IMF Managing Director Christine Lagarde speaks at a press briefing in Washington on November 30, announcing the decision to include the Chinese yuan into its SDR currency basket (IC)
China has entered the big league with its currency's inclusion into the International Monetary Fund (IMF)'s basket of reserve currencies, but analysts are already looking to see what the next move is as the country continues to reform and open its financial markets.
Experts interviewed expect more reforms like those that led to the IMF's decision, including allowing the yuan's value to be determined to a greater extent by the market, to push the currency onto the global stage.
The Chinese yuan was added as the fifth currency to the IMF's Special Drawing Right (SDR) basket on November 30, marking a historic moment in China's journey toward globalizing its currency. The decision also underscores the country's rising financial and economic heft.
Yi Gang, Vice Governor of the People's Bank of China (PBOC), the country's central bank, said the yuan's inclusion in the SDR is just the beginning and China has a long way to go before it closes the gap with more mature financial markets.
"Joining the SDR means the world will expect more from China in its financial and economic reforms. Therefore, China should learn from developed countries as well as other developing countries and emerging markets in a modest manner," Yi said during a press briefing on December 1. "China will press ahead with its reforms and opening up so as to consolidate its status as a reserve currency in the SDR basket."
SDR is an international reserve asset created by the IMF in 1969 to supplement its member countries' official reserves. SDRs are allocated to IMF members from time to time, based on each country's quota in the IMF. The composition of the SDR basket is reviewed every five years.
As of September 2015, a total of 204.1 billion SDRs (about $280 billion) have been allocated, most recently in 2009 when 182.6 billion SDRs were allocated, according to the IMF data.
The PBOC said it welcomes the IMF decision, calling it an acknowledgement of China's economic development, reform and opening up.
"The inclusion of the yuan in the SDR basket will increase the representativeness and attractiveness of the SDR, and help improve the current international monetary system, which will benefit both China and the rest of the world," it said in a statement following the IMF announcement. "It also means that the international community expects China to play a bigger role in the international economic and financial system."
The inclusion will go into effect on October 1, 2016, with the yuan joining the U.S. dollar, euro, Japanese yen and British pound. In an announcement following a vote by the IMF's executive board, Managing Director Christine Lagarde said the yuan meets all existing criteria and is determined to be a freely usable currency.
"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 in her announcement.
She continued, calling the decision "an important milestone in the integration of the Chinese economy into the global financial system" and an important validation of China's efforts to reform its monetary and financial systems.
Toward a global currency
Wu Jianhong (left) and Chen Han (right), executive board members of the China Europe International Exchange (CEINEX), ring the bell to inaugurate the exchange in Frankfurt, Germany, on November 18. As the first global trading venue for yuan-related investments, CEINEX is bringing China’s capital market to the international investor community (XINHUA)
Indeed, the yuan has passed multiple milestones over the past year. It is now the world's fourth most-used payments currency, passing the Japanese yen. In August, the yuan accounted for 2.79 percent of global payments in terms of value, according to data from the Society for Worldwide Interbank Financial Telecommunication.
The currency's elevation to the club of elite reserve currencies is the icing on the cake, so to speak, and represents a historic moment for China akin to when the country was included in the World Trade Organization in 2001, said Guo Tianyong, a finance professor with Beijing-based Central University of Finance and Economics.
"It means the international community has recognized the yuan's capability in shouldering the responsibilities of a global currency," Xu Hongcai, Director of the Economic Research Department at China Center for International Economic Exchange (CCIEE), told Beijing Review . "In the meantime, it will help facilitate further globalization of the yuan."
Xu said the inclusion marks an increase of the yuan's international credit, which will pave the way for broader use of the currency in global trade and finance and help lower the financial costs and exchange rate risks for those who use the currency.
A report from the Shanghai-based Haitong Securities Co. Ltd. forecasted that the yuan's exchange rate will become more flexible in the future, predicting that the trading band will be expanded to 3 percent or more as the PBOC further loosens its grip over the currency following the IMF's decision. The PBOC changed the way the yuan's daily trading band is calculated on March 17, 2014, by setting a daily midpoint for the yuan that the currency can then be traded within a 2-percent range. The central bank previously controlled the midpoint and allowed the currency to fluctuate just 1 percent of the midpoint.
In August, China changed its central parity system to better reflect market development in the exchange rate between the Chinese yuan against the U.S. dollar, another step toward market forces determining the value of the currency.
The central bank has made other large strides in recent years to reform the financial markets and open its capital account.
It's those reforms that have led to China's economic progress and the IMF's decision to include the yuan in the currency basket, said Cao Fengqi, Director of the Research Center for Finance and Securities at Peking University.
He has no doubt that the yuan will become a global currency. "It's only a matter of time," Cao said.
Xu warned the government cannot be complacent now that the yuan has been included, saying it still has a long way to go before it will be considered a global currency.
China will face fresh pressure after the inclusion, as the government will need to pay more attention to fluctuations in financial markets both at home and abroad, said Xu.
"I think the opening up of the capital account should be pushed forward in a steady manner. Massive inflow and outflow of capital could be quite normal in the future," he said. The government should have additional supervision over speculative capital flows that can lead to market instability, which he says could include a Tobin tax--a tax on cross-border currency transaction.
Next big steps
Reforms are expected to continue. The Haitong Securities report predicts that three major reforms are coming down the pipeline following the IMF's decision: formation mechanism of the yuan exchange rate, management of international capital flow and further opening up of the domestic bond market.
Xu also said that China should step up its efforts of encouraging more foreign borrowers to issue yuan-denominated bonds on the Chinese mainland, also known as Panda bonds. The bonds development has lagged over the past decade because markets expect the yuan to appreciate against the U.S. dollar and to have a higher interest rate than its American counterpart, Xu said.
"But these two criteria are changing, as the value of the yuan is fluctuating both ways against the dollar and a narrowing interest rate gap between two currencies following five yuan rate cuts this year and upcoming dollar rate rise," Xu elaborated.
The first batch of overseas central banks and similar institutions were allowed to enter China's interbank foreign exchange market, the PBOC announced on November 25. Xu said global financial institutions should be, too.
"Global financial institutions, such as the World Bank, Asian Development Bank, European Bank for Reconstruction and Development, as well as the China-proposed Asian Infrastructure Investment Bank, should be allowed into China's interbank forex market as well," Xu said.
"They should be encouraged to issue yuan-denominated bonds to facilitate connectivity projects along China-proposed Silk Road Economic Belt and 21st Century Maritime Silk Road," Xu said.
Ultimately, the IMF's decision to include the yuan in the SDR will impact more than just markets by making it easier for ordinary Chinese to consume and invest overseas because more countries will recognize the currency, said Lian Ping, chief economist with the Bank of Communications.
"In the future, Chinese people don't have to convert foreign currencies before traveling abroad. Bringing the yuan is enough," he said.
Desmond Fu, a trader at Western Asset, told China Daily that the IMF decision marks recognition of the yuan's rising role in global financial markets, both as a reserve and settlement currency.
"This is beneficial to both China and its trading partners as bilateral trades can be transacted without reference to a third-party currency," he said.
Wang Tao, chief China economist with UBS AG, said the yuan's inclusion into the SDR basket will pave the way for the emergence, over time, of yuan-denominated assets comprising a significant share of global reserves.
But Xu warned that the SDR currency basket is limited in its usefulness. "It has not been widely accepted in the financial system," he said.
Copyedited by Jordyn Dahl
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