Devaluation throws spotlight on yuan’s reserve currency prospects

China’s devaluation of the yuan last Tuesday and Wednesday has drawn divergent reactions from international analysts about the likely impact the move would have on the country’s bid to have the currency become a global reserve currency. Since a rejection five years ago, China has been pushing to have the renminbi (official name of the yuan) accepted as a global reserve currency alongside the dollar, yen, euro and sterling by the International Monetary Fund (IMF).

The Fund, this month, cited the need for great exchange rate flexibility as a key requirement. The world’s second largest economy rattled global financial markets by devaluing its currency in what it said was an effort to make its exchange rate more market-oriented.

The yuan’s value declined 1.9 per cent on Tuesday, its biggest one-day drop in a decade, and dropped a further 1.6 per cent last Wednesday. The People’s Bank of China said that it acted because the yuan has been rising even when market forces say it should be falling.

An overvalued yuan has hurt Chinese exporters by making their products more expensive overseas. Analysts noted that a weaker yuan could reduce exports of US goods to China, already down nearly five per cent this year through June.

American politicians, who have long charged that China keeps its currency artificially low to give its exporters an edge, denounced the devaluation. But economists doubt that a one-day two per cent drop in the yuan, which is a move China has called a onetime event, will do much damage to exports from the United States or other countries. “Two per cent is no big deal,” said Mark Zandi, chief economist at Moody’s Analytics. “Ten per cent over the next few months would be a big deal.”

A senior fellow at the Brookings Institution, David Dollar, said that the move will allow the yuan to make bigger, faster moves up or down and better reflect investors’ outlook on the prospects for China and its currency. According to US Senator Charles Schumer, “Allowing the renminbi to be declared a reserve currency is akin to putting the fox in charge of the henhouse. Unless and until China stops artificially devaluing their currency, the renminbi should be barred from consideration as a global reserve currency by the International Monetary Fund (IMF).”

The Fund staff members disclosed last week that a decision on the yuan becoming a reserve currency could be postponed by nine months, until September 2016, pointing out that more “significant work” in analysing data was needed on the issue.

Analysts say that inclusion would help the world’s second-largest economy challenge the dollar’s dominance in global trade and finance. According to a Central Bank of Nigeria (CBN) publications survey of central banks carried out in March this year, sponsored by HSBC Holdings Plc, China’s currency will account for 10 per cent of world reserves by 2025.

The survey found that the yuan would make up an estimated 2.9 per cent of foreign-exchange stockpiles by the end of this year.

Of the 72 monetary authorities with $5.9 trillion in reserves that the authors of the report spoke with, 35 said they either held yuan or were considering doing so.