What does the inclusion of the yuan in the number of reserve currencies mean for the world? In this article I would like to summarize some consequences and outcomes of that really important event in the world financial system which were expressed by the number of top-recognized financial experts throughout the world.
The effects are manifested only in the long term, but may prove to be very ambitious. As we know, on the 30th of November the Board of Directors of the International Monetary Fund (IMF) decided to include the Chinese yuan in the calculation of the basket of special drawing rights (Special Drawing Rights - SDR). De facto, this means that the yuan is recognized as a reserve currency on a par with the dollar, euro, pound and yen. The decision was widely expected. Back in early November, IMF Managing Director Christine Lagarde sounded fund analyst recommendations on inclusion of the yuan in the SDR. Why is the Chinese government so strongly desired to see the yuan among reserve currencies? What will change after the actual inclusion in the October 1, 2016?
In August, when there was a sudden collapse of the yuan, many commentators considered this declaration currency war by the Chinese Central Bank. But the main purpose of the mechanism of formation of the course change to the dollar (and the devaluation was only a consequence of this step) - is the inclusion of the yuan in the basket of currencies the IMF. In other words, the Central Bank of China showed the IMF that:
a) the yuan - not the dollar,
b) the yuan is determined by the market rather than the central bank (although the little allowed himself to intervene to maintain the national currency) (see Pic. 1),
c) the Central Bank of China is set to further liberalization currency market,
g) Remove the disparity between the yuan within the country and in Hong Kong.
The IMF has assigned the weight of the yuan in the SDR at the level of almost 11% (slightly lower than expected at 14-16%) and with virtually no reduced the weight of the dollar; for the new neighbor "paid" the euro (-6.5 percentage points) and pound (-2.2 p. p.). At the same time the share in the SDR is not a special practical value - the actual distribution of foreign exchange reserves (GCR) in the world has essentially shifted to the dollar (it accounts for 2/3 of the reserves).
What will positively change for China?
In the short term, very little - except that the new reality of the Central Bank of China to ward off any drastic steps that could lead to high volatility of the yuan (because it may discourage the desire of other central banks to invest in it its reserves).
In the long term, the direct benefits from the inclusion of the yuan in the SDR and the continuation of the process of its internationalization (it is more important process, including in SDR - only a small part of it), besides the obvious geopolitical, as follows:
- China will actively participate in the "enslavement" of countries receiving financial assistance from the IMF, imposing their conditions for granting loans SDR;
- The central banks of developing countries will be able to buy their reserves yuan and receive bilateral loans in RMB by China, that will automatically increase the size of their gold reserves, making it easier to pass the test of the IMF's financial stability. Central Bank of China has already signed more than 30 countries currency swap agreements at 3.3 trillion yuan (over $ 500 billion) in Vol.
- China will become easier to manage their gold reserves. Yuan itself becomes a reserve currency and gold reserves need to be significantly reduced, and no longer need to buy foreign currency from exporters;
- To reduce foreign exchange risks for Chinese companies, which stimulates them to increase global expansion in trade and investment, and will disappear or greatly reduce the need for hedging;
- To reduce transaction costs in foreign trade. Do not have to "chase" the money through dollars and correspondent accounts in American banks, which will save money on commissions and in terms of handling of funds. It is worth noting that the volume of foreign trade and investments made directly in RMB, increasing from year to year, but does not exceed 25-30% of the total foreign trade turnover;
- Reform of the financial market will continue, increasing the efficiency and transparency of Chinese banks and financial service providers. It stimulates the growth of employment in the sector and the creation of an international financial center in China;
- Bank of China get seignior - revenue from the issue of yuan in favor of the rest of the world. Now almost all such seigniorage goes to the United States, estimates vary from $ 244 billion to $ 424 billion for 1990-2010. (Federal Economic data system and the Bureau of Economic Analysis);
- Help to "let off steam" from the debt market, especially in the municipal and corporate sectors where domestic sources of financing on the verge of exhaustion. The internationalization of the renminbi would help "move" part of the debt to foreigners.
What will negatively change for China?
But getting larger and rights always implies greater responsibility. Here are some negative consequences can wait China:
- There is a risk of excessive appreciation of the yuan, which would put an end to the old mercantilist growth model. But it will give an incentive to domestic consumption and the economy, which will be transferred to the dirty and low-profit production. The main problem - unemployment, and therefore need to increase government spending on the establishment of service industries and domestic outsourcing;
- The current account goes into deficit. Otherwise the rest of the world can not "be satisfied" in yuan. There are, however, a workaround: You can "saturate" the world of the yuan through financial balance. For example, by the purchase of Chinese companies assets in the economies of the partner countries not in dollars, and for the yuan, or by actively lending to foreign countries and companies in the RMB;
- No currency restrictions will increase volatility in the domestic financial market, because speculative capital will be the flow in, the flow out and are always in extreme scale. This, in turn, is closely linked to another problem. Ideally (within the meaning of the IMF), China will have to implement radical reforms for the opening of the financial market, which will lead to the loss of a significant part of the control over the domestic money market. Perhaps, Beijing will try to take into account the experience of Japan and implemented without the full opening of the internationalization of the financial accounts and the internal market. It means further development of the operations with offshore renminbi (CNH);
- There is a risk of negative reactions from the side of trading partners, especially the United States, which can start to interfere with the development of China's economy to avoid reducing the hegemony of the dollar.
What does all written above mean for us, traders? I think that it means that very soon we will get another extremely interesting trading instrument with quite substantial turnover to fall under technical analysis criteria. And we have to start to learn more about Chinese economy and factors which are influencing on Yuan movements to meet the rising trading opportunities. World is changing fast and who knows, may be in couple of years we will see dramatic changes in FOREX market preferences. Hope, this article was helpful for you, dear community members, to meet the future more prepared! Happy New Year!