At the end of March, the IMF for the first time revealed the yuan’s share of allocated global foreign exchange reserves. By the end of the last quarter of 2016, yuan-denominated holdings hit $84.51 billion, accounting for 1.07 percent of global foreign currency reserves, per IMF data, which gives the yuan a lending hand in making a fundamental change from zero to one. This is once again another IMF endorsement for the yuan’s global position, which boosts the Chinese currency’s international recognition yet indicates substantial room for the yuan to function as a global reserve currency and that the yuan a long way to go to be internationalized.
In September 2015, China started reporting quarterly statistics of its official breakdown of foreign currency reserves to the IMF on a volunteer basis. After the yuan’s official inclusion into the Special Drawing Rights (SDR) basket on October 1, 2016, the Washington-based fund began separately identifying yuan-denominated assets in its currency composition of official foreign exchange reserves (COFER) to reflect the yuan’s share of global foreign exchange reserves.The data announcement has three positive impacts for the Chinese currency.
First, the yuan’s internationalization has made a breakthrough.The yuan has become the eighth currency separately identified in the IMF’s COFER data, including the US dollar, euro, Japanese yen, pound sterling, Australian dollar, Canadian dollar and Swiss franc. This establishes the yuan’s role as a reserve currency, which means that the yuan is being gradually recognized and accepted as a reserve currency by other countries and regions.
Second, the announcement has added an important indicator to the yuan’s internationalization. According to IMF tradition, the COFER data is published at the end of every quarter. The IMF’s identification of the yuan in the COFER database reveals the absolute value of yuan-denominated holdings as well as the yuan’s share of global official forex reserves, enabling a comparison both horizontally and vertically of the yuan’s functioning as a reserve currency and thus clearly evaluating the progress of yuan internationalization.
Third, the identification sets a clear goal for the yuan to be globalized.Yuan assets only represent 1 percent of world forex reserves, which doesn’t match China’s position as the world’s second largest economy and indicates considerable room for improvement. Between 2014 and 2016, the US dollar, euro, Japanese yen and pound sterling accounted for roughly 64 percent, 20 percent, 4 percent and 4 percent, respectively, in global forex reserves, according to the IMF data. This suggests that it’s a practical goal for the yuan to catch up with the Japanese yen and pound sterling.
Serving as a reserve currency is one of the three main functions of an international currency. It can be said that it is the ultimate goal for a currency to be internationalized. The yuan is now being presented with the opportunity to become a reserve currency. International forex reserves are currently composed of currencies, gold and SDR, with the dollar taking the dominant role. However, the fact that the Asian financial crisis, the 2008 global financial crisis, European sovereign debt crisis and the US Federal Reserve’s monetary policy have led to continual turbulence in the global economy makes the case for an urgent change of the international reserve currency framework. Along with a conspicuous rise in China’s economic power and the overall national strength, there’s a growing demand for the yuan, which makes it increasingly urgent to push the yuan to be a global reserve currency. Additionally, China has in recent years taken a raft of measures to push for the internationalization of the yuan and has made substantial progress: a global network providing 24-hour yuan clearing capabilities has been established covering major financial hubs in Asia, Europe, Oceania and North America; direct convertibility has been launched between the yuan and several major currencies such as the euro, sterling pound, Japanese yen and Swiss franc; China has signed currency swap agreements with many countries and regions; and the yuan has been added into the IMF’s SDR basket.
As such, a strong yuan currency is indispensable for the country to become a decisive power in the world. It is advised that policymakers should have an eye to the future, steadily push forward with the yuan’s internationalization and focus on enhancing the yuan’s reserve capabilities. This means China should take the opportunity of the yuan’s SDR inclusion, increasing communication and collaboration with other central banks and further extending currency swap arrangements to more countries and regions. Also, the country is expected to borrow strength from the Belt and Road initiative, elevating the openness of its domestic bond market, enriching the portfolio of yuan-denominated products, and expanding the offshore yuan bond market. In this regard, it is an urgent priority to work out plans to put a bond connect in place between the Chinese mainland and Hong Kong. It also needs to be pointed out that the country should seek a balance between capital account opening, yuan internationalization and financial safety, avoiding backward steps yet getting ready to apply the brakes when needed.