5 Things to Know About China's Rising Redback

The International Monetary Fund will hold an informal board meeting this month to discuss potential changes to its Special Drawing Rights reserve-currency basket, with a formal decision set for later this year. IMF Managing Director Christine Lagarde recently said it is a question of when, not if, China’s yuan will be added. Here are five things to know about how global investors will be affected by the yuan becoming a globally usable currency.

#1: Use of the yuan is increasing

The yuan ranked fifth in world payments as of January, according to interbank network operator Swift. In forex trading, it ranked ninth with a 2% share in 2013, the latest year for which figures are available, according to the Bank for International Settlement. International use is still constrained by restrictions on convertibility of the capital account, because foreign investors lack a way to make their yuan work.

#2: China really wants the yuan to be an international currency

Beijing’s stated goal is to have a currency that matches China’s economic clout by 2020. Pride aside, it wants more foreigners buying shares of state-owned companies and local government debt as it repairs their balance sheets. It also wants to invest more overseas as growth at home slows. Authorities have sped up the financial overhaul in the past year, creating deposit insurance and expanding the interbank market.

#3: Yuan holdings by institutions outside of China is on the rise

More than 60 global banks and sovereign-wealth funds hold yuan-denominated assets worth $70 billion to $120 billion, or 0.6% to 1% of current world reserves, according to Standard Chartered. Being included in the SDR would help sentiment. Analysts at China International Capital Corp., a Chinese investment bank, forecast the yuan’s share of the world’s reserve holdings will climb to 3.7% this year and 7.8% by 2020, if the Chinese economy continues to grow at a 7% annually.

#4: No one can agree on whether the yuan is fairly valued.

Since January 2014, the yuan has weakened 2.5% against the dollar but strengthened 20% against the euro and 11% against the yen. Bank of International Settlements data suggests the yuan is the most overvalued of the world’s major currencies because of China’s weakened trade position. But investors expect increased inflows into China’s capital markets to drive increased demand for the currency.

#5: Chinese investors will likely hold onto their yuan

As China liberalizes its capital account for domestic investors, capital outflows should increase. Standard Chartered analysts expect any increase in outflows to be more than offset by an increase in capital inflows. As long as the exchange rate remains broadly steady, domestic investors are likely to have limited incentive to diversify into foreign assets.