China’s Yuan Level Remains in Line With Fundamentals, IMF Says

  • `Vigilance must remain the watchword' as spillovers increase
  • Policymakers have `adequate policy space' if stimulus needed

China’s yuan exchange rate remains "broadly in line with medium-term fundamentals" after its August devaluation, the International Monetary Fund said in a note on the nation’s economic transition.

While the Aug. 11 currency system shift had "large ripple effects" by creating uncertainty, the change is consistent with authorities’ intention to move to a more market-determined exchange rate, the IMF said. The note comes as the IMF looks at whether to add the yuan to its basket of reserve currencies, which is made up of the U.S. dollar, euro, yen and British pound.

China’s growing economic heft and integration with the global economy means its health is having an increasing bearing on other nations. The IMF estimated that a one percentage point slowdown in China’s growth translates into a 0.3 percent decline for other Asian countries. Such spillovers may have become even larger lately, coming via financial market linkages now as well as trade, the IMF said.

"The bottom line is: vigilance must remain the watchword," the IMF said. "For China, that means focusing on the downside risks, and for the rest of the world, guarding against potential spillovers. If managed well -- including with clearer communication to help guide market expectations -- China’s transition could provide the basis for renewed economic strength in a region that has led the world in growth for several years."

The IMF also noted global spillovers from the rout in Chinese stocks since June. Domestically, it said it expected "only a limited direct impact" on the economy given the low rates of share ownership among households and the low proportion of equity financing for companies.

China is shifting away from cheap exports and debt-fueled investment to increase the share of services and consumption in its $10 trillion economy. That rebalancing is affecting the rest of the world, especially nations that had benefited most from China’s rapid expansion, the IMF said.

"The transition is essential if China is to create a more inclusive economy that gives greater play to market forces and achieves safer and more sustainable growth," the IMF said. "This will involve a delicate balancing act for the Chinese government — implementing reforms while maintaining demand and financial stability. As reforms proceed, it will be critical to ensure effective governance of newly liberalized markets and enterprises."

As growth slows, authorities have "adequate policy space" should further stimulus be necessary, the IMF said. The focus of such measures should target both demand and rebalancing, the IMF said.

Chinese policy makers pressed ahead with a series of technical policy changes throughout the stock market turmoil and the uncertainty spurred by the attention-grabbing Aug. 11 currency devaluation, suggesting they are prioritizing IMF prescriptions in their quest to be added to the Special Drawing Rights basket. 

Policy makers see SDR inclusion as a way to help improve the nation’s status in trade and finance and reduce dependence on the U.S. dollar. The fund is assessing whether the Chinese currency meets the requirements of being "widely used” and "widely traded,” with the IMF’s executive board expected to vote on the matter in November.