On November 30, China will join the world economic power big leagues. But it will be a while before China really belongs there… and before it really matters.
That’s when the International Monetary Fund (IMF) is likely to announce that it will add the yuan, the Chinese currency, to its Special Drawing Right (SDR), a basket of the world’s four most liquid and freely traded international currencies.
China cares about the opinion of the IMF, a multi-lateral non-government organization that focuses on global financial stability and provides financial help and advice to its 188 country members. The SDR is a kind of artificial currency that member countries can use by exchanging it for other freely usable currencies. By being included – along with the U.S. dollar, the euro, the British pound, and the Japanese yen – in the SDR, the IMF is acknowledging China as a major player in global finance.
In practical terms, this will open the door to the yuan being able to be held as a reserve currency by central banks around the world. That means that over time, central banks will shift some of their assets into yuan and out of the other four main currencies used as reserve currencies. That should support China’s currency.
Diversifying the pool of reserve currencies might also reduce volatility in global markets. China’s government has argued that a global financial system that’s less focused on the U.S. dollar might be less vulnerable to interest rate changes by the U.S. Federal Reserve, for example.
Countries that do a significant amount of trade with China will probably be among the first to add yuan to their reserves. This would allow them to make payments to China directly – rather than converting into yuan from dollars or from other currencies held by governments.
Politics have played a big role in the decision to allow China’s currency to enter the SDR club. China is the second-largest economy in the world. The IMF could not ignore China any longer.
But China’s currency, and its financial system, are still only partly integrated into the global economy. “[Joining the SDR] is not a substitute for Beijing continuing to liberalise financial markets and capital flows in order to promote the use of its currency abroad,” wrote the Financial Times.
China still has to implement major economic reforms, such as dismantling the controls it currently has on the free movement of capital into and out of the country. In its latest Five-Year Plan, the Chinese government called for the yuan to become “freely convertible and usable” by 2020. That China still even has five-year plans, which date back to the communist era, goes against the economic liberalization that joining the SDR will require.
Until China makes real changes, joining the IMF’s SDR will be symbolic. November 30 will be important for China. But the most important things will only happen a lot later.