The addition of China's yuan to the select basket of currencies used as a yardstick by the International Monetary Fund is a sign, experts say, that the yuan may one day become as recognizable as the dollar or euro.
Adding the yuan alongside the U.S. dollar, euro, pound and yen is a symbolic victory for Beijing. It reflects the rising importance of the world's second-largest economy and is an endorsement of gradual Chinese moves toward making the currency freely traded.
Currency traders and economists see the change as encouragement to Beijing to make faster progress on promises to make the yuan "freely tradable" and open its financial system.
The IMF added the yuan to the basket of currencies used to calculate the value of special drawing rights, a notional currency used as the standard for dealing with its member governments. That came after IMF staff concluded in a Nov. 13 report that the yuan was "freely usable," meaning widely used for international transactions and widely traded in foreign exchange markets.
Why add the yuan?
China is the world's second-biggest economy and the biggest trader. The yuan is the No. 4 currency for global trade, accounting for about 2.5 per cent of the total, according to SWIFT, the organization for interbank financial transfers. Beijing controls the flow of money into and out of its economy but has encouraged the use of the yuan abroad, especially for trade, which helps Chinese exporters by eliminating the cost and risk of volatile exchange rates. Since 2009, China has signed currency swap agreements with central banks in Britain, Brazil, Canada, Indonesia, South Korea and other countries.
Impact on global finance
Over time, the IMF decision might prompt central banks to hold more reserves in yuan. JPMorgan Chase economist Haibin Zhu said yuan holdings might rise to 5 per cent of global reserves, or about $350-billion (U.S.), over five years. That might encourage more use of yuan for trade and investment. "Longer term, this is a huge step," said Stephen Innes, chief trader for the currency firm OANDA in Singapore.
Impact on China
Economists say the IMF decision could encourage Chinese leaders to further relax controls on the yuan. The ruling Communist Party's latest five-year development plan says the yuan will be "freely tradable and freely usable" by 2020. The surprise August introduction of a new mechanism for setting the government-controlled exchange rate led to a 3.5-per-cent devaluation.Some traders worry Beijing might devalue the currency further once it achieved its goal of being added to the IMF basket. But others say Chinese leaders want to be seen as reliable. The yuan's addition is "an endorsement as an international currency," said Chen Kang, chief bond analyst for SWS Research Co. in Shanghai.
The yuan's government-set exchange rate still follows the U.S. dollar, despite the new mechanism for setting its value. For now, that makes the yuan a dollar in disguise, according to Derek Scissors of the American Enterprise Institute in Washington. Until the yuan is allowed to trade freely, the IMF decision will "increase the dollar's importance," Mr. Scissors said. "Those governments or investors hoping for a dilution of dollar dominance for portfolio diversification or political reasons are getting exactly the opposite."