It’s a tumultuous time for China, with Beijing reluctant to fully relinquish control of the yuan and its stock markets at the same time as it seeks inclusion for the yuan in the IMF’s exclusive SDR basket. There are clear benefits for China if the yuan is included in the SDR, which already includes the US dollar, yen, euro and British pound, as it would solidify the yuan as a globally traded currency, but China’s extensive capital controls and some doubts about its commitment to reform, as evidenced by a mass rescue of its stock markets, are making the IMF nervous.
It has been reported that the PBoC spent around 900 billion yuan in the last couple of months attempting to stop the sell-off in China’s equity markets, which couldn’t be stopped by the use of conventional monetary policy alone. Nonetheless, investors in China’s heavily leverage retail-dominated market remain very nervous, although rumours this week that Beijing is planning to merge large state-owned enterprises has encouraged bulls to rally.
Will the yuan be included in the SDR?
There are two main criteria to determine whether a currency can be included in the SDR. The currency must be freely tradable and the issuing nation must be a major player in the export market. There’s no doubt that China satisfies the latter – it stands behind Europe and the US but ahead of Japan and the UK in regards to contribution to global exports – but the yuan is not freely tradable by most definitions. The renminbi (RMB) is loosely pegged to the US dollar, there are restrictions on how much residents can take out of the country and it’s hard to get even the limited amount of money allowed into its capital markets.
However, the RMB is widely used in international transactions and its usage is increasing year-by-year. It is being more widely used as a reserve currency as the government opens up its capital markets; it is now ranking around 7th among currencies in use by countries’ official reserve assets. Also, it’s accounting for more of the international debt market and for a significant amount of cross-broader payments, while similarly increasing its usage in the spot market. In fact, it’s hard to see the yuan not being included in the SDR at some point, especially if the PBoC relinquishes its grip on USD/CNY and Beijing continues to open ups its capital markets.
China enters the global currency war… sort of
A global drive towards the US dollar ahead of a tightening cycle in the US is putting immense pressure on the yuan to depreciate in light of some soft economic data and local monetary policy loosening. Yet, USD/CNY remained trapped around 6.2 since March, despite the damage inflicted on China’s massive export market. This is a clear threat to growth and the pressure is on the PBoC to expand the yuan’s trading band, allowing the market to push it higher, or, more likely, weaken the yuan reference rate against the US dollar.
Sure enough the bank succumbed to the pressure on Tuesday, widening the reference rate by 1.9%, which is the most on record. The PBoC also proposed extending the trading hours for foreign exchange and announced plans to converge onshore and offshore yuan exchange rates. The moves are likely in response to aforementioned threats to growth stemming from a soft export sector.
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