Yuan convertibility is vital for reform

PUBLISHED : Saturday, 25 July, 2015, 12:59am
UPDATED : Saturday, 25 July, 2015, 12:59am

It is 10 years this month since a landmark in the long and winding road towards full convertibility of the Chinese currency - the depegging of the yuan from the US dollar and the adoption of a managed floating exchange rate that remains in effect today. That may sound a painfully slow pace of reform, but globalisation of the economy is gathering momentum through incremental liberalisation of trade, investment and now finance.

Barring a setback like another financial crisis, internationalisation of the currency can be expected to accelerate, with a widening of the trading band and more transparency to allow the exchange rate increasingly to be influenced by market forces. Hong Kong has been at the forefront of reform, notably as a centre for settlement of cross-border trade in yuan and through the Shanghai-Hong Kong stock connect scheme, with a link to Shenzhen expected soon.

The 10th anniversary could be capped by inclusion of the yuan in the IMF's Special Drawing Rights (SDR) basket of currencies in a review at the end of the year, making it an anchor of global trade, investment and finance and helping to establish it as one of the world's reserve currency pillars. This would be welcomed by a number of big central banks forced to exclude large and increasing yuan deposits from their official reserves because of Beijing's capital controls. Inclusion in the SDR basket would also strengthen Beijing's case for a bigger say in world financial affairs through the IMF.

China raised questions about its reform credentials by intervening in the stock market earlier this month to prevent a meltdown, prompting foreign investors to continue selling shares. Beijing has since sought to reassure them that intervention was aimed at maintaining financial stability. It is also good to see Beijing send a positive reform signal by relaxing limits for some long-term foreign investors in its interbank market, and to learn that China has decided to report data on its official reserves assets such as gold and external debt position according to an internationally accepted standard. This means new and timelier disclosures and is an important step to increasing participation in global economic cooperation. Beijing needs to be seen to maintain the momentum of reform and not maintain more controls than necessary for stability. Internationalisation of the yuan, tipped to be made fully convertible in the next few years, is vital to reform of China's domestic economy and financial system.