform, strengthening transparency and reliability of capital markets and opening up more to the global economy.

Rory MacFarquhar, a visiting fellow at the Peterson Institute for International Economic and a former senior official at the White House National Security Council, said the inclusion of the RMB in the SDR is putting new responsibility on China.

“Those basically come down to the way China thinks of its currency, thinks of its economic management as in global terms,” he said.

“The decision is very good for China, IMF and international financial system,” said Eswar Prasad, the Tolani Senior Professor of Trade Policy at Cornell University. The former IMF chief in China believes it will be good for pushing forward China’s internal reform, especially in the financial sector.

He also believes it’s good in terms of making China a stakeholder of IMF and bringing on board the emerging markets, which feel somewhat unfairly treated in the international financial governance.