Here’s Why China’s Currency Will Be Included in the IMF’s Basket

November 16, 2015, 2:44 PM UTC
The Davos World Economic Forum 2015
Christine Lagarde, managing director of the International Monetary Fund (IMF), listens to a speaker during a session on the final day of the World Economic Forum (WEF) in Davos, Switzerland, on Saturday, Jan. 24, 2015. World leaders, influential executives, bankers and policy makers attend the 45th annual meeting of the World Economic Forum in Davos from Jan. 21-24. Photographer: Simon Dawson/Bloomberg via Getty Images
Photograph by Simon Dawson — Bloomberg via Getty Images

China finally got the news it has been lobbying for: its currency, the renminbi, is set to be included in the International Monetary Fund’s basket of top currencies alongside the world’s reserve currency, the U.S. dollar, as well as the Euro, British pound, and Japanese Yen.

It’s a win for China, which has lobbied for the past two years to be included in the club of countries whose currencies make up the ‘Special Drawing Right’. The SDR’s only practical purpose is that it’s the currency in which the IMF and other multilateral lenders draw up their accounts. But symbolically, it has always represented the balance of power in global financial markets.

As such, China’s inclusion significantly bolsters its prestige in the financial world: not because it forces people to hold the renminbi, but because it shows how far China is now dictating the rules of the game: since the collapse of the Bretton Woods agreement in 1973, the SDR has only ever included ‘freely usable’ currencies. The renminbi is still far from a ‘freely usable’ currency—as any trader or visitor to China who has trouble accessing the currency from abroad will tell you —but it has been liberalized enough to allow the IMF to yield to China’s pressure while saving some face.

In the past year, China has enacted reforms that included loosening the central bank’s strict management of the exchange rate, allowing foreign central banks unlimited investment in the domestic bond market, and establishing a market for three-month government bills (a technicality for IMF inclusion).

The inclusion affords China’s government under Xi Jinping, which has struggled to meet GDP growth targets amid an industrial recession, some diplomatic and political prestige. However, the only tangible benefit analysts can point to is that the renminbi’s inclusion in SDR will encourage more foreign investors over time to hold the currency because foreign central banks and even some private investors can now more easily access China’s bond market that was opened as a result of the reforms preceding the SDR inclusion.

Says Chen Long of Gavekal Dragonomics in Beijing: “Granting the renminbi the status of a “global reserve currency” could indeed encourage more central banks and other asset managers to take a look at China’s financial markets, especially the onshore bond market. But it would be wrong to think that central banks will be forced to buy substantial amounts of renminbi assets just because the currency is included in the SDR basket.”

Most analysts agree that the People’s Bank of China could use some help for its currency in the form of strong, stable, foreign demand, now that lower growth and returns at home are driving more private capital abroad.

Since this summer’s “devaluation,” when the yuan fell by 1.8% in one day in response to the loosening of exchange rate rules, it’s been the Chinese central bank itself that has spent tens of billions shoring up the currency–something that gives lie to previous accusations of a fresh attempt to boost the economy through the export channel.

Analysts including Long have argued the move was important not because of the “size of the depreciation”, but rather because the central bank was no longer fixing the trading price of the yuan on its own, instead using a range based upon the previous day’s close.