Keep yuan out of IMF currency basket

As expected, the Chinese currency came under the spotlight at the G20 meetings held in France during the weekend, although the currency issue was not formally tabled for discussions.

The calls for China to appreciate the value of the yuan are still loud, but now other voices can be heard as some people, including French President Nicolas Sarkozy, are calling for the yuan to be included in the international foreign exchange reserve assets allocated to nations by the International Monetary Fund, the Special Drawing Right (SDR).

With China now the world's second largest economy the calls to include the yuan in the SDR basket of currencies might appear to be out of respect for China. But is that really the case?

The SDR international reserve asset is seen as the best tool available to replace the US dollar at a time when the European Union, led by Germany and France, is keen to challenge, if not take over, the leadership of the world's financial system from the US.

To win that battle, they need the backing of China, and one of the best ways to get China onboard is to call for an inclusion of the yuan in the SDR basket of currencies.

Zhou Xiaochuan, governor of the People's Bank of China, has advocated replacing the US dollar with the SDR as a means of fending off the financial turmoil stemming from an exchange reserve system that relies too much on the greenback.

The SDR mechanism was originally established to mitigate the fact that the United States had to incur large trade deficits in order to meet the demand for dollars required by the global trading system, but these deficits in time have diminished the value of the dollar.

However, SDRs now account for about 4 percent of international reserves, compared with more than 60 percent for the US dollar and about 26 percent for the euro.

Drawing an analogy, the relationship between the SDR and the US dollar is like that between Esperanto and English. Despite the goodwill, the former, supposed to be the world's universal language, fails to challenge the de facto dominance of the latter.

And pragmatically speaking, the yuan has very little chance of becoming an SDR unit anytime soon, because SDR components are supposed to able to be freely traded in the open market. A fully convertible yuan is something no one expects to see in the coming few years, and foreign leaders have a clear understanding of that.

In this sense, the calls by foreign countries to include the yuan as part of the SDR is merely a tactic to press China to move faster to freely float its currency.

By doing so, some foreign countries could succeed in making the yuan a formal topic for discussion at future G20 meetings, which would then make China's currency policy a target for many.

If things go that way, China will have to pay a lot for letting its currency become a not-so-useful SDR unit.

This is not a good deal. If China wants to continue reforming the yuan at its own pace, it should give a cold shoulder to the proposal of including the yuan in the SDR, because the time is not yet right.

The author is an independent financial analyst and business consultant in Shanghai.

(China Daily 02/22/2011 page11)