Some 80 years ago Mao Zedong (leader of the Chinese Communists) commenced an epic Long March which covered some 4,000 miles, crossing 18 mountains and 24 rivers, lasting a year. By the end, Mao had grown his Red army, and defeated the Nationalist forces.
On Monday the International Monetary Fund (IMF) approved the decision to add the Chinese yuan (also known as the Renminbi) to its reserve currency basket from 1st October 2016. Chinese Central Bank officials lauded the inclusion, saying it would be an important starting point for Chinese financial reforms.
The new “Long March” for Beijing’s official recognition as a global economic power has begun.
The IMF decision places the yuan alongside the British pound, Euro, Japanese yen and U.S. dollar in an exclusive group of currencies that are included in the basket of the IMF’s Special Drawing Rights (SDR) — a type of reserve asset that makes up a small but symbolic portion of overall currency reserves. The basket also determines the currency mix that countries like Greece receive when the IMF disburses financial aid.
When the Yuan is added to the SDR in late 2016, it will account for about 11 per cent of the basket and will likely increase demand for the currency.
The time is right
The idea of including the yuan as the fifth currency in the basket was around when the previous review of the SDR was conducted in 2010. Back then, China was already well-qualified under one of the two criteria for SDR inclusion: it was a major global exporter of goods and services. But the Executive Board of the IMF considered that the yuan did not meet the other criterion of being a ‘freely-usable’ currency.
This time, the yuan’s ‘free-usability’ has led to an affirmative decision and opened the door to the SDR.
China to benefit from SDR inclusion
A currency’s status in the world’s reserves can mean big gains for the home economy. While inclusion in the SDR offers no tangible benefits to China inside the IMF, outside the IMF some strategists such as Hayden Briscoe, Managing Director of Asia Pacific Fixed Income at Alliance Bernstein have argued that including the yuan in the SDR “should help underpin China’s continuing efforts to internationalise the currency and could lead to inflows of up to $3 trillion over the next few years.”
However, as Bloomberg has noted, this will be a gradual process. With the perceived lack of transparency and market manipulation by Chinese authorities, foreign investor’s ability to hold more yuan is limited.
Similarly, Central banks tend to adjust reserve allocations slowly, so as not to pit market pricing against them, which suggests a steady gradual stream of demand for yuan assets over time rather than right away.
Economic reforms a step in the right direction
China is taking steps towards a more open, market-oriented economy and policymakers have cited the inclusion in the SDR basket as a crucial aspect of this metamorphosis.
It is a symbolic victory and the decision regonises China’s efforts to raise its status in the international financial community, commensurate with its growing importance in the global economy. China also believes this will help with their aspirations for diplomatic and economic prestige in the Asian region with their “One Belt, One Road” strategy.
In a statement, IMF Managing Director Christine Lagarde commented that 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.
And with our economy so strongly influenced by China, any growth to the Chinese economy can only mean good things for us. March on.
