International Monetary Fund approves reserve currency status for China's yuan
The inclusion of the yuan in the Special Drawing Rights basket - alongside the US dollar, euro, yen and British pound - could put it under pressure to weaken
The International Monetary Fund has approved the inclusion of the yuan among its Special Drawing Rights currencies at a board meeting in Washington, a move analysts say will put the currency under pressure to weaken.
The yuan, also known as the renminbi, will join the US dollar, euro, Japanese yen and British pound in the basket of currencies the IMF uses as an international reserve asset.
The IMF said on Monday that the yuan “met all existing criteria” to be included as one of the currencies used for the global organisation’s SDR, which is used as the standard for dealing with its 188 member governments.
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The Chinese currency will have a weight of 10.92 percent in the basket. It is lower than the dollar's 41.73 percent and 30.93 percent for the euro but above the Japanese yen's 8.33 percent and British pound's 8.09 percent. The addition will take effect on October 1, 2016.
Currently the weights of the dollar, euro, pound and yen are 41.9 percent, 37.4 percent, 11.3 percent and 9.4 percent respectively.
The move is seen as recognition of China's financial and economic progress after years of reform, though the authorities may take time to deliberate on how to further improve.
IMF chief Christine Lagarde, who along with in-house experts had previously given her support for the inclusion, made it clear she did not expect Beijing to stop there.
“The renminbi's inclusion in the SDR is a clear indication of the reforms that have been implemented and will continue to be implemented,” she told reporters.
The People's Bank of China said the move, which was backed by countries including the United States, Britain and Japan, showed the international community expected China to play a bigger role in the world economy.
“Going forward, China will continue to deepen and accelerate economic reforms and financial opening up, and contribute to promoting world economic growth, safeguarding financial stability and improving global economic governance,” it said in a statement.
The PBOC's vice governor Yi Gang said he expected the inclusion would make the yuan more stable and there was no basis for it to devalue further, as some traders had expected.
"SDR inclusion will be a recognition of how far China has come," said Jonathan Fenby, China managing director at research firm Trusted Sources. "But it remains a question whether China will continue to open up the capital account."
READ MORE: The rise of the renminbi: How adding China's yuan to IMF's SDR basket will spur the currency towards further reform
As its economy slowed, China would be reluctant to bring down capital flow barriers when "households are moving money out", said Fenby, a former editor of the South China Morning Post.
China has been making more changes to its financial system this year - it lifted controls on deposit and lending rates, opened up the interbank bond market to foreign central banks, tweaked the yuan exchange rate formation mechanism to give market forces greater play, and increased its frequency of releasing some of the country's financial data.
All these were done despite its weakening economy and rising financial risks with a clear target of getting the IMF to recognise the yuan as a stable currency.
While joining the SDR would boost foreign holdings of the yuan in the long run, the currency is now under pressure to weaken from a stronger US dollar and gloomy growth prospects.
The central bank also may not be able to intervene as easily in the foreign exchange market in future.
Banks such as Standard Chartered and Bank of America Merrill Lynch expect the yuan to weaken between 2 to 9 per cent next year. Researcher Zhang Ming, with the Chinese Academy of Social Sciences, said the yuan was overvalued and set to weaken. But he predicted "no big yuan fall immediately after the SDR inclusion".
China Merchants Bank analyst Liu Dongliang said the IMF decision would have "no direct relation" to the yuan's value. The currency's global profile would be decided by whether it was easy and cheap to use in payments, he said. "It means China has to open up domestic financial markets and accept international rules."
China would do so cautiously, Zhang said. "China has already [done so much] to get the SDR deal done. It would be unwise to open up while the risks are high."
WHY IS THE YUAN'S INCLUSION IN THE SDR SIGNIFICANT?
The reminbi is the first currency from an emerging market to be added to the SDR.
The yuan will have the third largest weighting in the currency basket, larger than the yen and pound.
The renminbi is the first SDR currency from a not fully open capital market.
Its inclusion is one of the biggest changes in the system since the introduction of the euro in 1999.
Additional reporting by Agence France-Presse, Reuters and Associated Press