IMF Officially Gives China A Seat at the Adult Table of World Economies

IMF Officially Gives China A Seat at the Adult Table of World Economies

China has the world’s second-largest economy, but its currency, the renminbi, has long been kept out of the International Monetary Fund’s elite club of the world’s strongest national tenders. That changed this weekend.

After years of liberalization reforms, the IMF announced Saturday the renminbi would join the bank’s group of Special Drawing Rights (SDR) currencies. The group curries a kind of pseudo-currency, which is used only by the IMF to supplement countries’ official coffers when finances are tight. The value of this currency is determined by the strength of each of the currencies in the basket — the dollar, the pound sterling, the euro, the Japanese yuan, and now the Chinese renminbi.

Inclusion in the SDR is largely symbolic in terms of market movement; China’s lagging economic growth isn’t going to get a shot in the arm simply because it’s now been included. But it is a reward for recent efforts by China to open up its economy to foreign investment and influence, something U.S. President Barack Obama and Treasury Secretary Jack Lew have for years demanded.

But IMF’s inclusion of the renminbi is important. It’s an acknowledgement that China, after decades of being closed to the kind of foreign investment that can be made in free markets all over the world, is opening for business. It also shows that Beijing is allowing its economy to be subject to the same supply and demand forces that push the American, European, Japanese, and British economies in positive or negative directions.

Finally, the IMF’s decision shows that the emergency-lending bank believes China is increasingly allowing markets to determine the value of the renminbi. Currency manipulation by Beijing is a hot-button issue on the 2016 U.S. presidential campaign trail, where both Republican Donald Trump and Democrat Hillary Clinton have accused Beijing of keeping the value of its currency low to promote lagging Chinese exports.

“The inclusion into the SDR is a milestone in the internationalization of the renminbi, and is an affirmation of the success of China’s economic development and results of the reform and opening up of the financial sector,” the People’s Bank of China, China’s central bank, said in a statement

The IMF rejected China’s application to join the SDR in 2010. It had kept the renminbi out of the SDR because it historically hasn’t been “freely usable,” meaning that it wasn’t widely used to pay for international transactions or traded on international monetary exchanges. In August 2015, the fund extended its SDR currency basket window to September 2016. At the time, the IMF said the new timeline would give countries drawing from the fund, like Ukraine, “lead time to adjust in the event that a decision were to be taken to add a new currency to the SDR basket.” But it also gave China more time for liberalization reforms.  

China took full advantage. After an August 2015 IMF progress report determined China hadn’t embraced liberalization reforms the IMF demanded — and that Chinese President Xi Jinping had long promised — Beijing took the hint. A week later, it allowed the renminbi to “float” for three days and let supply and demand determine its value, just like the euro, pound, and dollar do each day. As its value decreased, the value of Chinese stocks plummeted, taking the rest of the world down with them.

Then, in September 2015, China announced it would open its domestic foreign exchange market to foreign central banks, allowing the likes of the U.S. Federal Reserve and the European Central Bank to make bets on the renminbi’s value. In the past, central banks would have had to route investments in the yuan, the name of an individual unit of Chinese currency, through local banks — a costly and complicated process. This move was an imperative one, because central banks can now hedge bets on other currency, like the euro or dollar, in China because they can take a position on the renminbi.

In addition, the People’s Bank of China announced in October 2015 it would remove caps on deposit rates. This means financial institutions can offer Chinese savers a market-based rate of return for their money, as opposed to one determined by the Chinese central bank.

None of this means that the renminbi will be replacing the dollar as the world’s standard currency any time soon. As Lew noted last week, “Being part of the SDR basket at the IMF is quite a ways away from being a global reserve currency.”

The IMF’s decision also does not mean that Chinese authorities will stop meddling in their economy to keep its currency strong or to prevent massive stock losses Chinese stocks experienced last summer.

“We believe that the Chinese authorities will remain committed to exchange rate flexibility and capital account liberalization over the long-term as they hope to internationalize the [Chinese yuan] but progress is likely to be gradual and bumpy,” a team from BMI Research, which covers emerging markets, said a recent research note.

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