IMF's decision to include yuan in SDR basket raises geo-political concerns

The International Monetary Fund (IMF) yesterday decided to allow the Chinese yuan also known as renminbi to enter the prestigious reserve currency basket. The IMF’s decision described as "an important milestone" for the Chinese economy was also supported by the U.S. The decision that will come into effect on 1st October 2016 has paved the way for yuan to join the US dollar, euro, Japanese yen and British pound as a special currency in the IMF’s special drawing rights (SDR) basket. 




With its decision the IMF stresses that it considers the yuan to be safe, reliable and freely usable. The IMF decided in favour of the yuan recognising the progress that the “Chinese authorities have made in the past years in reforming China’s monetary and financial systems,” Christine Lagarde, the managing director of the I.M.F. said.

China loosened control on yuan to meet IMF criteria

China in 2014 had asked for the yuan to be added to the Fund's Special Drawing Rights list. The IMF had however in August noted that the Chinese currency was too tightly controlled to meet IMF’s criteria. Following this the Chinese authority gave up some of its tight control over the yuan resulting in the devaluation of the renminbi. With opting for the currency devaluation, China changed the way it sets the renminbi value each morning thereby allowing market forces to play a bigger role. China’s efforts prompted the Fund to state in November that China had taken the required steps for its currency to be called "freely usable".

Last month saw China permitting an initial group of foreign central banks to enter the Chinese currency market to bolster further internationalisation of the yuan in global trading.

IMF’s decision highlighted rising economic power of China

The inclusion of the yuan into the basket comes with significant benefits. It will work to cement China’s position as a global economic power as it will increase yuan’s use in international trade and finance. Also, the currency will beginning September 2016 become one of the major currencies used in the disbursement as well as repayment of international bailouts. President Xi Jinping of China said the renminbi’s new status “will improve the international monetary system and safeguard global financial stability”.

IMF director Lagarde said the yuan's inclusion in the basket will help China to further open up to the world economy; while Ann Lee, an economics professor at New York University China would become a "much more responsible financial power” with the yuan’s inclusion in the SDR basket. The PBoC will now likely be under pressure to provide more transparency like the Federal Reserve and the European Central Bank.

China’s economic overhaul however does not end here. China continues to exercise regulatory control over its financial system. Also, the Communist Party continues to interfere in deciding court cases. This leads to the country to fall short in legal protections. Issues such as these will limit the currency’s overall appeal.
The SDR classification alone cannot make the yuan to challenge the dollar for the position of top global reserve currency. Economic attractiveness of particular currencies has been found to drive reserve decisions. This economic attractiveness is increased when the exchange rate is stable.

Geo-political impact

The IMF’s decision will have considerable geopolitical repercussions as well. Given that China is America’s geopolitical rival the yuan will be favoured as a reserve currency by those countries that are dissatisfied with the U.S. order. Countries that support the U.S.-led order are unlikely to be inclined to diversify their reserves into yuan. On the other hand states that are less supportive of the U.S. order will shift reserve assets into yuan.

The IMF’s decision will lead to the U.S.-led liberal order that upholds free market capitalism being challenged. The position of the dollar as top reserve currency is the symbol of the overall American power. Thus national decisions to invest in yuan instead of the dollar might read as rejection of American dominance.

Also, once decision to include yuan in the SDR basket comes into effect, it will be extremely difficult for the West to impose financial sanctions on countries accused of human rights abuses and other violations. In the event of such sanctions the accused countries like Sudan and North Korea will choose to carry out their transactions in renminbi.