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G7 support means yuan closer to becoming international currency
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THE push to make the yuan a more international currency is approaching a symbolic milestone as it sits poised to join the basket of currencies accepted by the International Monetary Fund for lending to financially strapped countries.
The Group of Seven finance ministers in late May agreed to support the inclusion of the yuan in the IMF currency basket used to calculate what are known as special drawing rights, or SDRs. China has only to meet technical criteria for the designation.
SDRs are rarely used. Rather, they are a kind of foreign-exchange reserve representing the internationally recognized status of component currencies, such as the US dollar, yen, pound and euro.
“We were in complete agreement that it is desirable in principle,” German Finance Minister Wolfgang Schaeuble said of yuan inclusion after a May 29 meeting of finance ministers and central bank governors. “Only technical conditions must be examined, but there were no politically divergent views on this.”
As of March 17, 204 billion SDRs had been created and allocated to member nations. That is equivalent to about US$280 billion, or about 2 percent of the total foreign-exchange reserves of 167 countries.
Currencies within the SDR basket must be freely convertible so holders of the rights can exchange them for any usable currency.
Not being a fully convertible currency has held the yuan outside the IMF basket in the past.
The IMF is set to review the composition of SDRs toward the end of this year. Chinese Premier Li Keqiang in March reiterated China’s desire to join the basket to support global financial stability.
It’s hard for anyone to ignore the yuan, though it may not be free-floating. It became the world’s fifth-most used currency in global payments in April, with a market share of 2.07 percent. That’s a rise of nine rankings in the past three years. The yuan is now the most used currency in Asia-Pacific for payments with China’s mainland and Hong Kong, according to SWIFT data.
IMF officials have also welcomed the idea of the yuan in the SDR basket. The issue is when, not if, according to IMF Managing Director Christine Lagarde.
Joining the basket would encourage wider use of the yuan worldwide and perhaps open the door to becoming a component of the foreign-exchange reserves of more IMF members.
Still work to do
Economists take a slightly less euphoric view, pointing out that China still has to ensure that the yuan meets all the criteria before it can actually become part of the SDR basket.
“China has met some standards because it is the world’s largest exporter, and the yuan is already the fifth-biggest currency in the world,” said Kelvin Lau, senior economist of Standard Chartered Bank. “However, in some aspects, such as yuan transactions and bond value offshore, it has not yet reached the level of other SDR currencies such as the pound or yen.”
In joining the SDR, a country needs to open its domestic bond market to central banks so they can invest in yuan-denominated assets and hold the yuan as a reserve currency, he added.
Standard Chartered Bank said the yuan has a 60 percent chance of being accepted into the SDR program within this year, but China will have to accelerate the opening up of its capital account and allow greater outflows of capital.
That means lifting controls on the exchange rate, conversion and cross-border investment — steps that some in China fear will expose the country to financial turbulence.
Chang Fang Tien, head of group treasury at OCBC China, put a question mark on the real benefit of joining the SDR, which has always been an arcane topic because it concerns only central banks, with little relevance to commercial financial systems and real economies.
“Hong Kong and Singapore both have rejected invitations to join the SDR program because they found it necessary to keep part of their capital accounts closed,” Chang noted. “They both avoided financial crises because of those partly closed financial systems. It is impossible for China’s mainland to absolutely open its capital account within this year, and convertibility will be only gradually realized.”
What’s more, China may not necessarily have to join the SDR program to realize its currency ambitions. Many countries, including Britain, Germany, Australia and South Korea, are already using the yuan as part of their foreign-exchange reserves, Chang noted.
The SDR channel ultimately may be a means to press development of more practical issues, such as cross-border capital flow relaxation and domestic reforms to nurture a stronger financial market.
So far this year, progress is being made in those directions.
New yuan clearing banks have been set up in Thailand, Australia and Chile.
“It is clear China is still active in driving yuan internationalization,” said Lau of Standard Chartered.
“In the next few years, we will see internationalization driven not by the yuan’s appreciation but by actual needs, such as corporate trade settlements, diversification of investment portfolios, offshore yuan products and cash management.”
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