Ambitious Plan to Make the Yuan the World’s Go-To Currency
Robin Ganguly and Cedric Sam
Sept 28, 2016
China’s long-held desire to provide an alternative to the
U.S. dollar will get a boost on October 1, when the yuan
enters the International Monetary Fund’s basket of reserve
currencies, placing it alongside the pound, euro, yen and
dollar. The yuan’s ascent
is a validation of the importance of the world’s
second-biggest economy and the work policy makers have done
to allow freer access to the nation’s markets.
China’s currency hasn’t kept up with its global ambitions
Still, there’s a long way to go. While China’s the biggest
trading nation, the yuan is barely used in world markets.
Even in U.S.-China trade, just 2.4 percent of all payments
by value were conducted in yuan.
Comparison of international trade and currency use
Sources: IMF and SWIFT
The yuan’s elevation could bring billions in
The yuan’s inclusion in the Special Drawing Rights (SDR)
basket will prompt central banks and fund managers to buy
more Chinese assets, with estimates of as much as $1
trillion of inflows in a five-year period. China needs the
cash, with its economy growing at the slowest pace in more
than two decades.
Among the main beneficiaries will be the onshore bond
market, which foreign investors have been flocking to since
the government accelerated the lowering of barriers in
February 2016. Global funds boosted their holdings of
Chinese government debt by the most in two years in June,
while the benchmark yield touched a record low in August.
Global sovereign bond market projections
Sources: BIS, Oxford
Economics, Credit Suisse estimates
Then there’s the issue of interest rates: with SDR entry,
Chinese sovereign bond yields will decline further, lowering
the government’s borrowing costs. The yield on 10-year
Treasuries is now less than 1.7 percent, compared with more
than 2.7 percent for Chinese sovereign debt.
Ten-year bond yields
The world will only play along if China leaves the yuan
One of the basic definitions of a reserve currency is that
it must be freely traded. And the yuan is not quite there
yet. The People’s Bank of China is often suspected of
intervening in the market to nudge its exchange rate one way
or the other. The central bank also limits onshore daily
moves to 2 percent on either side of a fixing that it sets.
Then there are capital controls, which restrict the ability
to move money out of the country.
Despite this, people have found ways to move money out to
escape yuan depreciation pressures and a volatile stock
market. An estimated $1 trillion has flowed out of China
since September 2015.
Estimated China capital flows
The Federal Reserve Bank of Dallas suggested in July that
the yuan failed a safe-haven test, finding that China’s
currency underperforms as market volatility increases.
SDR inclusion is likely to prompt the Chinese government to
push ahead with reforms to its exchange-rate policy, as part
of its efforts to bolster international usage of the
currency. But challenging the dollar’s hegemony will take
more than a while, with the memory of the shock August 2015
devaluation relatively fresh in investor minds. The
greenback has maintained its dominance since the mid-20th
century, fighting off competition from the yen and the euro.
After the IMF in 2010 rejected China’s request to include
the yuan in the SDR basket, the nation took several steps to
support its claim. It made the yuan’s fixing more
market-based, allowed greater access to its bond market and
closed the gap between the currency’s rates at home and
abroad. In November last year, the IMF deemed that the yuan
was freely tradable enough to become a global reserve
In the long run, a stronger yuan could be a much-needed fix
for the global economy as it would increase the purchasing
power of China, the biggest consumer of commodities in the
What Now for China as Renminbi Joins SDR?
Since being admitted to the IMF’s elite currency club,
Beijing has prioritized GDP growth over structural reforms.