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Paola Subacchi: Seeing through the SDR hype

The inclusion of the yuan among the currencies that compose the Special Drawing Rights -- the International Monetary Fund's international reserve asset -- is a "milestone" for China, as IMF Managing Director Christine Lagarde said when she presented the executive board's decision on Nov. 30. Indeed, including the yuan, or renminbi, in this group -- the other key currencies are the dollar, the euro, the yen and the pound -- is hugely symbolic for the Chinese leadership.

     The decision recognizes the work that China's monetary authorities have done in the last five years to push the yuan's transformation into an international currency. The outcome of this process has been remarkable. Approximately 25% of China's trade is now settled in its own currency -- the ratio was less than 1% in 2009 -- and the redback is now the fourth most-used currency in international payments. It was No. 12 in 2012.

     In addition, the inclusion is a step toward addressing the contradiction that China has faced for years, that of being the world's second-largest economy and the largest exporter without a currency that reflects that role.

A "GREAT CURRENCY"   For years, the dollar has been the currency used in China's trade and investments -- and this is still largely the case. This suited China well throughout its transformation from a poor and isolated nation into an industrial powerhouse that is well-integrated in regional and international supply chains. But China's dollar dependence no longer reflects Beijing's ambitions for a more engaged and assertive role in international economic and financial affairs and governance. If "great nations have great currencies," to paraphrase Nobel laureate Robert Mundell, then the Chinese leadership's push to turn the yuan into a "great currency" is understandable.

     Finally, and even more critically, being part of the SDR basket implicitly recognizes the role the yuan can play in the international monetary system. The issue of how that system will look in the future was raised by China's central bank governor, Zhou Xiaochuan, in 2009 -- a few months after the eruption of the global financial crisis. He questioned whether a dollar-centered system was suitable for a more complex, multipolar world economy, where large emerging markets increasingly drive growth along with advanced countries.

     Still, the hype that has surrounded the IMF decision -- the SDR has made headlines beyond the financial press, perhaps for the first time since its creation in 1969 -- should not obscure the fact that the yuan's development is not a linear process, even if it is heavily policy-driven. And there is no guarantee that progress will continue at the same impressive pace.

     The yuan remains a currency with limited international circulation because of obstacles that are still in place to constrain capital flows into and out of China. As a result, it is fully convertible only in designated financial centers -- Hong Kong, Singapore and London, for example -- with a renminbi offshore market.

     To make the yuan an international currency that foreigners want to hold as a store of value -- one of the three functions of money -- the Chinese leadership needs to forge ahead with reforms. At the top of the list is the exchange rate and the abandonment of the system where the central bank intervenes every time the value of the yuan moves outside a predetermined range. Until foreign investors believe the Chinese currency is as liquid and trustworthy as the other components of the SDR basket, it will remain of limited international use and circulation.

     Until then, any suggestion that the yuan may one day rival the dollar and seriously threaten the greenback's dominance is wishful thinking. The Chinese leadership is conscious of the limits of their currency. In fact, there has been no hint to the possibility -- or ambition -- that the yuan will eventually replace the dollar as the key international currency. Instead, Beijing policymakers openly discuss the transformation of the current monetary system into a multicurrency one that reflects the main regional trading blocs -- America, Europe and Asia.

     The inclusion of the yuan in the SDR basket is a step in the right direction, but much more needs to be done to make it a pillar of this multicurrency system.

Paola Subacchi is director of economic research at Chatham House (the Royal Institute of International Affairs) in London.

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