The Fuse

Reserve-Currency Status for Yuan to Boost China’s Clout in Global Economy, Oil Markets

by Matt Piotrowski | November 30, 2015

The International Monetary Fund’s (IMF) inclusion of China’s yuan in the global currency basket is a big deal for the world economy and the international oil market. It provides a powerful message that China has indeed arrived as an economic superpower. Chinese financial institutions can further expand into the global marketplace that has been dominated by the U.S., Europe and Japan, while the government can continue to open its markets to outside players. Moreover, it gives the country a symbolic victory ahead of the launch of its yuan-denominated crude futures exchange.

The IMF’s inclusion of China’s yuan in the global currency basket is a big deal for the world economy and the international oil market. It provides a powerful message that China has indeed arrived as an economic superpower.

The IMF decided Monday that the yuan is “freely usable” and will be part of the Special Drawing Rights (SDR), where it will join the dollar, euro, pound and yen starting October 1, 2016. This action cements the yuan as a legitimate reserve currency and sets the stage for it to be used more in international trade, including commodity markets. The SDR, set up in 1969 as an international reserve asset, gives IMF members the ability to borrow among the basket’s currencies when necessary. The yuan will have a weighting just under 11 percent, higher than both the yen and the pound. The euro’s share is just under 32 percent, and the U.S. dollar is at about 42 percent.

Skeptics will likely downplay the IMF’s decision, saying it is mostly symbolic for China and the country has further reforms to make before its currency becomes a force in financial markets.

In many respects, the inclusion in the SDR is highly symbolic, but China’s currency has been gaining traction as a major currency for some time, well before the IMF’s decision. International trading in the yuan has been increasing considerably among Asian countries, the Chinese economy has been on track to surpass the U.S. in GDP in the next couple of decades, and Beijing was already moving forward with a crude futures benchmark in its own currency. The Asian juggernaut has also liberalized its economy with a bond market to allow foreigners to include yuan in their portfolios.

The IMF’s decision is a “recognition of the progress that the Chinese authorities have made in the past years in reforming China’s monetary and financial systems.”

The IMF’s decision is a “recognition of the progress that the Chinese authorities have made in the past years in reforming China’s monetary and financial systems,” the Fund’s Managing Director Christine Lagarde said Monday. “The continuation and deepening of these efforts will bring about a more robust international monetary and financial system, which in turn will support the growth and stability of China and the global economy.”

The yuan has begun to find traction outside of Asia. Michael R. Bloomberg, former mayor of New York and the founder of Bloomberg LP, plans to lead The Working Group on U.S. RMB Trading and Clearing, which will work to establish U.S. trading and clearing of the yuan, while the Bank of China recently launched its first yuan-denominated exchange-traded fund. Russia and Iran have accepted the yuan in oil trades, as have Angola, Venezuela and Sudan.

Decision provides support for new crude futures exchange

The inclusion in the global currency basket provides support for the country’s crude futures benchmark, which will be denominated in yuan.

Most importantly for the oil markets, the inclusion in the SDR provides support for the country’s crude futures benchmark, which will be launched in the first quarter of 2016. The new Chinese crude futures contract will be denominated in yuan, a key development in further strengthening the currency’s status and challenging the U.S. dollar’s supremacy. Developing more pricing power in commodities was Beijing’s main motivation in establishing the benchmark.

It’s fair enough to assume that the new crude futures market will struggle to fully rival Atlantic basin benchmarks West Texas Intermediate (WTI) and Brent. China’s new crude contract will need to attract a large amount of investors in order to provide deep liquidity. Some potential investors will likely be skeptical of oil being traded in a non-dollar currency and the heavy presence of state players.

It’s also fair to assume that with rising crude imports in China—which has surpassed the U.S. as the world’s largest importer—and throughout Asia, and the country’s determination to flex its muscles in oil and other financial markets, it’s only a matter of time before the Chinese benchmark becomes dominant in the global oil market. The yuan’s new role as a reserve currency will help accelerate the country’s ambitious plans for its crude futures exchange.

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