Big steps ahead for yuan internationalisation
Winning the International Monetary Fund's approval for the inclusion of the Chinese yuan into its into its Special Drawing Rights (SDR) basket is just the first step to internationalise the currency. Yet, the authorities need to do more, to ensure that yu
"The inclusion of the yuan in the SDR basket was a tectonic change, but the big task facing the Chinese authorities is to convince the private sector to hold yuan for reasons other than trade facilitation," said Standard & Poor's Asia-Pacific chief economist Paul Gruenwald.
The rating agency pointed out that the yuan is largely a trade currency, with minimal private holdings for store-of-value reasons. Liquidity is guaranteed for official sector trades under the People's Bank of China's bilateral swap agreements with various central banks. No such guarantees exist for the private sector, which is therefore at the mercy of any market interventions by the authorities. If markets trust the PBOC, then this is not a serious issue.
"The Chinese authorities have received a shot in the arm and an important vote of confidence from the IMF. But private markets are a whole, new challenge: they have a lot of convincing to do," said Gruenwald.
The rating agency today published an article titled "IMF Inclusion Of The Chinese Yuan In The SDR Basket Is A Momentous Non-Event".
Effective October 1, 2016, the yuan will join the US dollar, the euro, the British pound, and the Japanese yen in the SDR basket. The IMF announced yesterday that the yuan will have a 10.9 per cent weight. The dollar retains much of its original weight at 41.73 per cent, while the euro would come in at 30.93 per cent, down from 37.4 per cent previously. At this point, one should not be overly concerned what the starting weight is for yuan, as it is subject to review every 5 years.
As part of its review, the IMF Board implemented a new formula for SDR weights, increasing the importance of financial variables, where China is relatively weak; its strengths are the size of GDP and the share of global trade. The US dollar, in contrast, is relatively strong in financial variables given its global reserve currency status.
The inclusion of the yuan is the first major change to the SDR basket composition since 1980 when the basket size was reduced from 16 to 5 currencies (which was later reduced to the current four in 1999, when the euro replaced the Deutsche mark and the French franc).
