China’s yuan is poised to enter the big leagues of global currencies, according to the judgment of the International Monetary Fund.
IMF staff have recommended the yuan be included in the fund’s Special Drawing Rights reserve-currency basket, alongside the U.S. dollar, euro, pound and yen, IMF Managing Director Christine Lagarde said Friday. The staff nod makes approval by the fund’s board this month all but certain, as major IMF shareholders including the U.S. have said they will support inclusion if the yuan meets IMF criteria. It would be the first change in the SDR’s currency composition since 2001, when the euro replaced the German deutsche mark and French franc.
The Washington-based fund’s endorsement would mark a major milestone in a decades-long ascent toward international credibility for the yuan, which was created after World War II and for years could be used only domestically in the Communist-controlled nation. Approval probably will make more countries comfortable including the currency in their foreign-exchange holdings, while boosting President Xi Jinping’s drive to open up the world’s second-biggest economy.
Inclusion would also be a bright spot for China in a tumultuous year for its economy, which has been buffeted by slowing growth, a tumbling stock market and a shift by authorities toward a more market-oriented exchange rate. Market turmoil worldwide followed a devaluation of the yuan in August and the government attempted to prop up equities, spurring investors to question the credibility of policy making.
IMF staff members determined that the yuan meets the requirement of being “freely usable,” Lagarde said in an e-mailed statement. The board had rejected including the yuan following the last review, in 2010, concluding the currency didn’t meet the test.
“The staff also finds that the Chinese authorities have addressed all remaining operational issues identified in an initial staff analysis submitted to the Executive Board in July,” Lagarde said, adding that she supports the findings. 
The IMF said “freely usable” refers to a currency being widely used for international transactions and widely traded in foreign-exchange markets. The fund didn’t immediately provide a copy of the report to be presented to the board.
This “is a very clear and strong endorsement,” said Brendan Ahern, managing director of Krane Fund Advisors LLC in New York. “No hesitation, no ifs, no buts. Very strong recommendation from Christine Lagarde. It isn’t a vote but at the same time it is hard to find any reasons to disagree.”

Board Meeting

The report will inform the IMF executive board, which represents the fund’s 188 member nations, ahead of a meeting planned for Nov. 30 to consider the matter. The IMF is wrapping up its twice-a-decade review of the composition of the SDR basket.
“Essentially this is a done deal,” said David Loevinger, managing director of emerging-markets sovereign research at asset manager TCW Group Inc. in Los Angeles. “We could end up seeing more flexibility in the currency” once the yuan is added to the IMF basket, said Loevinger, a former China specialist at the U.S. Treasury Department.
Gaining the reserve status would be a crowning achievement for central bank Governor Zhou Xiaochuan, 67, who has held out the obscure SDR, the IMF’s unit of account, as a potential badge of global prestige for China, persuading Communist Party leaders to open up the financial system and set up trading for the yuan around the world.
The People’s Bank of China said it welcomed the IMF staff proposal. The yuan’s inclusion will make the SDR more representative and attractive, improve the international monetary system “and is a win-win result for China and the world,” the central bank said in a statement on its website.
Standard Chartered Plc and AXA Investment Managers have predicted at least $1 trillion of global reserves will convert to Chinese assets if the yuan joins the IMF’s reserve basket.

IMF Standing

Adding the currency to the basket may also help the IMF improve its standing with China, which passed Japan in 2010 as the world’s No. 2 economy. China and other emerging markets were supposed to gain greater representation at the fund under reforms agreed to in 2010, but the U.S. Congress has yet to ratify the changes.
The fund created the SDR in 1969 to boost global liquidity as the Bretton Woods system of fixed exchange rates unraveled. While the SDR is not technically a currency, it gives IMF member countries who hold it the right to obtain any of the currencies in the basket to meet balance-of-payments needs. The equivalent of about $280 billion in SDRs were created and allocated to members as of September, compared with about $11.3 trillion in global reserve assets.
The U.S. took a step toward backing China’s SDR bid in September, when it softened its insistence that the Chinese implement financial reforms to win support. The U.S. said it would support inclusion of the yuan if it demonstrates it meets the IMF’s technical criteria.
IMF staff said in the report to the board earlier this year that the yuan trails its global counterparts in major benchmarks, such as its use in official reserves, debt holdings and currency trading. Following the recommendation of staff, the board delayed by nine months, until the end of September 2016, the implementation of any change to the basket.
Since that report, the PBOC and Finance Ministry took various steps to satisfy the IMF’s issues, including overhauling the reference-rate mechanism, allowing foreign central banks to trade all onshore currency products and issuing three-month debt to improve the short-term yield curve.
“China needs to improve the policy transparency to convince and attract global investors,” said Zhou Hao, a senior economist at Commerzbank AG in Singapore. While China has moved to reform its markets, the PBoC “should reduce the frequency of market intervention, allowing market forces to really play a critical role.”
In a 2009 speech, Zhou said the global financial crisis underscored the risks of a monetary system that relies on national reserve currencies. While not mentioning the yuan by name, Zhou argued that the SDR should take on the role of a “super-sovereign reserve currency,” with its basket expanded to include currencies of all major economies.
Chinese officials had since become explicit in their ambitions for the yuan to gain the status at the IMF. After meeting President Barack Obama in September at the White House, President Xi thanked the U.S. for its conditional support for the yuan joining the SDR.