The IMF will add the yuan to its basket of reserve currencies, an international stamp of approval of the strides China has made integrating into a global economic system dominated for decades by the U.S., Europe, and Japan.
The International Monetary Fund's (IMF's) executive board, which represents the fund's 188 member nations, decided the yuan meets the standard of being "freely usable" and will join the dollar, euro, pound, and yen in its Special Drawing Rights (SDR) basket, the organization said Monday in a statement. Approval was expected after IMF Managing Director Christine Lagarde announced Nov. 13 that her staff recommended inclusion, a position she supported.
It's the first change in the SDR's currency composition since 1999, when the euro replaced the deutsche mark and French franc. It's also a milestone in a decades-long ascent toward international credibility for the yuan, which was created after World War II and for years could be used only domestically in the Communist-controlled nation. The IMF reviews the composition of the basket every five years and rejected the yuan during the last review, in 2010, saying it didn't meet the necessary criteria.
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The decision is a "recognition of the progress that the Chinese authorities have made in the past years in reforming China's monetary and financial systems," Lagarde said Monday. "The continuation and deepening of these efforts will bring about a more robust international monetary and financial system, which in turn will support the growth and stability of China and the global economy."
The addition will take effect Oct. 1, 2016, the IMF said. The fund said the yuan would have a 10.92 percent weighting in the basket. Weightings will be 41.73 percent for the dollar, 30.93 percent for the euro, 8.33 percent for the yen, and 8.09 percent for the British pound. The dollar currently accounts for 41.9 percent of the basket, while the euro accounts for 37.4 percent, the pound 11.3 percent and the yen 9.4 percent.
In a preliminary report in July, IMF staff estimated that the yuan would have a weight of about 14 percent to 16 percent. The weighting will affect the interest countries pay when they borrow from the IMF. It may also affect the scale of in-flows that the Chinese currency receives in the coming months.
Yuan a Fixture in International Monetary System
The decision establishes the yuan as a fixture in the very international monetary system Chinese leaders criticized following the global financial crisis. In a landmark 2009 speech, People's Bank of China (PBOC) Governor Zhou Xiaochuan argued that a global system so reliant on a single currency—the U.S. dollar—was inherently prone to shocks. That conviction set off a global push by China's leaders, including now-President Xi Jinping, to have the yuan included in the SDR, which countries can use to supplement their currency reserves.
The IMF endorsement is a bright spot in what has been a tumultuous year for the world's second-biggest economy, which has been buffeted by slowing growth, a tumbling stock market, and a shift by authorities toward a more market-oriented exchange rate.
Approval is unlikely to have much impact on short-term demand for the yuan, given the SDR's minor share of global reserves, according to economists at banks including HSBC Holdings Plc and ING Groep NV. But the backing of the IMF, as well as the financial reforms required for China to secure and maintain it, could propel use of the yuan past the pound and yen over the medium term, said Viraj Patel, a currency strategist at ING Bank in London.
"We're going to see sort of the emergence of a renminbi trading bloc" mostly composed of Asian countries, Patel said in a phone interview before the decision, using the official name which means "the people's currency" in Mandarin.
Yuan in SDR Should Lead to Further Opening of Chinese Financial Markets
The decision should boost efforts by Xi to open up China's financial markets. China implemented a series of reforms to win IMF support, such as opening its on-shore bond and currency markets to foreign central banks and reporting its reserves to the IMF.
The question is whether China, which will host meetings of the Group of 20 economies next year, will try to leverage the IMF's support to pursue broader changes to the global monetary system. In his 2009 speech, Zhou suggested the IMF expand the use of the SDR to tap its potential as a "super-sovereign reserve currency."
The Washington-based fund created the SDR in 1969 to boost global liquidity. Under the Bretton Woods system of fixed exchange rates, countries pegged their currencies to the U.S. dollar. But for nations to increase their dollar reserves, the U.S. would have to run persistent current-account deficits, threatening the value of the greenback.
The SDR addressed this dilemma by serving as a supplementary reserve asset to augment countries' gold and dollar holdings. While the SDR isn't technically a currency, it gives IMF member countries who hold it the right to obtain any of the currencies in the basket to meet balance-of-payments needs.
–With assistance from Kasia Klimasinska.
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