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Here’s Why the IMF Just Gave a Boost to China’s Yuan

November 30, 2015

The Davos World Economic Forum 2015The Davos World Economic Forum 2015
Your move, Angela...Photograph by Simon Dawson — Bloomberg via Getty Images

The International Monetary Fund on Monday, as expected, admitted China’s yuan into its benchmark currency basket in a victory for Beijing’s campaign for recognition as a global economic power.

The IMF executive board’s decision to add the yuan, also known as the renminbi, to the Special Drawing Rights (SDR) basket alongside the dollar, euro, pound sterling and yen, is an important milestone in China’s integration into the global financial system and a nod to the progress it has made with reforms.

To meet the IMF’s criteria, Beijing has undertaken a flurry of reforms in recent months, including better access for foreigners to Chinese currency markets, more frequent debt issuance and expanded yuan trading hours.

IMF chief Christine Lagarde, who along with in-house experts has previously backed the move, made it clear she did not expect Beijing to stop there.

“The continuation and deepening of these efforts will bring about a more robust international monetary and financial system, which in turn will support the growth and stability of China and the global economy,” she said in a statement.

The currency will have a 10.92% share, in line with expectations, after a review of the weightings formula for the SDR, which determines which currencies countries can receive as part of IMF loans.

The yuan’s inclusion is a largely symbolic move, with few immediate implications for financial markets. But it is the first time an additional currency has been added to the SDR basket and the biggest change in its composition in 35 years.

Last set in 2010, the basket is currently 41.9% dollar, 37.4% euro, 11.3% sterling and 9.4% yen. The yuan would not join until October 2016, allowing reserve managers time to prepare.

Under the new formula, the euro’s share will drop to 30.93%. Sterling and yen will also have lower weights while the dollar remains about the same.

To be included in the SDR basket, the yuan had to meet the criteria to be “freely usable,” or widely used to make international payments and widely traded in foreign exchange markets — a yardstick it missed at the last review in 2010.

The addition is likely to fuel demand for China’s currency and for renminbi-denominated assets as central banks and foreign fund managers adjust their portfolios to reflect the yuan’s new status.

Currency analysts estimate the IMF seal of approval could fuel demand worth more than $500 billion in coming years and take the yuan’s share of global reserve holdings to around 5%, overtaking the Canadian and Australian dollars.

“I’m very excited about the yuan joining the SDR basket,” said Chapdelaine Foreign Exchange Managing Director Douglas Borthwick.

“I think that it’s going to be very beneficial to the Chinese financial system as they develop a short-term treasury market to really accommodate reserve managers and their holdings of the yuan. So I think it’s all positives.”

In a factsheet accompanying the decision, the IMF said that since Chinese interest rates were higher than those of other currencies, it was likely that the SDR interest rate would rise as a result of the yuan’s inclusion.