Mid-Year Perspective on the Status of China’s Currency

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Written by Todd R. Vollmers, Managing Director, Global Access CSG

There has been increasing interest in trends pertaining to China, particularly given its relatively new role as the world’s second largest economy and growing importance to international trade and the global economy. Since 1978 (when China began instituting political reform making it more open) according to the International Monetary Fund (IMF) China’s Gross Domestic Product (GDP) has increased from 2.3 percent of the world economy to almost 18 percent. As a result, the Chinese economy exerts substantial influence on a variety of economic measures, including U.S. imports and exports, as well as global prices for such commodities as agricultural products and oil.    

A key question related to China has been its progress toward a flexible exchange rate for its currency (officially called the Renminbi (RMB), which is denominated in “yuan” as the unit of account).  China is one of the “Original members” of the IMF, which oversees the international monetary system as one of its core responsibilities. In addition, the IMF also monitors the financial and economic policies of its 189 member countries, which for each member country is part of a process known as an Article IV Consultation. The IMF recently concluded its Annual Policy Dialogue in Beijing in mid-June, and among other things, made some comments relevant to China’s monetary policy.

As described by the IMF, the key subject of discussions with Chinese officials and policymakers was the urgent need to accelerate the pace of reform, including allowing the yuan to move more freely, with improved communication with markets. A statement from the IMF’s First Deputy Managing Director, David Lipton, summarized that “[c]apital flow measures should be applied transparently and consistently” and that “[f]urther capital account liberalisation should be carefully sequenced with the necessary supporting reforms, including an effective monetary policy framework, sound financial system, and exchange rate flexibility.”  

Incidentally, the IMF meeting in Beijing happened less than one month after the Chinese central bank changed its daily yuan reference rate formula and introduced a “counter-cyclical adjustment factor” that it said was meant to reduce volatility in the currency.  Reacting to this move, some analysts have argued that the change was meant to reduce transparency over the yuan exchange rate, while others speculated that it was intended to counter downward pressure on the yuan in the event the U.S. Federal Reserve raises interest rates (thereby increasing the demand for the U.S. dollar). Bloomberg, citing unnamed sources, reported that the “counter-cyclical adjustment factor” will be added to the closing exchange rate and to the basket of currencies for calculating the yuan’s daily fixing, or the mid-point rate from which the yuan is allowed to trade by up to 2 percent. In any case, this new component was expected to undermine the significance of the daily closing price against the U.S. dollar in the calculation. 

One of China’s primary goals is to further solidify its position as a global economic power. In a milestone event toward that goal, in 2016 the yuan joined the U.S. dollar, euro, Japanese yen, and British pound in the IMF’s Special Drawing Rights (SDR) basket (which determines the currencies that countries can receive as part of IMF loans), and which was the first time that a new currency had been added since launch of the euro in 1999. Some pointed out at the time that the addition of the yuan was largely symbolic, since the yuan did not yet fully meet the IMF reserve currency criteria of being freely usable, widely used to settle trade, or widely traded in international financial markets. Symbols matter. China’s inclusion in the SDR basket is and has been a significant event. Chinese policymakers are, of course, aware that there is more work to do before full reserve currency status is achieved. It will be interesting to follow China’s path.