Biggest Yuan Reforms in a Decade Did Little for China's IMF Push

  • Exchange rate isn't more market-driven now, says Greenwood
  • Yuan's chances of reserve status receding, says Bocom

China’s biggest exchange-rate reforms in a decade have had little impact on the yuan’s chances of winning reserve status at the International Monetary Fund, with questions still being asked about the extent to which the currency has been freed.

The People’s Bank of China surprised investors in August with a devaluation and a shift to a more market-oriented yuan reference rate, moves that triggered the steepest depreciation in two decades. Policy makers responded with record intervention, curbs on forwards trading and increased scrutiny of outflows. John Greenwood, chief economist at Invesco Asset Management and architect of Hong Kong’s currency peg to the greenback, says the yuan’s chances of being selected this year to join the dollar, euro, pound and yen in the IMF’s Special Drawing Rights are at best 45 percent.

The exchange rate "does not appear to be any more market-driven today than it was," said Greenwood, who is based in London. "We don’t really understand or know what has changed. The system, as is typical in China, is so opaque - they don’t disclose or explain anything."

While the decision to admit the yuan into the SDR basket is largely a political one, the currency does have to meet certain technical criteria in order to be eligible for inclusion. The IMF in a July report expressed concern about disparities between China’s onshore and offshore exchange rates, saying it could lead to valuation difficulties, and the gap has widened since the devaluation. To help mitigate this, the nation has opened its interbank currency and bond markets to foreign central banks this year.

UBS AG, which estimated in July that the probability of the yuan winning SDR approval this year was 70 percent or more, said the likelihood hasn’t reduced since then, while Standard Chartered Plc said the chance is more than 60 percent. Bank of Communications Co., China’s sixth-largest lender, says prospects of admission this year are zero.

"The yuan is becoming less and less likely to be included in SDRs this year," said Lian Ping, chief economist at Bank of Communications in Shanghai. "The possibility is becoming smaller as the financial markets, especially the stock and foreign-exchange markets, go through turmoil and China’s capital account isn’t open enough, though the government has made some progress."

The IMF’s reserve endorsement could lead to about $1 trillion of global reserve assets being switched into yuan-denominated assets, Standard Chartered and AXA Investment Managers estimated in May. The bulk of fund movements of late have largely been the other way, with net outflows estimated by Bloomberg at a record $141.7 billion in August and $124.6 billion in July.

Yuan Decline

The PBOC on Aug. 11 revamped the methodology used to determine the yuan’s reference rate, which restricts the spot rate to moves of a maximum 2 percent on either side. Under the new regime, market makers who submit contributing prices have to consider the previous day’s close, foreign-exchange demand and supply, as well as changes in major currency rates.

The onshore yuan sank as much as 3.7 percent to a four-year low in the two trading sessions following the shift, kicking off a regional currency selloff that led to a devaluation in Vietnam and a change of exchange-rate regime in Kazakhstan. The yuan closed at 6.3744 a dollar in Shanghai last week, while the offshore rate was 0.4 percent weaker at 6.3975 in Hong Kong.

The yuan’s decline this year has affected debt sales as well, with Dim Sum bond issuance tumbling 38 percent to 232 billion yuan ($36 billion), Bloomberg-compiled data show. Full-year sales are likely to be only about 60 percent of last year’s tally, said Ben Yuen, Hong Kong-based head of fixed income at BOCHK Asset Management. Yuan savings in Hong Kong probably shrank in August, according to the city’s association of banks.

London Sales

To bolster global usage, the PBOC said last week it would sell yuan bonds in London "in the near future." Share of official reserves is a key indicator used to determine qualification for the SDR basket and the yuan ranked seventh last year, according to the IMF’s July report. The currency accounted for 1.1 percent of the total compared with 63.7 percent for the U.S. dollar.

"Overall, the one-off yuan devaluation and the exchange-rate reform are in the right direction for the SDR bid," said Richard Tang, chief executive director of ICBC Credit Suisse Asset Management International Ltd. in Hong Kong. "The probability for yuan SDR inclusion this year is still quite high, though in reality the decision-making lies in the hands of the U.S."

While IMF staff may make a recommendation, the final decision rests with the executive board, which represents the fund’s 188 member nations. The U.S. and Japan control about 23 percent of the votes -- not enough to veto inclusion on their own -- as the call will probably require 70 percent approval. 

U.S. Treasury Secretary Jacob J. Lew has put the onus on China to prove the yuan belongs in SDRs, saying the country needs to further liberalize its currency policy and complete financial reforms before it can join.

High Intervention

The yuan devaluation confirms among those who would vote “no” that the rate is still subject to a high degree of intervention and the market mechanism is not driving the yuan, said Invesco’s Greenwood. The Chinese currency isn’t a free one as long as restrictions on capital flows remain, he said.

China’s foreign-exchange reserves tumbled a record $93.9 billion in August as the PBOC sold dollars and bought yuan. Earlier this month, the PBOC asked financial institutions to set aside 20 percent of yuan forward contract sales in reserve for a year with zero interest, while the State Administration of Foreign Exchange has told banks to conduct special checks on currency trading under capital accounts.

"It’s like one step forward and one step back," said John Chambers, the chair of global sovereign ratings committee at Standard & Poor’s Ratings Services in New York. "The medium-term plan is to let the currency be more flexible."

— With assistance by Tian Chen, and Fion Li

Before it's here, it's on the Bloomberg Terminal.