A drive to include China's renminbi in the International Monetary Fund's Special Drawing Rights basket for global reserve currencies has been thrown into disarray following the rout in Chinese equities that erased 25% from the Shanghai Composite Index in a matter of weeks. If, as many now expect, the government is forced to intervene in the currency as a defence against the weakening effects of contagion from the stock market rout, it will hand ammunition to those hoping to slow the march of the renminbi towards SDR inclusion.
"The probability of yuan inclusion has significantly fallen over the past three weeks since the stock market peaked," said David Woo, head of rates and currencies strategy at Bank of America Merrill Lynch. "The government is increasing their control of the economy and that is likely to extend to the currency. That is the opposite of what the US and IMF want to see in terms of liberalising the currency, and gives them the opportunity to make the case that China still does not fit the criteria for SDR inclusion."
Inclusion into a basket currently comprising the US dollar, sterling, the Japanese yen, and the euro, would bring legitimacy to the renminbi, which has long been perceived as being manipulated by Chinese authorities. The SDR is a virtual currency that reflects the value of IMF reserves. It represents the rate at which the IMF makes loans to distressed countries and acts as a supplement to the existing reserves of member countries. If the renminbi joins the basket, it would be the first emerging market currency to do so and would raise China's influence at the IMF in the process. Reserve Missing out on the five-yearly SDR review would be a painful blow to the Chinese government, which has made a host of concessions to global demands for a loosened grip on its currency with the stated goal of establishing it as a global reserve currency.
The renminbi was considered for inclusion in the exclusive basket in 2010, the last time the IMF ran a formal review of the programme. "My concern is that this distracts them from following through on capital account inter-nationalisation measures." The IMF announced a comprehensive review of the yuan in April and dispatched a team to China in June to have technical discussions with the government. It is expected to conclude by year's end.
China has agreed to limit interventions in the foreign exchange markets only to periods of extreme volatility, and to allow visibility into interventions close to real-time - concessions that US Treasury Secretary Jack Lew lauded on Wednesday during a panel discussion at the Brookings Institute. "I don't think it's the moment to declare victory but through 10 years of dialogue with China on this subject, over the last few years we've seen substantial change," said Lew. "They were on a path to making [the required] reforms as recently as two weeks ago."
PROMISES But with the government continuing to implement a raft of unprecedented measures such as halting trading on more than half of Chinese stocks, implementing billions of dollars of stimulus, cutting rates to a record low, and ordering state-run funds to buy stocks, analysts wonder whether it will follow through on promises to minimise currency intervention. The government will also have to overcome the destabilisation brought on by the equity rout and implement more liberalisation reforms quickly if it is going to be accepted by the time the IMF conducts its formal SDR review this autumn.
"My concern is that this distracts them from following through on capital account internationalisation measures," said Mirza Baig, head of Asia currency strategy at BNP Paribas. Among other remaining questions, the IMF has expressed a desire to ensure the renminbi's convertibility and there are questions around whether to use the onshore or offshore renminbi, each of which have prospective pitfalls. The offshore renminbi is "freely usable", or convertible, but does not have a developed reference interest rate - the CNH Hibor fixing was only launched in 2013.
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