Nobel laureate Robert Mundell once said: “Great powers have great currencies.” China, whose government Mundell long advised, seemed to take this notion to heart, prodding the IMF for years to add the yuan to the basket of currencies that determine the value of the IMF’s reserve assets, the special drawing rights (SDR). And now the IMF has decided to do just that, in what amounts to a huge vote of confidence in China’s capacity to play a major role in international finance.
However, many market participants remain skeptical about the decision. Does the yuan really belong in the same category as the US dollar, the euro, the yen and the pound sterling in the international monetary system?
No doubt, China has made remarkable progress over a relatively short period. Since 2009, the share of China’s trade settled in yuan has increased from less than 1 percent to more than 20 percent. And the yuan now ranks fourth among the world’s currencies used for international payments.
However, the yuan’s 3 percent share in global payments lags far behind that of the dollar (45 percent) and the euro (27 percent). Moreover, growth in the use of the yuan to settle trade has been concentrated largely in the Asia-Pacific region, and specifically in transactions between China and its neighbors. Demand for yuan-denominated assets remains relatively low, with a mere 1.5 percent of total yuan bank deposits held outside China.
The contrast between the yuan and its SDR counterparts is stark. The yuan offshore bond market amounts to just 0.5 percent of the world’s total, with 40 percent issued in dollars, 41 percent in euros, nearly 10 percent in pounds and 2 percent in yen. The value of loans denominated in yuan — 188 billion yuan (US$29 billion) — is tiny, especially when one considers that almost 50 percent of total international banking liabilities are denominated in dollars, approximately 30 percent in euros, 5 percent in pounds and about 3 percent in yen. And the yuan accounts for 0.6 percent to 1 percent of global foreign exchange reserves held by central banks, whereas the dollar and the euro account for 62 percent and 23 percent respectively.
In short, unlike the rest of the currencies in the SDR basket, the yuan is an international currency in the making, just as China is an economic and financial power in the making. Indeed, like most developing countries, China remains an “immature creditor” that lends mainly in dollars; and if it needed to borrow in international markets, it would have to issue most of its debt in dollars, not yuan.
Clearly, China’s standing in international finance does not match its status in international trade.
Nonetheless, there is a distinct sense that the yuan is to become a key player in global financial markets. After all, unlike other developing countries — even large ones like Brazil, India and Russia — China has an economy that is large enough to provide critical mass to its currency’s development.
Furthermore, Chinese leaders are determined to push through reforms — especially of the banking sector and state-owned enterprises — that are to help drive forward this development. They have made it clear that one of their key goals over the next five years is to narrow the gap between the international standing of the yuan and that of the world’s “great currencies,” as they promote use of the yuan far beyond the Asia-Pacific region.
However, it is important to note that China’s leaders do not seem to be angling for the yuan to replace the dollar as the dominant international currency. Their approach — based on the belief that a more diversified, and thus more liquid, international monetary system would contribute to a more balanced and less volatile global economy — is more pragmatic. Anticipating a shift from a dollar-based — and, more broadly, US-dominated — system toward a multicurrency, multipolar system, China’s leaders are laying the groundwork for their country and its currency to grasp one of the positions at the top, alongside other great powers.
This goal certainly seems attainable. Indeed, IMF Managing Director Christine Lagarde’s assessment of the yuan’s chances of joining the SDR basket earlier this year — the question is “not if, but when” — seems to apply to China’s broader financial rise. While some countries — the US and Japan in particular — are far from enthusiastic about that, it is difficult to deny what seems inevitable (neither country formally opposed the SDR decision when it came). And, as China gains more financial clout, its role in global economic governance is undoubtedly to grow as well.
Given all of this, it is unsurprising that the reform of the international monetary system and its governance is to feature prominently at next year’s G20 summit, hosted by China, which is to hold the group’s rotating presidency.
It is not yet clear how China will shape the debate, but the mere fact that it will happen at the G20, rather than at the long-dominant G7, sends a clear message that the global economic and monetary system is changing for good.
Paola Subacchi is research director of international economics at Chatham House and a professor of economics at the University of Bologna.
Copyright: Project Syndicate
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