Demand unlikely to boost yuan despite basket inclusion

If anything, the yuan's chances of being taken seriously as a reserve asset have gone backward recently. China's leadership responded to concerns over capital outflows by making it harder to move capital abroad and to worries over the bursting of an equity bubble by suspending trading in many shares - in effect preventing those holding assets from selling them. Managers of foreign exchange reserves will think twice before entrusting their country's assets to policymakers who have shown that they could steamroll the rights of investors whenever it suits them.

The bid for the yuan's inclusion in the SDR basket is not the sole reason that the People's Bank of China intervened to shore up the yuan. Chinese policymakers have prioritized exchange rate stability because of concerns over the impact rapid depreciation would have on the financial sector and on enterprises that have borrowed from overseas institutions. They are also unwilling to cede control over the exchange rate to market forces which they believe are capricious, driven by sentiment rather than fundamentals. Our (Capital Economics') view is that the yuan will strengthen over the medium term, but its inclusion in the SDR basket has nothing to do with it.

If the inclusion in the SDR basket doesn't really matter, then the question is: Why has China pushed for it? One answer is simply because it could. There is no downside to it, there has been little resistance because it is an issue few in the international community cared about, and there is a modicum of prestige in being asked to join a small club, even if few were aware of its existence before.

Efforts to join the SDR, spearheaded by China's central bank, also strengthened its hand in pushing for reforms China has long been pursuing. A number of steps this year, including the expansion of foreign access to China's bond markets, improvement of liquidity in the treasury market and August's exchange rate reform, appear to have been responses to discussions with the IMF over the yuan's inclusion in the SDR basket.

The bigger picture, though, is that China's commitment to liberalizing its financial market, and so its appeal to asset managers, is still limited - as underlined by the market interventions this year. The inclusion of the yuan in the SDR basket changes none of these facts.

The author is chief Asia economist at Capital Economics.