Sat, Dec 19, 2015 page8

• Inclusion of yuan in SDR matters

  • By Zhang Jun 張軍
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  The IMF’s recent decision to add the yuan to the basket of currencies that determine the value of its reserve assets, the special drawing rights (SDR), has captured headlines around the world. However, the SDR itself has not exactly dominated discussions — much less transactions — since its creation in 1969. So, does the decision really matter?

  Given the SDR’s very limited role in the global economy, the move would have few concrete effects in the short term. However, in the longer term, the attention the decision has attracted could spur wider use of the SDR. More important, at least for now, the decision amounts to an endorsement by the IMF of the progress China has made toward yuan internationalization, while reflecting — and reinforcing — China’s growing economic clout.

  Since joining the WTO in 2001, China’s GDP has surged from about 20 trillion yuan to 60 trillion yuan (US$3.1 trillion to US$9.3 trillion). In 2009, China became the world’s largest exporter. And last year, according to the IMF, China overtook the US to become the world’s largest economy (in purchasing power parity terms).

  The acknowledgement by the IMF board, which represents all 188 member countries, that the yuan meets “all existing criteria” for inclusion in the SDR basket is another step forward along this path of progress.

  However, it is important to note that meeting “all existing criteria” does not place the yuan on par with, say, the US dollar — or, indeed, with any of the other SDR currencies: the euro, pound sterling or yen — in terms of international usage.

  On the contrary, despite China’s massive GDP and trade volume, the yuan’s share in the global foreign-exchange market remains negligible. And the process of internationalizing the yuan is far from complete.

  Given this, the IMF could easily have rejected the yuan’s bid for inclusion in the SDR basket, as it did five years ago. However, the IMF seemed eager — especially in the past few months — to bring China on board this time around. What brought about the IMF’s change of heart?

  The explanation lies largely in the Aug. 11 devaluation of the yuan, after a decade of appreciation. By moving away from the yuan peg to the US dollar — an undoubtedly risky move — China demonstrated its willingness to allow market forces to establish the exchange rate in the long term.

  Of course, now that the yuan has been accepted into the SDR basket, China must prove that it can manage dramatic currency depreciation effectively and continue to make progress toward internationalization. This will be no easy feat, especially at a time of slowing economic growth.

  A gradual depreciation would create expectations of further exchange rate weakening, thereby fueling capital outflows and undermining companies’ willingness to use the yuan in exports and imports. The yuan offshore market, which has strengthened considerably over the past few years, would lose value, forcing the People’s Bank of China to channel foreign exchange reserves toward that market to offset the decline. Already, China’s reserves have declined considerably — by US$87.2 billion last month alone.

  Despite these challenges, China’s leaders anticipate that, in the longer term, the yuan’s inclusion in the SDR basket would help to bring about the currency’s steady appreciation and, by serving as a kind of certification of credibility, support its continued internationalization.

  They are probably right. Nonetheless, what would really drive the yuan’s continued rise would not be the SDR, even though it will help, but China’s own long-term economic performance. Indeed, as Indian economist Arvind Subramanian has said, China’s share of global GDP and trade is what makes the yuan likely to become a global reserve currency.

  The question is when. According to Subramanian, it could occur as early as 2020.

  Chinese researchers are somewhat less optimistic. Five years ago, Shanghai Jiao Tong University’s Pan Yingli (潘英麗) projected that, without accounting for other currencies’ incumbency advantage, the yuan’s share of foreign exchange reserves worldwide could reach 26 percent by 2025 — about the current level of the euro. Accounting for the incumbency advantage, the share falls to 10 percent. However, even at that level, the yuan could be the world’s third reserve currency, after the dollar and the euro, by 2030.

  In short, the inclusion of the yuan in the SDR basket does matter, and not just symbolically. By demonstrating its confidence in the yuan’s continued rise, the IMF has reinforced global expectations of — and lent implicit support to — the yuan’s progress toward internationalization. Whatever challenges China faces, its steady march to the forefront of the global economy is set to continue.

  Zhang Jun is a professor of economics and director of the China Center for Economic Studies at Fudan University in Shanghai.

  Copyright: Project syndicate
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