Why China Wants Yuan to Be the World’s 5th Reserve Currency

Why China Wants Yuan to be Reserve Currency

China is a step closer to obtaining Special Drawing Rights status for its currency from the International Monetary Fund, a move that would see the yuan joining the greenback, euro, yen and British pound.

At a forum on Sunday, central bank Governor Zhou Xiaochuan swapped the topic of a panel discussion so he could pitch the renminbi’s readiness for reserve status to his co-speaker, IMF Managing Director Christine Lagarde. Premier Li Keqiang told Lagarde in a meeting Monday that China hopes to get the IMF’s seal of approval, according to the government. It may have worked.

“The authorities have also expressed interest in having the RMB included in the SDR basket,” Lagarde said in a statement at the conclusion of her visit to China on Monday, referring to the renminbi, another term for the Chinese currency. “We welcome and share this objective, and we will work closely with the Chinese authorities in this regard.”

Addition to the SDR -- created in 1969 to support the Bretton Woods system of fixed exchange rates after supplies of gold and dollars proved inadequate -- would add the yuan to the basket of currencies IMF member countries can count toward their official reserves. Approval at the once-in-five-year review due later in 2015 hinges partly on whether the IMF reverses its 2010 decision that it wasn’t “freely usable.”

Here are a few reasons why Zhou wants the yuan in:

1. Global Prestige

While China has become the world’s second-largest economy, its currency has lagged behind in international stakes.

SDR status “will be recognition of China’s rise,” said Xi Junyang, a finance professor at Shanghai University of Finance and Economics.

2. Lower Borrowing Costs

A reduction in regulations on capital flows accompanying China’s SDR push will result in an internationalized yuan. That may help Chinese companies venture abroad and cut their borrowing costs.

“A more open capital market can better meet domestic firms’ financing needs,” HSBC Holdings Plc analysts including chief China economist Qu Hongbin wrote in a note. “Capital account convertibility and associated reforms are well aligned with China’s longer term financing needs.”

3. A Multi-Polar World

China’s strategic view is for a “multi-polar” world where the U.S. is just one player rather than a hegemon. In the past, Zhou has called for expanded use of the SDR as an alternative to the dollar. Globally recognized reserve status makes that a step closer, at least on the currency front.

4. Price Setter

The yuan’s use to settle cross-border trade and investment has been rising, but the currency isn’t used to set prices of international commodities from oil to iron ore.

“It may help to make the yuan a pricing currency,” said Shanghai University’s Xi.

That means more influence in setting global commodity prices and helps remove currency volatility from the equation.

More than half of businesses surveyed by HSBC this year expect to increase their cross-border trade with China in the next 12 months, according to the bank’s RMB internationalization study released Tuesday.

5. Yuan Demand

More than 60 central banks currently invest in the yuan, according to an estimate by Standard Chartered Plc. A move into the SDR basket would lure more official buyers.

“One of the key practical implications is that all central banks around the world would become holders of RMB exposure overnight,” said Jukka Pihlman, global head of central banks and sovereign wealth funds at Standard Chartered. “But even more significant thing is the automatic acknowledgment of ‘Official Reserve Currency’ status, which would remove the remaining impediments from several central banks wanting to invest in RMB.”

6. Reform Driver

To win the SDR prize, China will have to press on with plans to open its capital account -- a reform that stands to shake up industries and the way Chinese companies do business.

“It will make Chinese officially more confident in, say, pushing forward full yuan convertibility,” said Li Jie, head of the foreign-exchange reserve research office at the Central University of Finance and Economics in Beijing.

7. IMF Recognition

For PBOC Governor Zhou, SDR status would represent endorsement from the IMF for his reform efforts that have also included steps to liberalize interest rates and ease the so-called financial repression of savers subsidizing investment-led growth.

— With assistance by Xin Zhou

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