Chinese currency included in International Monetary Fund basket

The executive board of the International Monetary Fund on Monday approved including the Chinese yuan in its basket of currencies that it uses as an international reserve asset.

The basket is now made up of the United States dollar, the euro, the British Pound and the Japanese Yen.

In practice, what determines whether central banks are willing to consider a currency a reserve asset is their confidence that they can sell that asset whenever needed into deep and liquid markets.

The addition could provide enough of a boost for China’s currency that the country should be able to limit future moves to prop up its currency – like its August devaluation that rocked global markets.

“What is interesting about the new weightings is that the biggest change is for the euro, which now accounts for 30.9 percent of the basket instead of 37.4 percent”.

The yuan will have a 10.92 percent share, in line with expectations, after a review of the weightings formula for the SDR that also cut the euro’s share by more than 6 percentage points. Worldwide trading in the yuan has been increasing considerably among Asian countries, the Chinese economy has been on track to surpass the U.S.in GDP in the next couple of decades, and Beijing was already moving forward with a crude futures benchmark in its own currency. Under the Bretton Woods system of fixed exchange rates, countries pegged their currencies to the USA dollar.

The yuan’s inclusion will contribute to stability in the global monetary system and is a welcome development, Bank Negara Malaysia Governor Zeti Akhtar Aziz said in Kuala Lumpur. Being included in the SDR should also increase demand for the yuan.

The entry itself into the special drawing right is mainly symbolic.

The yuan has begun to find traction outside of Asia.

Wang Tao, a UBS economist, expects a 5 percent depreciation of the yuan against the USA dollar in 2016 in a gradual rather than one-off manner. “That will encourage China to adopt more measures toward accelerating the process of the opening of its foreign exchange markets and capital markets”. The widely expected move was a milestone in China’s integration into global finances and a nod of approval to the progress the country has made with reforms. During this year’s review, the International Monetary Fund chose to add the yuan.

The senior policy maker, however, warned in the same article against any possible financial attacks or sanctions from overseas in some extreme circumstances.

China has been working towards this for the last few years – and it’s remarkable that their highly managed currency has been deemed fit to enter this special basket of freely traded currencies. Indirectly, it might have a beneficial effect because the Korean economy depends so much on the yuan and this gives more legitimacy to having the Chinese yuan as a reserve currency. Does it go without saying that the change is likely to be deflationary to the yuan?

On Oct. 20, the PBOC extended an agreement on a reciprocal currency swap scheme with the Bank of England to promote London as an offshore RMB center.