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With IMF recognition, reform now key for yuan

AFP-JIJI, Kyodo

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

The Washington-based institution on Monday welcomed the yuan into its elite reserve currency basket known as Special Drawing Rights, recognizing the ascendance of the Asian power, already the world’s second-largest economy.

Starting October 2016, the yuan will get a share of 10.92 percent in the SDR basket, surpassing the yen’s 8.33 percent. The dollar at 41.73 percent and the euro at 30.93 percent still make up the lion’s share of the basket, however.

On Tuesday, Finance Minister Taro Aso voiced hopes that China would “make efforts” toward reforming its financial and capital markets as the country becomes further integrated into the global financial system.

Still, it is a symbolic victory for Beijing, which has spared no efforts to strengthen the international role of the yuan — also called the renminbi (RMB) — and its acceptance as a reserve currency.

China’s is the fifth most widely used currency in international payments but accounts for less than 3 percent of transactions.

That compares with over 43 percent for the U.S. dollar, and nearly 29 percent for the euro, global banking transaction organization SWIFT said in October.

Analysts believe the impact of the IMF 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 basket, but in practice they pay a lot of attention to the basket’s composition and weights,” said Dariusz Kowalczyk, senior emerging market strategist at Credit Agricole.

“This pattern will also materialize in the case of the renminbi,” he said. “It simply makes sense to diversify reserves into an emerging market that is also a global economic superpower.”

He forecast the move could eventually imply yuan buying of the equivalent of up to $110 billion annually.

However, such a development will not be achieved overnight and 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, the ANZ Banking Group said.

The yuan can only move up or down 2 percent against the U.S. dollar from a midrate set daily by the central bank.

“It will take time for the RMB to become a popular global asset,” ANZ said in a research report last month.

True acceptance of the yuan as a reserve currency also depends on liquid markets and transparent policies, a challenge for the communist-ruled country.

“We think the world’s central banks will be reluctant to invest much in renminbi for many years to come,” said Andrew Kenningham, senior global economist at Capital Economics.

“Central banks, like other risk-adverse asset managers, 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,” he said.

The Chinese government intervened in the stock market over the summer after a rout sent shock waves around the world, by tasking an agency to buy up shares as part of a massive bailout.

The People’s Bank of China (PBC), the central bank, also unveiled a surprise devaluation of the yuan against the dollar, moving it nearly 5 percent lower over one week in August.

“Investors will also be looking for reassurance that economic policy and financial markets in China will be managed in a more professional and predictable manner,” Kenningham added. “In that respect, this year’s heavy-handed intervention by the authorities in China’s equity markets will surely have made investors more wary.”

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

The PBC said the IMF move was an acknowledgement of China’s economic development and pledged further reform.

Analysts seemed to endorse that view hours after the IMF decision.

Ivan Chung, a Moody’s analyst said it was “recognition of China’s commitment to reform its financial sector and liberalize its capital account, and will support market-oriented reforms.”

Such liberalization is likely to lead to falls in the yuan’s valuation, but Beijing remains far from allowing complete liberalization to avoid larger falls, experts added.

“The PBC should be reducing its currency intervention and the yuan is likely to decline on weak economic fundamentals in China,” DBS Group Holdings’ Nathan Chow said.

“That said, China will have to strike a balance between letting the market play a bigger role and not allowing any major depreciation.”