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Currency markets wait to see whether yuan joins the SDR basket

Discussion in 'Fundamental Analysis' started by FXStreet_Team, Nov 5, 2015.

  1. FXStreet_Team

    FXStreet_Team Well-Known Member Trader

    Oct 7, 2015
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    FXStreet (Mumbai) - The International Monetary Fund (IMF) policy makers are set to meet in November to review whether or not to include the Chinese yuan in the Fund's reserve currency basket. The Chinese government has been lobbying hard to secure a place for the yuan in the Special Drawing Rights basket to raise the global acceptability of the yuan so that more and more countries add yuan to their reserves. Also, Beijing wants to reduce the dependence of yuan on dollar. In its effort to secure yuan’s place in the SDR basket, the Chinese government has introduced significant reforms in its foreign exchange market. China's deputy central bank governor, Yi Gang has assured trading partners that the efforts to make the currency more flexible will continue.

    What are the chances of the yuan being accepted in the SDR basket?

    There are two broad criteria that determine whether a currency can be part of the SDR. One of the criteria is that the issuing country has to be a major exporter. China passes this test with flying colours. In the last five years its exports accounted for 11 per cent of the global total.

    However, it is the second criteria that experts feel China will not be able to meet. For a currency to be able to be added in the SDR basket it must be freely usable. China’s currency is not freely convertible as it places caps on the following: a) how much cash its residents can take out of the country; b) forces international companies to do extensive paperwork before bringing large sums in; and c) limits foreigners to strict quotas for investing in its capital markets. Thus with respect to convertibility China may not make the mark. An IMF staff mentioned that the yuan is yet to meet operational requirements thereby allowing IMF members to use yuan-denominated instruments to manage reserve holdings and hedge risks.

    The deputy central bank governor told the IMF that steps are being taken to improve the transparency of Chinese data, develop representative foreign exchange and interest rates as well as open interbank markets to address operational concerns.

    How will its inclusion in SDR basket impact the yuan?

    If the IMF decides in favour of including the yuan in the SDR basket despite China’s extensive capital controls, it will pronounce big victory for the PBOC which can then prove that opening up the economy has its own advantages.

    The inclusion, if at all, will help to strengthen the yuan’s global profile and reduce its dependence on the dollar. It will not overnight enhance its position to the level of the USD but will definitely go a long way in boosting its international standing. More countries will then be onfident to add the yuan to their currency reserves. The acceptability will increase with more countries using the currency in trading activities.

    What if the IMF decides against adding the yuan in the SDR basket?

    Depreciation pressure might be further added in case the yuan does not get added in the SDR basket. In the process Beijing's attempts to hold the currency stable without draining its foreign exchange reserves will get further complicated. Also, if the IMF responds in the negative the yuan’s inclusion in the SDR basket will be postponed to 2020 as the SDR’s composition is reviewed only once in 5 years.
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