CHINA-ECONOMY/CPI

(Reuters)

Yuan's New Status To Pressure Beijing

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As expected, the International Monetary Fund's confirmed the announcement that the yuan will join the elite club of reserve currencies. Now Chinese officials will have to prove they can treat it like one.

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Next year, the IMF will add the yuan to the group of currencies that comprise its lending reserves, a status enjoyed only by the U.S. dollar, euro, British pound and Japanese yen.

The inclusion represents recognition that the yuan's status is rising along with China's place in global finance.

Now comes the hard part. It also puts new pressure on Beijing to change everything from how it manages the yuan, also known as the renminbi, to how it communicates with investors and the world. China's pledges to loosen its tight grip on the currency's value and open its financial system will come under new scrutiny.

"We will have to build up confidence in renminbi assets from investors both at home and abroad and at the same time prevent the financial risks associated with a more global currency," said Sheng Songcheng, head of the survey and statistics department at the People's Bank of China, the country's central bank. "That calls for carrying out various financial reforms in a coordinated way."

Inclusion also puts pressure on the central bank to offer the same degree of clarity and transparency that the U.S. Federal Reserve, European Central Bank and other vital institutions strive for. That could be difficult: In the past six months alone, the PBOC shocked markets with a surprise currency devaluation, stood mostly silent during a Chinese stock-market rout and confused investors by issuing a new proclamation that turned out to be months old.

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"It needs to more clearly and effectively communicate with the market," said Zhou Ping, founder of Bin Yuan Capital., an asset manager in Shanghai. "It would be like a cultural change of sort for the central bank."

One immediate challenge is how to deal with market pressure to weaken the yuan due to China's slowing economic growth, after three months of trying to strengthen it. PBOC advisers say the bank will likely allow a gradual and modest depreciation of the currency of between 3% and 5% in the next 12 months. The challenge, they say, is how to clearly signal its intentions to the market.

The inclusion marks a crowning achievement for China's top central banker, Zhou Xiaochuan, and his lieutenants, who have built political support around the idea that the yuan's status in international finance should match China's heft as an emerging world power. To meet IMF's reserve-currency criteria, the central bank pushed through a slew of changes -- such as freer interest rates and easier access for foreign investors to China's markets -- despite opposition from some powerful interest groups.

But Mr. Zhou, 67 years old, and any successor will have to press for more changes in China's economy to turn the yuan into a global currency. Already, China's leadership has slowed down a number of key initiatives for financial reform amid worries about the less robust economy. Notably, top leaders have set aside a goal of creating freer financial markets by the end of this year and pushed the target back to the end of 2020.

The slowdown has also dimmed investor enthusiasm for the yuan. Mr. Zhou of Bin Yuan Capital said the yuan is overvalued by about 20% and that keeping it at the current level would only hurt the economy. In a Nov. 19 report, Goldman Sachs Group (GS) listed a "significant depreciation" of the yuan as the biggest risk facing emerging-market assets next year. A drop could help China's export sector but raise new criticism from the U.S. and elsewhere that Beijing is playing politics with its currency.

While IMF inclusion may be largely symbolic some say, it could open Beijing to criticism of its financial policies when the fund conducts its five-year review of the currencies in its basket. Formally, inclusion would add the yuan to the IMF's special drawing rights, or SDRs, a virtual currency that the fund uses for emergency lending to its members and that countries can use to bolster their reserves.

"The actual inclusion of the yuan in the SDR is a nonevent for most investors. The sound you'll hear is a collective yawn," said David Loevinger, a managing director at fund manager TCW in Los Angeles and a former U.S. Treasury official focusing on China. "The lack of data and policy transparency remains a risk for investors."

In the near term, inclusion would lead to a modest, less-than-$30 billion in new foreign demand for yuan-denominated assets, estimates Zhang Ming, a senior economist at the Chinese Academy of Social Sciences.

"Domestically, it's far from certain whether the SDR status could force other, structural overhauls," Mr. Zhang said.

Meanwhile, the PBOC must chart a path for the yuan to help the economy while avoiding triggering a loss of faith from investors world-wide. In August, it devalued its main gauge for the yuan by 2%, triggering an even sharper selloff in the currency in financial markets and raising concerns that more such moves might come.

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