Why It Matters

Putting faith in the yuan

The Chinese yuan will likely mark a new milestone soon, but it will be a symbolic one with little impact on the currency's value, at least over the next few years.

There is a high probability that the International Monetary Fund (IMF) will include the yuan in a basket of major currencies making up its Special Drawing Rights (SDR) on Nov 30. The SDR is an international reserve asset created by the IMF in 1969 to supplement its member countries' official reserves. Its value is based on a basket of key currencies. Today, these are the US dollar, the euro, the Japanese yen and the pound sterling.

The inclusion of the yuan in this basket would serve as a symbolic vote of confidence by the IMF in China's efforts to liberalise and internationalise its currency. However, it will not have much impact on the yuan's capital flows. After all, the SDR is a supplementary reserve asset - because of its small size, it will not boost the yuan's capital flows much.

Beyond the SDR, China's longer-term aim is for the yuan to be a global reserve currency. That refers to a currency held by central banks, sovereign wealth funds and other financial market participants to pay off their debts or manage currency exchange rates. Credit Suisse noted in a report that for this to happen, China would have to do much more to liberalise the yuan. After all, it is not yet fully convertible and key restrictions in China's capital account remain.

"All the above-mentioned limitations introduce high levels of uncertainty and will likely have significant impact on long-term investment considerations of global central banks," said Credit Suisse's senior foreign exchange analyst Koon How Heng. "Global reserve managers have a strong fiduciary duty to ensure the long-term purchasing power and liquidity of their reserve assets and are unlikely to rush into purchasing yuan-related official sector bonds and investments."

So while the IMF's vote of confidence is nice to have, it will take a lot more work on China's part to convince global reserve managers and investors to put their faith in the yuan too.

A version of this article appeared in the print edition of The Straits Times on November 18, 2015, with the headline 'Putting faith in the yuan'. Print Edition | Subscribe