Central bankers unlikely to beat a path to yuan’s door after IMF decision
The decision of the International Monetary Fund (IMF) to make the yuan a 10.92 per cent constituent of the Special Drawing Right underscores the yuan’s global credibility but should not trigger a mad rush from the world’s reserve managers to buy the Chinese currency.
Those who manage central banks’ currency reserves are not in the habit of making snap decisions.
There is no doubt, as London-based SLJ Macro put it on November 9, that “the SDR decision would lend credibility [to the yuan] as a reserve currency; it would be a certification, an endorsement, and a validation for the rising (and its future potential) international status.”
But that does not mean, especially with the operational date for the inclusion of the yuan in the SDR is not slated until Oct 1, 2016, that the Chinese currency should automatically move higher in value in the immediate aftermath of the IMF decision.
Japan’s BTMU calculates that for the yuan to eventually make up 10 per cent of global foreign exchange reserves, it would mean some US$1.25 trillion equivalent of yuan would have to be bought.
Yet although the Japanese bank is persuaded that the demand for yuan will be there, it argues that the pace of the move will occur more slowly than perhaps many market participants expect.
Noting a 2012 IMF survey of central bank reserve managers, BTMU said that in actual reserve management, the No 1 “criterion given by managers as a reason to hold a currency was the depth and liquidity of that currency’s assets (primarily bonds in the case of central banks).”
“The irony in [the yuan’s] SDR entry at this time is that Chinese official interference in asset markets has probably been the most extensive since the Global Financial Crisis,” BTMU added, arguing that “there is rarely a time when [Chinese] officialdom doesn’t seem to have a direct preference on the pace and direction of capital flows.”
A perception that Beijing cannot resist “guiding” markets might arguably make reserve managers think twice before reallocating too many reserves into yuan-denominated assets.
After all, global diversification of foreign exchange reserves in recent years, perhaps most notable in demand for the Australian and Canadian dollar, owes nothing to SDR membership and almost everything to the perceived stability and transparency in those two countries’ asset markets.
Others actually see the yuan falling in value in coming months.
ING forecasts China’s currency falling in value against the dollar in early 2016, despite the IMF’s SDR decision, and expects there to be 6.55 yuan to the greenback by the end of June.
Given that the IMF is on record as stating the yuan is “no longer undervalued”, ING concludes that “henceforth, if the [dollar] appreciates significantly against most currencies, it will appreciate against the [yuan].”
There is also the fact that while the yuan’s SDR entry could support the argument for a stronger yuan, there is also the great likelihood that others may wish to send money out of China.
“Considering the changes in the trade and current account balances, and the changes in China’s official reserves, we believe the net capital outflows China suffered since last summer have been around US$600-800 billion,” SLJ Macro wrote on Nov 25.
“If we are right on the nature of the capital outflows that began last summer, it would be very difficult and inappropriate for China to stop these outflows,” SLJ says, concluding “that the medium-term risks are biased to the downside for the [yuan].”
Potential reserve manager purchasers of yuan might also reasonably conclude that the macroeconomic situation lends itself to a weaker, not stronger, yuan at the current time, notwithstanding the currency’s entry into the select club of currencies that comprise the SDR’s constituents.
As China seeks to rebalance its economy towards a domestic consumption-led model rather than an export-driven one, wages must necessarily rise if the disposable income is to be generated that will underpin the desired increase in consumption.
But if productivity fails to increase commensurately, then manufacturing in China becomes a more expensive proposition.
A weaker yuan would potentially alleviate that problem, with the hope productivity would pick up, by making exports cheaper and encouraging the substitution of locally made products, where possible, for what would now be more expensive imports.
All in all, the world’s central banks might well conclude there’s no rush to buy more yuan for their reserves, despite the currency’s admission into the SDR.