All you wanted to know about Yuan & special drawing rights

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After lots of gloomy news for China, there’s some good news at last. Last week IMF Chief Christine Lagarde announced that the bank’s staffers had voted in favour of the Chinese renminbi (yuan) being ushered into the select club of currencies that make up the IMF’s Special Drawing Rights (SDR) basket. Market experts say the yuan’s entry into SDR is now a done deal. They predict this will be a watershed moment for global markets.

What is it?

Just as the central bank of a country is the lender of last resort for its commercial banks, the IMF is a lender of last resort for its member nations. The SDR is a reserve fund that functions as an emergency reserve to supplement the forex coffers of member nations. IMF members are allocated SDRs and can borrow against them in case of a cash crunch.

The SDR reserve is made up of four major currencies — the US dollar, the euro, the Japanese yen and the British pound. The IMF has been quite picky about including any new currency in it and requires a new entrant to be stable, widely used and market-determined. No new currency has made it to the SDRs since the euro in 2001. The inclusion of the yuan would, therefore, represent a public acknowledgement by the IMF that China, a developing nation, has arrived on the global stage.

Why is it important?

One, central banks have been facing a devil-and-deep-sea choice on whether to hold more of their forex reserves in US dollars or gold (the euro has been a spent force lately). Now they have a third choice — the yuan. They may choose to buy the yuan to diversify forex reserves, ending the dollar’s hegemony.

Two, the yuan’s entry into SDR would be a pretty big boost for China’s prestige globally. After all, this would be an open acknowledgement by the Western world that the Chinese government is loosening its iron grip on the economy and is willing to take steps towards free markets.

China’s reputation for being reformist and market-oriented has taken a fair beating of late, after its knee-jerk moves to halt its August stock market rout by pulling up brokers for shorting stocks, suspending trading in large swathes of stocks and attempts to ‘talk up’ markets. But China’s decision, also in August, to allow the renminbi to ‘float’ just a tiny bit, seems to have convinced the IMF that it is SDR-worthy.

Three, the yuan could come to be used more widely in global trade transactions and borrowings. Today, the dollar leads that race by a mile; 43 per cent of international payments are settled in dollars and 28 per cent in euros, the yuan at a distant 2.4 per cent.

Why should I care?

Market players expect that the yuan’s inclusion into the SDR will set off a celebratory rally in the currency in the short term, as demand for it shoots up. That should be good news for Indian manufacturers, such as steel and chemical makers, who have been witnessing falling realisations due to China dumping its cheaper goods into global markets. You should cheer if you’re invested in commodity, engineering or power equipment stocks, the most affected by Chinese imports.

If you’re a big buyer of Chinese mobile phones, electronics and toys, prepare to shell out a little more for these products in the long run. However, given its large forex reserves, the Chinese central bank is expected to step in to arrest currency volatility.

The bottomline

Love it or hate it; but even the IMF can’t ignore China.

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Published on November 16, 2015

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