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UPDATED: May 11, 2015 No. 20 MAY 14, 2015
A Change in Value
The West may accept an undervalued yuan as default, but the IMF is about to change that
By Wang Jun

A branch of Bank of China in Taiyuan, capital of north China's Shanxi Province (CNS)

A Wall Street Journal report on May 3, said the IMF is likely to declare, for the first time in more than a decade, that the yuan is fairly valued.

"China's contributions to the world economy in recent years are obvious to all. It's natural for the IMF, a multilateral international organization, to change its attitude toward the Chinese currency," Tan Yaling, President of China Forex Investment Research Institute, said during an interview with China Radio International.

However, since the yuan may weaken the dollar hegemony, the United States insists (and will most likely continue to insist) that the yuan is undervalued to make the yuan less competitive. Despite the debate, current economic conditions show that the yuan is in fact not undervalued but overvalued.

In IMF's Article IV Consultation with China last year, the organization said the yuan remained moderately undervalued by 5-10 percent.

As a matter of fact, the yuan appreciated by more than 10 percent against a basket of currencies within the past year, and the appreciation has surpassed 30 percent since China's exchange rate reform in 2005.

Against such a backdrop, Markus Rodlauer, Deputy Director of IMF's Asia Pacific Department, said in April that the world approaches a point where the yuan is close to no longer being undervalued.

IMF stance changes

The IMF has not always treated the yuan gently. In 2006, the organization enhanced its bilateral exchange rate assessment scheme on its member nations, mainly evaluating the equilibrium real exchange rate, external sustainability and macro-balance. In an assessment made in 2011, the IMF concluded that the yuan remained undervalued by 3 percent, 17 percent and 23 percent, respectively, according to the above three indicators.

Now, the yuan is actually appreciating despite nominal depreciation against the U.S. dollar. In 2014, currencies of emerging economies, excluding the ruble, depreciated by an average 11 percent against the U.S. dollar, but the renminbi only dropped by 2.5 percent, making the currency appreciate by 5 percent in terms of real effective exchange rate.

The change in the IMF's standpoint, then, makes sense.

The last time that the IMF has changed its standpoint on the yuan was in July 2012. A report released on July 24 said the yuan "is assessed to be moderately undervalued against a broad basket of currencies." That was a change from the previous stance that the currency was substantially undervalued.

The IMF had kept the same standpoint since then. In an interview with China Business News in 2014, David Lipton, First Deputy Managing Director of the IMF, said the organization continued to view the yuan as moderately undervalued.

U.S. view stagnant

The IMF may change its evaluation of the yuan, but the United States doesn't plan to do the same.

For years, the United States has been pressing China on the topic of yuan appreciation--and for "good" reason. Yuan appreciation favors the United States because China is the America's biggest lender. If the yuan goes up against the U.S. dollar, the United States will ultimately pay less to China. In addition, yuan appreciation will also push up prices of Chinese products, narrowing China's trade surplus.

After the IMF set out to declare yuan fairly valued, U.S. Treasury Undersecretary for International Affairs Nathan Sheets said, "China's exchange rate remains significantly undervalued."

His sentiments echoed those of the U.S. Treasury's recent semiannual report to the U.S. Congress on international economic and exchange rate policies. The report also cited China's rising trade surplus, falling oil prices, higher levels of productivity and the need to foster more domestic consumption as reasons why the yuan should trade at higher levels.

However, in February this year, Sheets said at Peterson Institute for International Economics that China has stopped intervening in its currency market, reversing the long-standing criticism of the United States that China deliberately undervalues its currency.

Actually China has always been specially reviewed by the United States in the Treasury's semiannual reports. The October 2013 semiannual report said the yuan was appreciating on a trade-weighted basis, but not as fast or by as much as was needed, and intervention had resumed. The April 2015 report said the renminbi exchange rate remained significantly undervalued, but the report took note of China's reduced level of intervention in the foreign exchange market.

Landing the basket

The IMF is conducting a comprehensive assessment over the renminbi in its special drawing right (SDR) review to decide whether the currency will be included in the SDR currency basket or not, Zhu Min, Deputy Managing Director of the IMF, said in April.

The SDR is an international reserve asset created by the IMF in 1969 to supplement its member countries' official reserves. Its value is based on a basket of four key international currencies and SDRs can be exchanged for freely usable currencies. Today, the SDR basket consists of the euro, the Japanese yen, the pound sterling and the U.S. dollar. The basket composition is usually reviewed every five years by the Executive Board of the IMF, and the most recent review was made in November 2010.

Since the Chinese Government is actively pushing forward the yuan being included into the SDR currency basket, the IMF's position on the value of the renminbi will certainly help.

Xu Bo, an analyst of Bank of Communications Financial Research Center, said that if the IMF changes its standpoint, the value of the yuan will remain stable, and China can no longer merit criticism for the manipulation of exchange rate. This will help the yuan become an international currency and be included into the SDR currency basket.

Tan said China thinks highly of yuan's inclusion into the SDR currency basket. Being included into the basket, the yuan will have a higher status in the international market. Considering the real economy in China, there will be many uncertainties in the future for the yuan exchange rate. The yuan may remain stable or appreciate to maintain its status, but this will impose severe downward pressure on China's real economy.

Liu Dongliang, a senior analyst from China Merchants Bank, said that to be included into the SDR currency basket, a currency must be freely convertible, which is a major obstacle for the yuan.

However, government views indicate that China's exchange rate reform is likely to accelerate.

Chinese central bank governor Zhou Xiaochuan said in April during IMF and World Bank conferences that China will accelerate the process of yuan's free convertibility under the capital account and introduce the Shenzhen-Hong Kong stock connect program, with the aim of making the renminbi a more freely usable currency and included into the SDR currency basket.

Copyedited by Kylee McIntyre

Comments to wangjun@bjreview.com

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