The recent devaluation of the Chinese currency needs to be studied in the context of the country’s efforts to include its currency in the IMF’s special drawing rights (SDR) basket. But whether China is really keen on allowing its currency to float, abandoning its two-decade-old policy of controlling its exchange rate, is a moot point.
Created in 1969 in order to supplement its member countries’ official reserves, the SDR basket currently comprises the US dollar, the euro, the pound and the yen.
The IMF reviews the SDR basket valuation every five years. The last review was in 2000 when the euro replaced the French franc and the German’s deutschemark. Currently the weights assigned to the currencies in the SDR basket are: US dollar (41.9 per cent), euro (37.4 per cent), British pound (11.3 per cent) and Japanese yen (9.4 per cent)
Freely usable currency
In April this year, IMF’s managing director, Christine Lagarde, noted that it was a question of when, not if, China’s renminbi (RMB, also known as yuan) will be included in the SDR basket. According to Lagarde, China’s economic reform plansshould help Beijing meet IMF criteria to join its SDR currency basket. According to reports, the IMF has decided to defer inclusion of the yuan to November since the currency showed mixed performance while meeting financial norms. It appears that while the Chinese currency could meet the requirements as a significant currency in terms of international trade, the yuan had failed to meet the requirements as a freely usable currency.
The IMF concept of a freely usable currency refers to the actual use and trading of currencies; it is distinct from whether a currency is freely floating or fully convertible. Noting that the currency was only thinly traded in North America and was not commonly used in international debt securities, the IMF paper said, “Across a range of indicators, the renminbi is now exhibiting a significant degree of international use and trading. At the same time the four freely usable currencies generally rank ahead of it.”
Hayden Briscoe of the asset management firm, Alliance-Bernstein, says the reason why the yuan may not be included in the SDR basket this November could be due to President Xi’s visit to the US in September when talks with President Obama will cover bilateral trade agreements — which is of great significance to China as it has been excluded from the Trans-Pacific Partnership Trade Agreement, now under negotiation between the US and several Pacific Rim countries. Given the influence that the US and its allies wield within the IMF, the inclusion of the yuan may have to wait at least till the US-China talks reach an agreement that both sides can support.
The rate record
Neither Japan nor China has a clean record in exchange rate management. Both the countries have manipulated their respective currencies to boost their exports. One may recall that in 1985, the Japanese yen at 220 to the dollar had almost killed the auto industry in the US, flooding the US market with Japanese cars. President Ronald Reagan intervened by imposing import quotas on Japanese cars. The yen rose to 120 to a dollar.
While the protagonists of free trade chose to denounce Reagan as a heretic, the fact remains that the US auto industry was saved by him.
China’s record is almost similar. With the end of recession and consequent recovery since March 2009, all the emerging economies in Asia witnessed surging capital flows causing significant appreciation of their currencies, to the point of destroying their export competitiveness. President Obama, during his maiden visit to Beijing in November 2009, called upon the Chinese government to allow the country’s currency to appreciate further. But the then Chinese president, Hu Jintao, chose to ignore the demand.
China’s currency was held at 6.83 to a dollar between mid-2008 and mid-2010. Prior to this, US policy documents observe that the dollar-yuan exchange rate went from 8.11 to 6.83 between July 2005 and July 2008. From June 2010 to July 2013, the yuan appreciated from 6.83 to 6.17 against the dollar, an insignificant rise.
The US, the European Union and the IMF had individually and collectively taken all possible measures during 2009 to persuade China to move away from its fixed exchange rate regime to a market-oriented one, but China was in no mood to oblige. The current devaluation of the yuan reflects China‘s desperation to get included into the SDR basket.
Currencies of countries that have a record of manipulating them should not find a place in the SDR basket. Since the yen already figures in the SDR basket, if the yuan is included, the combined weightage of the yen and the yuan should not exceed the existing weightage of 9.4 per cent currently assigned to the yen. This can be justified in terms of trading volumes.
The writer was with the International Monetary Fund
