Currency analyst

Global yuan: a true blessing or a burden for the Celestial Empire?

On 1st of October, the Chinese yuan will join the International Monetary Fund’s basket of elite reserve currencies (commonly known as Special Drawing Rights currency basket).  At first glance, this piece of news may appear insignificant, you may even wonder why Chinese government exuberates over it. Let us explain why.    

The SDR is an international reserve asset, created by the International Monetary Fund in 1969 to supplement its member countries’ official reserves. A basket of the SDR currently includes four major currencies – the US dollar, euro, the Japanese yen, and pound sterling. To join the basket, each currency must meet the criterion of being “a freely usable currency”. In other words, it must be widely traded in the main exchange markets and widely used to make payments for international transactions. China is well-qualified under one of the two criteria: it is a major global exporter of goods and services. But the yuan does not meet the other criterion – it’s not a ‘freely usable’ currency. Despite this missing characteristic, the yuan managed to become an integral part of the IMF’s basket.

Now, when we learnt what lies behind the concept of the SDR currency basket, you may say: “What a cheering piece of news for the People’s Republic of China! Yes, indeed, this country need to be rewarded for the years-long efforts to raise its status in the international financial community”. But what the yuan’s prominence will entail for the Chinese economy? Let’s delve into solving this conundrum.

Actually, the inclusion of yuan in the basket of international currencies offers no privilege to the currency issuer. It bears no tangible benefits for the country. China’s voice in decision-making process of the IMF remains unchanged so far. Therefore, the fact that yuan has become an official reserve currency is just a symbolic victory of China, a sort of recognition of the country’s role in the global economy, and it comes with a string attached to it.

China will have to transform its economy into market-oriented one. It is a subject to less government intervention and broader, more liquid and better-regulated financial markets. China will also need to undertake reforms that engender the trust of foreign investors and make its currency more attractive for investors’ asset portfolios. This includes a more open and transparent government, primacy of the rule of law and an independent central bank. Without them China will never gain the trust of foreign investors. Will the Communist Party of China agree to alter its current political line and introduce a package of political, legal, and institutional reforms? I would doubt it. Therefore, the yuan will unlikely replace the US dollar and other SDR currencies from their leading positions.  


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