Yuan Trades Higher Offshore as IMF Approves a Reserve Currency

(Bloomberg) -- The Chinese yuan traded higher offshore as the International Monetary Fund decided to include it in a basket of reserve currencies, a move that will integrate the country into to a global financial system dominated for decades by the U.S., Europe and Japan.

The yuan held a gain of about 0.4 percent, trading at 6.4243 per dollar as of 3:54 p.m. in New York after the IMF’s executive board voted to add it to the Special Drawing Rights, which currently includes the dollar, euro, pound and yen. Prior to the announcement, the yuan, known as renminbi or RMB, reversed losses amid speculation that Chinese banks sold the dollar to support the yuan.

The inclusion of the yuan, which will take effect Oct. 1, 2016, is the first change in the SDR’s currency composition since 1999, when the euro replaced the Deutsche mark and the French franc. It is a “recognition of the progress that the Chinese authorities have made in the past years in reforming China’s monetary and financial systems,” IMF Managing Director Christine Lagarde said Monday.

“It is a bigger political move than economic move,” Danny Blanchflower, professor of Economics at Dartmouth College and former member of the Bank of England’s Monetary Policy Committee, said on Bloomberg Television. “It is an acceptance of economic reality: China has become more important in world trade.”

Bretton Woods

The SDR, created in 1969 following the collapse of the Bretton Woods system of fixed exchange-rates, gives IMF member countries who hold it the right to obtain any of the currencies in the basket.

Currently, IMF members hold about 204 billion SDRs, equivalent to $285 billion, according to the Washington-based organization. That is only a fraction of $11.3 trillion in global reserves.

The fund said the yuan would have a 10.92 percent weighting in the basket, the third largest following the dollar’s 41.73 percent and the euro’s 30.93 percent. The yen has a weighting of 8.33 percent and the pound 8.09 percent.

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. By Barclays Plc’s estimate, the SDR inclusion could increase the demand for the yuan from global central banks by as much as $300 billion by 2020.

Small Impact

The decision “may spur central banks to purchase more RMB- denominated assets for their portfolios,” analysts led by David Fernandez at Barclays wrote in a note. “However, we think the direct impact of RMB inclusion on reserve managers’ holdings will be relatively small in the short term.”

The People’s Bank of China has burned through $126 billion in foreign reserves to offset capital outflows and stabilize the yuan since August when it revamped its currency regime, aiming to give the market more sway in determining the exchange rate.

More Liberalization

Now that China has been awarded SDR status, the government is more likely to reduce its intervention, according to Barclays. The analysts expect the yuan to weaken to 6.8 per dollar by mid-2016. That is more bearish than the median forecast of analysts surveyed by Bloomberg, which is for the yuan to trade at 6.5 per dollar by June 2016.

The IMF decision establishes the yuan as a fixture in the very international monetary system that Chinese leaders criticized following the global financial crisis. In a landmark 2009 speech, People’s Bank of China Governor Zhou Xiaochuan argued that a global system so reliant on a single currency -- the U.S. dollar -- was inherently prone to shocks.

Zhou and his reformist allies have used the SDR inclusion, which requires the currency to be “freely usable,” to lobby the Chinese political leaders to open up and liberalize the country’s capital markets. Last week, the PBOC granted foreign central banks, including those in Hong Kong, Australia and Hungary, access to China’s interbank foreign-exchange market for the first time.

“The important aspect about this inclusion is the signaling effect that the yuan is now one of the global reserve currencies,” said Jorge Mariscal, the chief investment officer of emerging markets at UBS Wealth Management, which oversees about $1 trillion, said by phone on Monday. “For that to happen, the yuan needs to be more convertible. Hopefully this would be an incentive for the Chinese government to continue on that path.”

--With assistance from Tian Chen, Fion Li and Andrew Mayeda.

To contact the reporters on this story: Ye Xie in New York at yxie6@bloomberg.net; Bonnie Cao in New York at bcao4@bloomberg.net To contact the editors responsible for this story: Nikolaj Gammeltoft at ngammeltoft@bloomberg.net; James Regan at jregan19@bloomberg.net Richard Richtmyer