The Chinese economy is telling us two different stories at a time. While on one hand, the Chinese economy is persistently delivering offhand economic numbers and even raised hard landing fears at some point of time, its currency yuan received a privileged reserve status from the IMF recently.
Notably, the inclusion of yuan to IMF’s reserve currency list gives the economy a cream-of-the-crop class as this emerging currency will now sit beside the developed currencies like the U.S. dollar, pound, euro and yen. Also, the IMF nod indicates economic stability in China. The IMF’s executive board, which represents the fund’s 188 member nations, recently settled on the fact that the yuan now enjoys a “freely usable” status.
The move marked the first change in SDR’s currency portfolio since 1999, per Bloomberg. Not only this, China’s currency will have a weight of 10.92%, per Bloomberg yen (8.33%) and pound (8.09%) but lower than the euro (37.4%) and the U.S. dollar (41.9%). The move will take effect in October 2016.
Why the Move?
Though several theories are doing rounds right now, both positive and negative, IMF viewed it as the consequence of reformative measures presently being undertaken in China. However, one school of analysts addressed the decision as ‘political’ and is not counting on the easy accessibility of the currency because yuan cannot be transferred into other currencies without restrictions.
The believer of this school also indicated that the IMF head “realized how bad things are in China, so what she (Christine Lagarde) decided to do was to throw China a lifeline.” This way IMF boss can press the Chinese government to launch a total convertibility for its currency.
Notably, the Chinese economy is on its way to deliver a 25-year low expansion this year. Despite the roll-out of a flurry of measures, the economy has showed no signs of a steady recovery and financial markets remained highly volatile due to extreme risk-taking.
Investors should also note that movements in the yuan market have been rampant this year. In August, China’s central bank devalued the currency by 2%, following which yuan posted the largest single-day decline since the historical devaluation in 1994, after the country arranged its official and market rates in a line (read: Be Weary of 3 ETFs as Chinese Yuan Weakens).
Notably, the Chinese authorities follow a trading band around the official reference rate it sets each day for the value of the yuan against the dollar. The Chinese government announced in August that renminbi’s central parity rate would follow the previous day’s closing spot rates more closely going forward.
This indicates China’s intent to make its currency more market driven. As a result, a section of analysts believe that the actual motive behind this currency move was to prepare yuan as a reserve currency. Most importantly, the Chinese central bank assured the market that it would promptly intervene into the currency market if depreciation crosses the 3% mark.
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