IMF says China needs to do more to earn yuan status as an official reserve currency
A cautionary statement from the International Monetary Fund on the prospects for granting China’s yuan new international status sent the currency briefly lower on Wednesday, as traders bet that Beijing could lower its value to combat slowing economic growth.
In often blunt terms, the Washington-based IMF said in a report published Tuesday and in comments to reporters that China needs to do more to liberalize its currency exchange system to earn the yuan a status as an official reserve currency. Yuan selling when trading began Wednesday in China reflected a view among traders that the IMF’s latest assessment may give Beijing more wiggle room to depreciate its currency to support economic growth.
The IMF in its 63-page report cast doubt it is ready to immediately include the yuan in a basket of currencies that constitute its Special Drawing Rights, a designation investors say Beijing has sought in part by maintaining stability in its exchange rate in recent months. The report said Beijing has taken numerous steps to make its currency freely exchangeable but that its value isn’t market determined and significant liberalization is needed before it can be considered an international reserve currency.
“Across a range of indicators, the [yuan] is now exhibiting a significant degree of international use and trading,” the IMF said in its report. But it said the U.S. dollar and three other currencies in the basket “generally rank ahead” of the yuan in terms by a measure it calls “freely usable.”
The exchange rate move on Wednesday was brief but notable in the context of China’s market, with selling in yuan seen both on the tightly controlled domestic market and in derivatives markets where traders bet on its future movements. On Wednesday morning in Shanghai, the U.S. dollar rose as high as 6.2122 yuan from around 6.2093 yuan where it had traded for several weeks. By late in Wednesday’s session, the dollar slid back and settled at 6.2096 yuan in Shanghai amid what traders said was suspected central bank support for the yuan.
“It is clear that the market takes this slightly negatively, seeing this IMF report,” said Kewei Yang, head of foreign exchange, rates and credit strategy in Asia for Morgan Stanley in Hong Kong.
Some analysts say the report could spur foreign exchange reforms sooner rather than later including a widening of the trading band, in an effort to make the currency more market driven.
That though, could put depreciation pressure on the yuan against the U.S. dollar, amid sluggish economic growth and weakening macroeconomic conditions.
Traders were betting the Chinese leadership would keep the yuan stable to help its chances of being designated an international reserve currency. A lower yuan could spur economic activity, for example by lowering the cost of investment in China for foreigners and making the country’s exports cheaper on world markets.
“The market believes the [yuan’s] stability in recent months [is related to] the SDR review,” said Mr. Yang.
IMF officials stopped short of ruling out inclusion of the yuan in the SDR basket, and several economists on Wednesday said they remain confident the fund will announce a decision to include it as soon as late this year. Some said actual inclusion of the yuan into the SDR might now not happen until September 2016 but that the move will ultimately encourage global central banks to hold yuan and buy government bonds issued in the currency.
But the hurdles identified by the IMF pose challenges to Beijing to liberalize the exchange rate at a faster pace, even as authorities have surprised some investors by rolling out reforms more quickly than many predicted. What remains unclear is how recent turmoil in China’s stock market might affect Beijing’s appetite for faster liberalization in the foreign exchange system, which is considered among top policy makers as particularly sensitive.
Sacha Tihanyi, a senior currency strategist at Scotiabank in Hong Kong says that it is likely that China’s desire to “move more quickly on reform has been restrained by the financial market volatility and still lack of significant stabilization and pickup in the economy.”
Derivatives on the yuan’s future value have indicated since the stock market rout began in late June that more investors expect the currency to fall in coming months. But Beijing has also continued to open the system since then, for instance by announcing late last month that authorities would remove restrictive quotas on foreign central banks and sovereign-wealth funds that would allow them more room to invest in the country’s $6.4 trillion domestic bond market.
The People’s Bank of China, the country’s central bank, said in a statement on Tuesday that it will continue to carry out market-oriented financial reforms and maintain stability in the yuan’s exchange rate at what it described as a reasonable level.
original source: http://www.wsj.com/articles/imfs-currency-reservations-send-chinas-yuan-lower-1438778511