Earlier this week, the International Monetary Fund (IMF) announced that it is finally granting the Chinese yuan the coveted reserve currency status by September next year. Now this is something that the Chinese government has been dreaming of and working hard for in the past few years, so I guess you can say that this is as big of a deal as Leonardo DiCaprio finally winning his much-deserved Oscar!
Unfortunately for Huck who has adored Leo since his pre-Titanic teenybopper days, the Academy Awards odds are still looking slim. China, on the other hand, has managed to pass through the eye of a needle, meet all the strict requirements, jump through hoops, and get the thumbs-up from IMF head Christine Lagarde.
What does a world reserve currency status entail?
Premium perks such as priority boarding, access to exclusive airport lounges, waived baggage fees, and the occasional business class upgrades. Kidding! Getting that world reserve currency badge does open up a ton of economic, political, and financial advantages reserved only for VIPs. And now China gets to sit with the cool kids in the IMF’s Special Drawing Rights (SDR) table!
The SDR was created by the IMF in 1969 as an international reserve asset to maintain the balance between borrowing and lending countries. Being part of this SDR is essentially a nod of approval from the IMF, which is the lender of last resort, to currencies that it deems safe and reliable. With that, the currencies included in this basket (U.S. dollar, euro, Japanese yen, British pound, and Chinese yuan) tend to enjoy high demand from governments, commercial banks, and institutions who want to hold stable assets in their vaults.
How did the Chinese yuan achieve this status?
It was a long and difficult road that China took before the yuan was finally allowed to join the gang of elite currencies, as it was often criticized for being undervalued and manipulated by the government. But Chinese officials wanted the yuan to be part of the SDR so bad that they implemented several economic and financial reforms to prove that they can comply with the IMF’s requirements.
Unlike most currencies whose values are determined by forex market forces such as supply and demand, the yuan’s forex trading range is actually fixed by monetary authorities daily. A few years back, officials had been trying to keep the currency weak in order to give the Chinese economy an advantage in international trade, as a depreciating local currency makes the country’s exports more affordable and desirable. Months before the IMF’s SDR decision, China adjusted its method of setting the yuan trading range and developed a set of yuan-denominated securities to show that they’re ready to play fair with the rest of the world.
So what does this mean for the Chinese economy?
For one, yuan-denominated assets could start selling like hotcakes, which could bring a huge inflow of capital to the mainland. This increased investor activity and yuan forex demand might shore up the Chinese stock market, which has hit a lot of road bumps earlier this year. Rising equity prices could boost financial confidence and revive business prospects, likely contributing to stronger overall economic performance.
As you’ve probably guessed, this could also usher in a better outlook for Australia, which is China’s BFF in terms of international trade. After all, higher investments in Chinese companies and infrastructure could spur a pickup in demand for Australia’s raw material commodity exports such as iron ore, lifting the Aussie against its forex rivals in the process. To top it off, positive growth forecasts for China would be great for the global economy and forex risk appetite.
Of course monetary authorities and government leaders in China would have to do their part to ensure that the yuan is able to meet the standards set by the IMF, which means less forex devaluation and more policies to ensure that economic and financial stability are maintained. This includes the mandate that the currency must be “freely usable” or easily convertible. Does this mean we’ll see Chinese yuan pairs as part of the forex majors soon?