The IMF's decision on the yuan is a victory for China -- and a challenge

Nov. 30, 2015 7:50 PM PT

Reporting from Washington and Beijing — The International Monetary Fund’s decision to add the Chinese yuan to its basket of elite global currencies gives China a significant boost -- as well as increased pressures -- as it seeks to expand its international influence and rival the global economic order long dominated by the American dollar.

No one expects the Chinese currency to seriously challenge the dollar’s international preeminence for years to come; little will change in practical terms any time soon as a result of the IMF decision announced Monday. But by including the yuan in the basket of currencies that make up its so-called Special Drawing Rights – now composed of the dollar, euro, pound and yen – the IMF essentially endorsed the yuan as a currency that is stable enough and widely enough accepted to be a haven for assets. The IMF, the international lender of last resort, in fact gave the yuan greater weight than the yen or the pound.

That is powerful symbolism and represents a major victory for China, which has eagerly sought reserve currency status for the yuan. Five years ago, China lost a bid to be added to the IMF’s reserve currency basket. China is the world’s second-largest economy after the U.S. and in recent years has sought to spread the yuan’s use by capitalizing on its extensive trading relations around the world.

“This is something they wanted as a signal of their ascendancy and acceptance as a global player,” said Oded Shenkar, a China economy specialist at Ohio State University.

But with the IMF’s seal of approval, Beijing now faces pressure to continue, if not accelerate, efforts to liberalize its currency and broader financial and capital markets.

“This status comes with a certain set of burdens,” said Damien Ma, a fellow at the Paulson Institute, a Chicago-based think tank on U.S.-China relations. “Now that they’re in, their choices are limited.”

If China fails to meet expectations on transparency and financial reforms, Beijing could risk losing credibility or even its place in the IMF currency basket, Ma said.

Chinese officials have pursued the IMF status to a degree that may outweigh the practical benefits to their economy, some analysts noted. The Special Drawing Rights are not a currency, but a kind of accounting unit that the IMF uses. The value of an SDR is based on the basket of currencies, so Monday’s announcement means that as of next fall, when the decision takes effect, the yuan’s value will be included in those calculations.

In practical terms, other countries’ central banks may now be more likely to hold some of their own reserves in yuan, much as they currently hold dollars or euros. How much they will choose to hold remains to be seen.

But in China, the SDR status has taken on greater symbolic meaning.

“I think there is a fascination in China with the reserve status of the dollar, just like there was in France in the 1950s and 60s,” said Patrick Chovanec, chief strategist at Silvercrest Asset Management and former professor at Tsinghua University’s School of Economics and Management in Beijing. “There’s a mindset that the dollar somehow enjoys this unique status that gives the US immense economic and financial power, and if China could only replicate that, China would enjoy similar kinds of power.”

“I think that’s wrong,” he added. “The dollar’s status is actually a reflection of the status that the U.S. has in the world economy, which has advantages and disadvantages.”

But despite the limited practical impact, the jubilant reaction in China’s state media made clear that the government regarded the IMF’s seal of approval as a significant victory.

The announcement “has won widespread applause,” the state-run China Daily newspaper wrote Tuesday morning.

The decision “will increase the representativeness and attractiveness of the SDR and help improve the current international monetary system, which will benefit both China and the rest of the world,” the People’s Bank of China, China’s central bank, said in a statement, according to the newspaper. “It also means that the international community expects China to play a bigger role in the international economic and financial system,” it continued.

The IMF’s move is “strategically important on the macro and political level,” said a commentary on the state-run news website China.com.cn. The commentary added that the move would bring “visible benefits” to ordinary Chinese people.

And despite the Chinese government’s still-strong grip on the country’s economy and recent criticisms of its bungled management of a stock market bubble and abrupt currency devaluation this summer, the IMF decision amounts to a big vote of confidence in China’s reform efforts. It provides a boost in prestige for the current government under President Xi Jinping.

The IMF’s managing director, Christine Lagarde, called the board’s action “an important milestone in the integration of the Chinese economy into the global financial system.” She added that it is a “recognition of the progress” in financial reforms made by Chinese authorities.

The move also represents another large step for Beijing as its rising power challenges the American-led financial system that has held sway since the end of World War II. Earlier this spring, in another sign of China’s ascendance, many of the world’s leading economies, with the notable exception of the U.S. and Japan, announced their participation in a China-led infrastructure investment bank that some analysts viewed as a rival to the IMF and the World Bank.

The U.S., lobbied behind the scenes in an unsuccessful effort to persuade allies against taking part in that infrastructure bank. But as the IMF’s largest shareholder, it supported the fund’s decision on the yuan.

China opened its doors to foreign investments in the late 1970s, and its trade of goods took off after it joined the World Trade Organization in 2001, along the way surpassing Japan as the world’s number-two economy. Beijing has slowly relaxed controls over the value of its currency and its capital accounts, but the government still places restrictions on what investments can come in and go out as well as on the currency’s value.

In 2005, China lifted the yuan’s decade-old peg to the dollar, and this summer, Beijing made another significant adjustment, moving away from setting the daily exchange rate at will to using the yuan’s closing value from the previous day’s trading session as a mid-point exchange rate.

That policy change and the devaluation of the yuan that followed initially jarred global markets. But it allowed Beijing to meet one of the IMF’s requirements for adding the yuan to its currency basket – that the currency be freely tradable. The IMF’s other criterion for including a currency in the Special Drawing Rights basket – that it must be issued by a major exporter, was a condition that Beijing easily met.

For many years and even today, American politicians and businesses have argued that Beijing has deliberately kept the yuan’s value low to gain an advantage in trade. Some have pressed for economic sanctions against China for allegedly manipulating its currency. But the yuan has strengthened significantly against the dollar in recent years and some economists have argued that it was, if anything, over-valued earlier this year.

The yuan could weaken in the near term if the Chinese currency is allowed to more accurately reflect the relative state of major economies. The Chinese economy has slowed notably in the last year as it transitions from investment-led and export growth to expansion driven more by domestic consumption and services. Meanwhile, the U.S. has maintained fairly steady growth, leading to a sharp appreciation of the dollar against other major currencies.

Lee reported from Washington and Kaiman from Beijing.

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