LOS ANGELES (MarketWatch) — In what would be a huge milestone in China’s emergence as a major world financial power, the International Monetary Fund looks likely to adopt the country’s currency into the basket that makes up its global forex benchmark.
Or so say strategists at Bank of America Merrill Lynch, writing in a note Wednesday that they believe the IMF will vote this October to include the yuan USDCNY, -0.09% as one of the units that make up the Fund’s “Special Drawing Rights” (SDR), a sort of meta-currency used in IMF transactions.
This might not seem like a big deal, but Merrill Lynch assures that it is. By joining the elite club — there are only four currencies in the basket right now: the U.S. dollarDXY, +0.42% , the euro EURUSD, -0.80% the British pound GBPUSD, -0.24% and the Japanese yen USDJPY, -0.25% — it would “legitimize its use as a reserve currency,” possibly reducing China’s cost of foreign borrowing and offering an “extra degree of freedom in financing future current-account deficits,” the strategists said.
In fact, given that the yuan already enjoys significant use as a reserve currency, its weighting in the SDR system would likely be higher than that of the pound and yen, they said. According to Merrill Lynch estimates, central banks around the world currently hold a total of more than $80 billion in Chinese government bonds, which would make it the seventh largest reserve currency on earth.
China, and in particular long-serving People’s Bank of China Gov. Zhou Xiaochuan, has for awhile now been pushing for inclusion in the SDR, which is reweighted just once every five years. They didn’t make the last cut in 2010, as the IMF deemed China’s current account hadn’t opened enough to meet the “freely usable” criteria required of SDR currencies.
But Merrill Lynch sees the Fund as likely to give the go-ahead at this year’s review. There’s now a lively offshore market USDCNH, +0.07% for the yuan (also known as the “renminbi” or “people’s currency”), for instance. Also, the strategists think the U.S. is unlikely to block the move, as it wants China more engaged in international institutions where Washington has wide sway, and in any case, it wouldn’t want to strain relations with Beijing.
Although obtaining such a high status in the foreign-exchange world would have deep symbolic value for China, the actual effect on the value of the yuan is a little harder to predict.
SDR induction might well boost demand for the Chinese unit. Some economists see it as likely to lift the yuan’s value further against the dollar, or at least add upward pressure, since, despite the chance to qualify to join the SDR, the yuan’s exchange rate is still constrained in a daily trading band set by the central bank.
But the Merrill Lynch strategists see increased volatility as the more likely result.
“If China is to mature into a global reserve currency with rising capital-account convertibility, this must entail more two-way movement and volatility,” they wrote. “Ultimately, its success will depend on long-term stability and its ability to provide a store of value and liquidity to international investors.”
original source: http://www.marketwatch.com/story/chinas-yuan-may-join-elite-money-club-this-year-2015-03-25