BEIJING • The International Monetary Fund's recognition of China's currency is a step towards encouraging its global use, but banks will remain reluctant to hold yuan unless Beijing pushes deeper financial reforms, analysts say.

Monday's inclusion of the yuan in the Washington-based institution's elite reserve currency basket is a symbolic victory for Beijing.

The yuan is the fifth most widely used currency in global payments but accounts for less than 3 per cent of transactions. That compares with over 43 per cent for the US dollar, and nearly 29 per cent for the euro, global transactions organisation Swift said in October.

Analysts believe the impact of the IMF's decision on foreign exchange markets will be muted, though it will encourage central banks to speed up diversification of their currency reserves by buying yuan.

"There is no obligation for central banks to align their forex reserve holdings with the SDR (special drawing rights) basket but, in practice, they pay a lot of attention to the basket's composition and weights," said Mr Dariusz Kowalczyk, emerging market strategist at Credit Agricole. He forecast an annual buying of US$110 billion (S$155 billion) worth of the yuan.

However, such a development depends on reforms undertaken by Beijing, including opening its tightly-controlled onshore financial market, allowing more capital outflows and widening the trading band for the yuan, ANZ Banking Group said.

The People's Bank of China (PBOC) holds virtually all yuan reserves under swap agreements rather than as physical currency, which gives it control over its pricing. This firm grip on the yuan undercuts investors' emphasis on size, stability and liquidity when investing in reserve currencies.

The yuan can now only move up or down 2 per cent against the US dollar from a mid-rate set daily by the PBOC.

"Central banks... invest the bulk of their funds in currencies which are fully convertible and for which there are deep and liquid markets for foreign exchange, bonds and derivatives," said Mr Andrew Kenningham of Capital Economics.

Despite slowing growth, China has moved gradually to implement economic reforms, liberalising interest rates in October and pledging to move towards making the yuan fully convertible by 2020.

Analysts say such liberalisation is likely to lead to falls in the yuan's valuation, but Beijing is far from allowing complete liberalisation in order to avoid larger falls.

DBS Group's Nathan Chow said: "China will have to strike a balance between letting the market play a bigger role and not allowing any major depreciation."

AGENCE FRANCE-PRESSE, BLOOMBERG