The International Monetary Fund (IMF) on Monday, as expected, admitted China’s yuan (CNY) into its benchmark currency basket.
The IMF’s special drawing rights (SDR) basked now also includes yuan along with the dollar, euro, pound sterling and yen. The move was expected as China undertook a number of reforms in the last couple of months - access for foreigners to Chinese currency markets, more frequent debt issuance and expanded yuan trading hours.
The CNY will join the basket from October 2016. Till then, the composition stays - 41.9% dollar, 37.4% euro, 11.3% sterling and 9.4% yen. Post Oct 2016, CNY will have a 10.92% share, the euro’s share will be 30.93%. Sterling and yen will also have lower weights, while the USD share will stay more or less same.
However, in the long run, the currency internalization could lead to export of Chinese savings far higher than what China may receive. The re-balancing process is still underway and thus China could slow down even further and thus Chinese financial assets may not be as attractive for foreign investors.
Household, business and government savings in 2013 as a percentage of GDP stood at 51% in 2013, compared to 17% in the USA. These huge savings could be exported (in other high yielding economies) leading to a weak CNY. The nation is also expected to continue easing its monetary policy (rate cuts), which will further make the Chinese currency unattractive and trigger more outflows of Chinese savings.
Moreover, the PBOC does not need to do QE in case the currency wars intensify and the CNY stays overvalued and results in a recession. The export of Chinese savings after opening up its capital account and accelerate domestic financial reforms would be enough to trigger a sharp drop in the CNY.
Overall, a short-term demand for the CNY denominated assets could lead to a minor bout of strength, still, the odds are very low given the PBOC is on the easing cycle, while the Fed is likely to begin tightening.
The Yuan’s inclusion in the SDR and the ensuing reforms means the markets would eventually have the last word on the yuan in the long-run, which again indicates at the CNY weakness in the long-term.
A short-term strength in the CNY due to a rise in the CNY denominated assets may not rub other Asian currencies positively, however, an eventual decline in the CNY is likely to force other Asian central banks to stay accommodative and lead to drop in their respective currencies.
The IMF’s special drawing rights (SDR) basked now also includes yuan along with the dollar, euro, pound sterling and yen. The move was expected as China undertook a number of reforms in the last couple of months - access for foreigners to Chinese currency markets, more frequent debt issuance and expanded yuan trading hours.
The CNY will join the basket from October 2016. Till then, the composition stays - 41.9% dollar, 37.4% euro, 11.3% sterling and 9.4% yen. Post Oct 2016, CNY will have a 10.92% share, the euro’s share will be 30.93%. Sterling and yen will also have lower weights, while the USD share will stay more or less same.
Inclusion in SDR does not mean Yuan will be stronger
The popular opinion says the inclusion in the SDR would result in CNY strength. To some extent that may happen as countries having strong trade and funding ties with China could increase Yuan holdings. As per the Chinese academy of Social Sciences, the inclusion in the SDR could add less than USD 20 billion in new foreign demand for CNY-denominated assets.However, in the long run, the currency internalization could lead to export of Chinese savings far higher than what China may receive. The re-balancing process is still underway and thus China could slow down even further and thus Chinese financial assets may not be as attractive for foreign investors.
Household, business and government savings in 2013 as a percentage of GDP stood at 51% in 2013, compared to 17% in the USA. These huge savings could be exported (in other high yielding economies) leading to a weak CNY. The nation is also expected to continue easing its monetary policy (rate cuts), which will further make the Chinese currency unattractive and trigger more outflows of Chinese savings.
Moreover, the PBOC does not need to do QE in case the currency wars intensify and the CNY stays overvalued and results in a recession. The export of Chinese savings after opening up its capital account and accelerate domestic financial reforms would be enough to trigger a sharp drop in the CNY.
Overall, a short-term demand for the CNY denominated assets could lead to a minor bout of strength, still, the odds are very low given the PBOC is on the easing cycle, while the Fed is likely to begin tightening.
The Yuan’s inclusion in the SDR and the ensuing reforms means the markets would eventually have the last word on the yuan in the long-run, which again indicates at the CNY weakness in the long-term.
USD/CNY – Weekly chart
- A bullish break from the triangle formation on the weekly chart, followed by a move in the rising channel indicates the pair is likely to test 6.60-6.70 in 2016. A break above the rising channel would open doors for 6.80-7.00 levels in 2017.
- The rising channel support around 6.28-6.30 could be tested on short-term rise in the Yuan denominated assets.
Yuan a regional anchor, other Asian currencies could weaken as well
Asian currencies excluding the Yen are known to follow the CNY. This was evident from the slide in the Asian currencies in August, after shift in PBOC’s FX policy triggered a drop in the CNY.A short-term strength in the CNY due to a rise in the CNY denominated assets may not rub other Asian currencies positively, however, an eventual decline in the CNY is likely to force other Asian central banks to stay accommodative and lead to drop in their respective currencies.
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