Beijing is on the right path with currency management

PUBLISHED : Sunday, 31 May, 2015, 4:03am
UPDATED : Monday, 27 June, 2016, 11:50am

Many economists and critics in the US Congress may remain unconvinced that the mainland no longer enjoys an unfair trade advantage, but the International Monetary Fund has just turned down the heat on China by reversing long-standing criticism of its currency management. The IMF's finding that the yuan is no longer undervalued is an endorsement of Beijing's policies that may cool a major friction point with Washington.

The agency said significant currency appreciation over the last year had brought the yuan up to fair value for the first time in more than a decade, during which undervaluation was a major factor in international imbalances.

Beijing can now be expected to reaffirm its strong wish to be included in the IMF's Special Drawing Rights basket of currencies in its October review, alongside the US dollar, the yen, the euro and pound sterling. This would bring recognition as an official international reserve currency. It could strike political opposition from the US, the major stakeholder in the IMF, and economic policy obstacles, but the agency agrees it is only a matter of time.

To pave the way it has called on Beijing to make the exchange rate more flexible and to quicken reforms in the dominant state sector of the economy. It emphasised that China would need to continue to allow its currency to reflect fundamentals - for example, by appreciating in line with productivity growth.

That said, China has been making great strides. It has advanced the currency's internationalisation, with HSBC estimating that yuan trade settlement might rise from a fifth to half of China's total trade by 2020. It has also completed a number of currency swap arrangements with trade partners to underpin stability, and has quickened the pace of reform and liberalisation, for example through the Shanghai-Hong Kong stock connect share trading scheme.

Inclusion of China's A shares in the closely followed MSCI index, considered a near certainty by next year given the pace of market liberalisation, will spark a sustained flood of foreign capital into the country's tightly controlled capital markets, creating further pressure on capital controls.

Beijing is on the right track with currency liberalisation. It must push ahead. A free-floating currency on an open capital account will enhance China's financial power.