On 11th August, 2015, the People’s Bank of China (PBOC) surprised the markets with three
consecutive devaluations of the renminbi or yuan, knocking over 3% off its value. Since 2005,
Renminbi has appreciated 33% against the dollar. This unexpected move is
believed by many to be a desperate attempt by China to boost its exports which
have been on a decline as compared to the previous years. The PBOC claimed that
the devaluation is all part of its reforms to move towards a more market-oriented economy.
Four years ago,
when Xi Jinping first took office, he had pledged the government’s commitment
to reforming China’s economy in a more market-oriented way. The devaluation is also seen as one
of many monetary policy tools that the PBOC employed in 2015,
including interest rate cuts and tighter financial market
behind the devaluation was China’s determination to be included in the International Money Fund (IMF)’s special drawing rights (SDR) basket of reserve currencies. The Special Drawing Rights basket of reserved
currencies is an international reserve asset that the IMF’s member countries can use to
purchase domestic currency in foreign exchange markets in order to
maintain exchange rates. The IMF checks and evaluates the currency
composition of its SDR basket every five years, the last time being in 2010. The
yuan was rejected in 2010 because it was not “freely usable”. Since, the
devaluation was supported by the claim that it was done in the name of
market-oriented reforms, it was welcomed by the IMF, and the yuan became a part
of the SDR by the end of 2016.
currencies have different weights in the basket, the Chinese renminbi has
a weight of 10.92%, which is more than the weights of the Japanese yen and U.K.
pound sterling, at 8.33% and 8.09%, respectively. The countries borrow funds
depending upon the interest rate of the SDR. Low rates mean that countries
might borrow more and vice-versa. As currency rates and interest rates are
interlinked, the cost of borrowing from the IMF for its 188 members will now be
influenced by China’s interest and currency rates.
In practical terms, other countries’ central
banks may now be more likely to hold some of their own reserves in yuan, much
as they currently hold dollars or euros.