The Chinese government took two important decisions yesterday. It devalued its currency, the yuan, against the dollar by 2% and reformed the exchange rate system . Both decisions have immediate objective stimulate the economy and promote exports.
The IMF considers an appropriate way the new mechanism to determine the parity of the yuan as flexible Chinese currency market and makes it more market and less state intervention.
But beyond the target appointed to support exports everything indicates that Chinese authorities seek another strategic objective, the yuan become part of the basket of currencies that make up the Special Drawing Rights (SDRs). While the IMF argues that the decision taken by the Chinese authorities has no direct implications on the criteria used for this, if you recognize that favors the inclusion of the yuan.
What are Special Drawing Rights?
According to the IMF, SDRs are an active international reserve created in 1969 to supplement the official reserves of member countries. Ie can be part of the reserves of a country like the dollar or any other hard currency.
The value of the SDR is currently based on an integrated by the US dollar, euro, British pound and Japanese yen basket.
IMF examines the method of valuation of the SDR basket every five years to ensure that it reflects the relative importance of currencies in the global trading and financial systems, with the aim of safeguarding the benefits of the SDR as a reserve asset . Towards the end of this year it is to review and may incorporate new currency basket, to which the Chinese government hopes the yuan.
The criteria used by the IMF to decide whether a currency to be part of the basket of coins SDRs are fundamentally
:: You are from countries or monetary unions with the highest value of exports of goods and services during a period of five years, ie, that are of central countries in the world economy,
:: That the currencies in the basket are widely used in financial transactions,
:: You are currencies “free use”.
China certainly more than meets the first requirement, but not the second and third. The action taken yesterday is aimed to meet them and also it is increasingly common for contracts signed by China are denominated in yuan rather than in euros, dollars or yen which facilitates compliance with the second requirement.
The agreement governing the SDR currency is understood that a “free use” when it is widely used to make payments for international transactions and actively traded on major markets currency. These requirements do not imply that the currency is fully convertible free or floating.
The next IMF review to be conducted will stop especially if the yuan qualify to become part of the “basket of currencies” and will focus on the criterion of “free use”.
But more likely is that the situation remains as it is now since the IMF staff proposed to be extended until October 2016. The rationale for this proposal is purely technical as it seeks to avoid changes in the basket at the end of the year and facilitate the smooth running of operations related to the SDR. “An extension of nine months would also allow users to adapt to a new basket composition if the IMF Executive Board decided to include the yuan”.
Modifying the SDR valuation method requires a majority of 70% of the total votes . Remember that US and Europe are overrepresented in the IMF and control it , so that if the two powers disagree, the yuan would stay out of the basket, but it seems that within a year the yuan will be in that basket and you become with it in a currency that will not only serve to designate the part of international transactions that make China, but will become a global reserve currency in competition especially with the dollar but also the euro, with the privilege this means for the country issuing the currency.