And China is in the basket… - HATICE KARAHAN

And China is in the basket…

I concluded my last column on the topic saying, "in slow but determined steps." I am talking about my August 15 column titled, "Çin'den Yuan Salvosu” (China's Yuan Salvo).

Back then I stated that the exchange rate move that stirred the world was actually strategic and also mentioned my June 23 column titled "Farewell to the US Dollar, Welcome Yuan." As for today, I am going to take as basis these two columns and continue to build on the topic with a new development.

First, let me summarize in a nutshell, for those who are unfamiliar with the topic, the main point in those two columns: China was making strategic plans in the finance front to achieve a maximum effective position in the future of world economy. Hence, as a step toward achieving this goal, it wanted to include the RMB in the International Monetary Fund's (IMF) Special Drawing Rights (SDR) basket of currencies on the path to making it an international currency.

Now, let's take a look at what happened within the context of the latest developments in points:

1- WHAT HAPPENED?

The IMF had been reviewing for some time within the context of its five-year observations, China's request to go in the SDR basket. It announced its decision with a statement it made on November 30: From now on, the Yuan/Renminbi (RMB) will be the fifth currency in the basket along with the US dollar, euro, yen and pound. The decision will become effective October 1, 2016 with the activation of the new basket. The new decision is the first major change since the Deutsche mark and French franc were replaced by the euro in 1999.

2- HOW DID IT HAPPEN?

So how did the RMB gain the right to get into the basket? At this point, the IMF raises two criteria. The first is that the currency in question must be that of an issuing country among the largest exporters in the world in the last five years. The second is the condition that its currency is “freely usable,” in order to emphasize the importance of financial transactions... Nobody has anything to say about the first condition; the figures say it all. However, approval of the second condition would confirm to the world that the RMB is a freely usable currency.

3- WHAT WILL HAPPEN NOW?

The weight in the new basket waiting to come into effect on October 2016 is gaining a new formula. Accordingly, while the weights for the dollar and euro are dropping to 41.73 percent and 30.93 percent, respectively, we see that the RMB entered the basket in third position, weighing in at 10.92 percent. In addition to being a lower rate than anticipated, the weight of the RMB is going to be in a better state than the Yen (8.33 percent) and pound (8.09 percent) it left behind. The value of the SDR will consist of the weighted average of these currencies. In the meantime, the SDR's interest rate will continue to be calculated within the scope of the interest rates of the short-term financial instruments in the markets of the relevant currencies. This means one more RMB instrument will be added to the calculations. In the meantime, according to Christine Lagarde, managing director of the IMF, the inclusion of the RMB will enhance the attractiveness of the SDR by diversifying the basket and making it more representative of the world's major currencies.

4- HOW WILL THIS AFFECT CHINA?

Getting in the SDR basket, is, for China, a victory whose real effect can be seen in the international platform, rather than a gain of power under the IMF.

Giving the world the message that the RMB is an important currency automatically consolidates China's position the in global financial system.

In line with this, another impact of being included in the SDR might be foreseen as the RMB increasingly becomes the currency with the most increased use worldwide. Because it might be thought that being in the basket will ensure more incline toward the Chinese currency and have a positive impact on the RMB and related assets. Both in terms of central banks and transactions/investors… Is it not China's aim anyway to gain international power for its currency through the channel of such impacts?

On the other hand, there is no doubt that the degree to which this impact is felt will be closely related to China's performance with regard to new reforms. As stated by Lagarde, the inclusion in the basket is an important milestone in China's global financial integration. This is also a positive indicator in the recognition of the progress that the Chinese authorities have made in the past in reforming the country's monetary and financial systems… However, in order to reach its intended destination, it will be appropriate for China to increase its efforts associated with the reform signals it gave to the IMF.

The point is, China has achieved another success that will consolidate its place in world economy by overcoming this hurdle, too. I am going to make the same conclusion as in my previous column, yet this fact has been confirmed once more: China is playing in every field, and smart for the long haul. On this path, it is progressing in slow but determined steps.







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