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China enters the global currency wars, eyes SDR status

A global drive towards the US dollar put immense pressure on the yuan to depreciate in light of some soft local economic data and monetary policy loosening. Yet, USD/CNY remained trapped around 6.2 since March, despite the damage inflicted on China’s massive export market, before the bank finally succumbed to the pressure on Tuesday, widening the reference rate by 1.9%, the largest move since 1993, and again by 0.1% on Wednesday. The moves are likely in response to aforementioned threats to growth stemming from a soft export sector.

China’s exports fell 8.3%y/y, completely missing an expected 1.5% drop, and imports fell for the ninth month in a row in July (-8.1% y/y). Clearly the domestic economy is struggling from a lack of demand, both from within China and globaly, and a relatively strong currency. This is further evidenced by a fall in producer prices in July to their lowest level since 2009. The PPI fell 5.4% y/y last month, extending 61 months of straight declines.

The move comes as Beijing is attempting to get the yuan in the IMF’s exclusive SDR basket. There are clear benefits for China if the yuan is included in the SDR, which already includes the US dollar, yen, euro and British pound, as it would solidify the yuan as a globally traded currency, but China’s extensive capital controls and some doubts about its commitment to reform, as evidenced by a mass rescue of its stock markets, are making the IMF nervous.

Will the yuan be included in the SDR?

There are two main criteria to determine whether a currency can be included in the SDR. The currency must be freely tradable and the issuing nation must be a major player in the export market. There’s no doubt that China satisfies the latter – it stands behind Europe and the US but ahead of Japan and the UK in regards to contribution to global exports – but the yuan is not freely tradable by most definitions. The renminbi (RMB) is loosely pegged to the US dollar, there are restrictions on how much residents can take out of the country and it’s hard to get even the limited amount of money allowed into its capital markets.

However, the RMB is widely used in international transactions and its usage is increasing year-by-year. It is being more widely used as a reserve currency as the government opens up its capital markets; it is now ranking around 7th among currencies in use by countries’ official reserve assets. Also, it’s accounting for more of the international debt market and for a significant amount of cross-broader payments, while similarly increasing its usage in the spot market. In fact, it’s hard to see the yuan not being included in the SDR at some point, especially if the PBoC continues to relinquish its grip on USD/CNY and Beijing continues to open ups its capital markets. The IMF responded to Beijing’s lower reference rate by stating that a more market-determined rate will facilitate SDR operations, implying that that they agree with the move, and that China should aim for a floating exchange rate system in 2-3years.

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