Wednesday, August 5, 2015

Will Chinese Market Drop Impact Yuan Inclusion in the SDR Basket?

The recent plunge in the Chinese stock market has caused some to question if this will impact the IMF decision to include the Yuan in the SDR currency basket. IMF Director Lagarde says she doesn't think so. Alasdair Macleod wonders if it might cause China to revert to "Plan B" (Gold). You see both points of view in the articles below. 

(Note: There is some breaking news on this which came out after this article was written, see note below. I decided to go ahead and run this article even though the IMF has now announced a delay in reviewing the Yuan).


China Still on Track for Reserve Status Bid says IMF

"China's interventions to stem its stock market turmoil should not derail its bid to gain reserve status for its currency, the International Monetary Fund managing director has said, predicting that the country's economy is strong enough to withstand the equity ruckus. 
Christine Lagarde endorsed Beijing's efforts to calm its stock market, playing down the declines in Shanghai to date as she pointed out that the market was still up 80 per cent on a year ago.
"We believe that the Chinese economy is resilient and strong enough to withstand that kind of significant variation in the markets," she said in an online question and answer session. 
China is seeking to gain admission for the renminbi to the IMF's basket of currencies making up its special drawing rights, or SDRs. The SDRs are funds that member countries can draw on in a crisis, and the inclusion of the Chinese currency in the basket of elite currencies would be an endorsement of its efforts to open up its financial system and a boost to the country's prestige."

"Bubbles collapse, period; and government interventions don't stop them. Furthermore, we are beginning to see a crack widen in the foundations of China's capital markets that could end up undermining the whole economy.

Since the government owns the banking system, some of the knock-on effects will doubtless be concealed. A consequence for China is that domestic financial instability could threaten her current plans for the international development of her currency. Here the timing couldn't be worse, because in a few months the IMF is due to announce its decision about the inclusion of the renminbi in the SDR*. The odds were in favour of China succeeding in this quest, on the basis that China was deemed to have fulfilled the necessary conditions, and the IMF itself has been supportive.

A 1929-style collapse in China's stock markets would change this delicate balance. In mainstream macroeconomic theory, the only way China can resolve her excessive financial imbalances is to devalue the renminbi against other SDR currencies, hardly a good start for a new member. The IMF, probably egged on by the Americans, could be forced to defer its decision again, reviewing it in 2020.

This would be a bad outcome, given China has set her sights on joining the IMF's top table. There can be little doubt that the recent announcement increasing her gold reserves by only 600 tonnes was made in the context of her desire for the currency to be included in the SDR. If she is rejected, China could swing the emphasis more firmly towards gold, which she owns and mines in abundance."


My added comments:

These articles are supportive of the blog article we did recently which looks at the current apparent sparring between the IMF and China. It also confirms that what happens with the IMF decision on including the Yuan into the SDR basket is a key event to follow. (see breaking news note below)

added note: Breaking news: Reuters is reporting the IMF will delay inclusion of the Yuan into the SDR until September 2016.  This article was written before this news brokeWe will do a full blog post on this news soon to look at what this may mean. It will include a comment by Jim Rickards on this news given for readers here.

Here is the official IMF comment on this:

IMF Survey: Why is staff proposing an extension of the current SDR basket?
Tiwari: To put this in context, the current SDR basket expires at the end of this year. We are proposing extending the current SDR basket by nine months until September 30, 2016. This is in response to feedback from SDR users on the desirability of avoiding changes in the basket at the end of the calendar year and facilitating continued smooth functioning of SDR-related operations. An extension of nine months would also allow users to adjust to a potential changed basket composition should the Executive Board decide to include the RMB.
The proposed extension, which will be decided by the Executive Board later this month, would not in any way prejudge the timing of conclusion or outcome of the review.

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