The Cable

China Just Took Another Step Toward Joining the IMF’s Currency Country Club

China's renminbi is one step closer to joining the U.S. dollar and other premier global currencies in the IMF's reserve fund.

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China took another step toward joining the International Monetary Fund’s reserve fund Monday, announcing it would allow its currency, the renminbi, to trade directly with the Swiss franc.

In a practical sense, China’s decision eliminates a step in converting the renminbi to francs. Before the announcement, both currencies had to be converted into U.S. dollars before a transaction could take place between Switzerland and China. Starting Tuesday, that will no longer be the case. The franc joins currencies in the United States, New Zealand, Australia, the United Kingdom, Japan, and the European Union that can be directly converted into renminbi. As of Monday afternoon, one U.S. dollar was worth about 6 yuan, the name for individual denominations of the renminbi.

Perhaps more importantly, China said it would allow the value of its currency to fluctuate a maximum 5 percent on the positive or negative side, meaning supply and demand would determine the renminbi’s value compared with the franc. This is something the IMF demands China must do if it wants the renminbi to join the euro, the Japanese yen, the British pound, and the U.S. dollar in the bank’s reserve fund, which is made up of a virtual currency, called special drawing rights (SDR), that is meant to back up national coffers

“This is an important step in strengthening bilateral economic and trade connections between China and Switzerland,” the People’s Bank of China said in a statement Monday. “And China and Switzerland will make further efforts to mutually promote the direct trading between the two currencies based on market principle.”

Getting into the reserve fund would be a “merit badge” that would show that the renminbi had the IMF’s seal of approval, as Alan Blinder, a former U.S. Federal Reserve vice chairman, said recently. But it would also show that China is beginning to play by the same economic rules as the rest of the world.

During the Great Recession, China kept the value of its currency artificially low, making its goods cheaper. This allowed Beijing to grow while the rest of the world contracted. The White House and the U.S. Treasury Department have long called for China to allow market forces determine the renminbi’s value.

Monday’s move by China’s central bank follows a series of other liberalization efforts by Beijing. In August, it allowed the renminbi to float for three days. Then, on Sept. 10, Beijing announced it would open its domestic foreign-exchange market to foreign central banks, allowing the likes of the European Central Bank and the U.S. Federal Reserve to place bets on the currency’s value. In late October, China announced it would remove caps on deposit rates, meaning Chinese savers can get a market-based rate of return for their money, as opposed to an artificial one set by the central bank.

The timing of these moves is no accident. The IMF is set to decide this month whether the renminbi can enter the reserve fund. If it is rejected, China will have to wait five years before the emergency lending bank will consider it again.  According to reports, China isn’t likely to have to wait and will join the reserve fund next year.

Photo credit: China Photos/Getty Images

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