China's yuan success hinges on reform despite IMF move

The International Monetary Fund's recognition of China's currency is a step towards encouraging its global use, but banks will remain reluctant to hold yuan unless Beijing pushes deeper financial reforms, analysts say.

The Washington-based institution on Monday welcomed the yuan into its elite reserve currency basket known as "Special Drawing Rights", recognising the ascendance of the Asian power, already the world's second largest economy.

It is a symbolic victory for Beijing, which has spared no efforts to strengthen the international role of the yuan -- also called the renminbi (RMB) -- and its acceptance as a reserve currency.

China's is the fifth most widely used currency in international payments but accounts for less than three percent of transactions.

That compares with over 43 percent for the US dollar, and nearly 29 percent for the euro, global transactions organisation SWIFT said in October.

Analysts believe the IMF decision's impact on foreign exchange markets will be muted, though it will encourage central banks to speed up diversification of their currency reserves by buying yuan.

"There is no obligation for central banks to align their forex reserve holdings with the SDR basket, but in practice, they pay a lot of attention to the basket?s composition and weights," said Dariusz Kowalczyk, senior emerging market strategist at Credit Agricole.

"This pattern will also materialise in the case of the renminbi," he said. "It simply makes sense to diversify reserves into an emerging market that is also a global economic superpower."

He forecast the move could eventually imply yuan buying of the equivalent of up to $110 billion annually.

- 'Heavy-handed intervention'-

However, such a development will not be achieved overnight and depends on reforms undertaken by Beijing, including opening its tightly-controlled onshore financial market, allowing more capital outflows and widening the trading band for the yuan, ANZ Banking Group said.

The yuan can only move up or down two percent against the US dollar from a mid-rate set daily by the central bank.

"It will take time for the RMB to become a popular global asset," ANZ said in a research report last month.

True acceptance of the yuan as a reserve currency also depends on liquid markets and transparent policies, a challenge for the Communist-ruled country.

"We think the world?s central banks will be reluctant to invest much in renminbi for many years to come," said Andrew Kenningham, senior global economist at Capital Economics.

"Central banks, like other risk-adverse asset managers, invest the bulk of their funds in currencies which are fully convertible and for which there are deep and liquid markets for foreign exchange, bonds and derivatives," he said.

The Chinese government intervened in the stock market over the summer after a rout sent shock waves around the world, by tasking an agency to buy up shares as part of a massive bail-out.

The People's Bank of China (PBoC), the central bank, also unveiled a surprise devaluation of the yuan against the dollar, moving it nearly five percent lower over one week in August.

"Investors will also be looking for reassurance that economic policy and financial markets in China will be managed in a more professional and predictable manner. In that respect, this year?s heavy-handed intervention by the authorities in China?s equity markets will surely have made investors more wary," Kenningham added.

-Support for reform-

Despite slowing growth, China has moved gradually to implement economic reforms, liberalising interest rates in October and pledging to move towards making the yuan fully convertible by 2020.

The PBoC said the IMF move was an acknowledgement of China's economic development and pledged further reform.

Analysts seemed to endorse that view hours after the IMF decision.

Ivan Chung, a Moody's analyst said it was "recognition of China's commitment to reform its financial sector and liberalise its capital account, and will support market-oriented reforms."

Such liberalisation is likely to lead to falls in the yuan's valuation, but Beijing far from allowing complete liberalisation to avoid larger falls, experts added.

"The PBoC should be reducing its currency intervention and the yuan is likely to decline on weak economic fundamentals in China," DBS Group Holdings Nathan Chow said.

"That said, China will have to strike a balance between letting the market play a bigger role and not allowing any major depreciation."