China: Renminbi/Yuan becomes an IMF reserve currency

The Chinese Yuan, also known as the Renminbi, has joined the IMF’s reserve-currency basket. This will add value to the currency but also brings obligations for Beijing.

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It’s been a done deal since the beginning of the week. The executive board of the International Monetary Fund (IMF) has decided to add the yuan in its currency basket. IMF Managing Director Christine Lagarde spoke of an “important milestone in the integration of the Chinese economy into the global financial system.” The Chinese currency becomes the fifth in the basket, alongside US dollar, the euro, the Japanese yen and British pound.

Decision made despite many critics

It was foreseeable that the IMF would make this decision, which nevertheless only comes into effect in October 2016. Beijing cannot rest on its laurels til then. It has to make progress on the financial reforms in China. It has done its homework, albeit much more slowly than had been hoped by the supporters of the yuan becoming a reserve currency. This is one reason why the list of skeptics is long. In the summer, when China’s stock markets went on a downward roller coaster ride, the signs that the yuan would meet the IMF’s strict criteria were still rather poor.

The main objection then (as now) was that unlike other reserve currencies, the yuan is not freely traded on the world markets. Beijing decides on the rate of fluctuation and its critics say that this is kept high through artificial means. But in the summer, the Chinese central bank devalued the yuan within a few days by more than 3 percent compared to the US dollar. Moreover, for over a year, China’s central bank has allowed the course to fluctuate up to 2 percent a day compared to the US dollar. The official justification for the measures is that Beijing wants to give the market greater leeway to balance the exchange rate. The five-year plan to be adopted in spring 2016 might perhaps allow the yuan to be traded completely freely.

More and more yuan-based business

The proportion of the yuan in global monetary transactions used to only amount to 2.8 percent, compared to 45 percent for the US dollar. The Chinese currency is catching up. For the past six years, Beijing has been trying to sign currency swap agreements with as many countries as possible. There are currently 40 such deals allowing countries to conduct their business in yuan rather than dollars. The yuan is also becoming increasingly visible on the world’s stock exchanges. In London, Zurich and Frankfurt, there are yuan clearing hubs that help make the Chinese currency more easily convertible. Two weeks ago, a new Sino-German exchange was launched in Frankfurt. Investors can trade about 200 yuan products at the CEINEX.

Now that the yuan has been admitted into the IMF currency basket, the era of the US dollar’s exclusivity is coming to an end. About a trillion yuan (147 billion euros) could end up on the bond market as soon as the yuan is activated in the IMF’s currency basket. The demand for the yuan could then rise to over 560 billion euros – although still only a fraction of the approximately 100 trillion dollar bond market worldwide. But, from Beijing’s viewpoint, it has won a round and secured glory for its historic advance into the international world of currencies and exchanges.

Related reports

The US versus China using the Fed’s numbers
How China’s race to reserve currency status will rock markets
The Chinese currency is on track to become more important globally

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