China has already pitched a political blitzkrieg for inclusion of yuan as a reserve currency. It had lobbied with the IMF chief Chirstine Lagarde, when she visited Beijing. It has asked other countries to support this bid. It has been working for pushing up pressure by extending yuan credit lines to countries facing exchange rate volatilities for their own currencies.
Why?

Inclusion of yuan into SDR basket apparently does not give China any major benefit. SDRs are not openly tradable. SDR status will not give any major leeway to China in its domestic policy making. On the contrary, being included into the SDR basket will place some responsibilities to the Chinese monetary authorities. But then why does China want this?

It appears as though this is another WTO moment for China. In 2001, China was admitted into the WTO. Following that China gained the status of a major trading nation in the world. Its exports now account for over 7% of global trade. It had accumulated foreign exchange reserves of over $4.5 trillion at its peak. It has ever since have had trade surpluses not seen by any other country.

In many ways, the massive imbalances in the balance of payments and consequent flow of capital across the geographies had resulted in destroying the stability of the global economy. The huge accumulation of exchange reserves with China were in turn deployed in securities and assets, the largest share flowing into US treasuries, persistently depressed interest rates.

Such expansion of the global financial system and depressed interest rates had in effect encouraged sub-prime loans and development of unsustainable financial products like the CDS and bonds, whose underlying worth was nil. Many believe that this had led to the global financial melt-down of 2008.

China’s ascendancy as the supreme player in global trade, as an exporter of manufactured goods, was engineered by abusing the rules-based world trading order under the WTO. Under the guise of free trade, China manipulated every rule and norm to push its export led growth strategy. It had persistently manage4d its exchange rate, artificially kept yuan exchange rates depressed, to gain competitive advantage. The United States had complained of these practices loudest, with little impact.

WTO membership had provided legitimacy and a wall behind which China operated its economy to gain the maximum out of the prevailing global dispensation. No other country could compete with China when its costs of production were pushed down by ignoring all price signals in the domestic economy. Interest rates were at rock bottom, wages were at subsistence levels and other input costs were kept at levels commanded by the politics of maximising growth.

Now that China had reached a position of strength, it wants to muzzle its way into the SDR basket to gain another legitimacy. If WTO membership had given China legitimacy in trade and in manufacturing, entry into the SDR basket will help its reach the same status in the global financial sector.

China is doing this because it has seen the limits of advantage to itself in the real sector, that is, in manufacturing and exports led growth. As its exports are falling, month after month, China is proclaiming to shift to consumption led growth. But that is nearly impossible to achieve. The huge overload of manufacturing capacity it has created cannot be fully utilised even with rising domestic consumption. In steel, China’s production capacity, for example, is many times its domestic steel consumption potential.

Hence, employment and income will fall and overall growth will stagnate, far from hitting a revised 6.5% growth target that its political leadership now hopes for. These shortfalls are sought to be met through expansion of its financial sector and by expanding the reach of its financial sector across its borders.

This can give rise to severe turbulence into the financial system. As evidence, one can recall what Chinese authorities did when its stock markets crashed. The government intervened to pump huge money into stock markets by ordering public sector units to place all their funds into stocks. This they did after artificially priming up their stock markets, the Shanghai exchange to astronomical heights, when 90 million retail investors were encouraged to put their lifetime savings into stocks.

The Chinese authorities do not have any respect for the operation of the free market. They want the markets to behave exactly in the way the government wants. Hence, any form of intervention is acceptable. The latest in the series is the widespread arrest of top market players in the name of insider trading by them. These moves are rattling all sentiment.

Further legitimisation of Chinese practises by giving its reserve currency status to yuan will only be a cover for China to follow its goals globally. Private sector players are seeing scope for gains from this. An exchange has now been floated in Germany for offshore trading in yuan denominated securities and bonds. Earlier, London had offered the similar facilities to China for yuan trading. However, all previous attempts have not been very successful.

China had depreciated its currency to give boost to its exports. This created serious instability for a number of countries which were closely integrated with the Chinese economy. Admittedly, if some countries suffer for China’s moves in the interest of its domestic economy, that’s none of China’s headache. IMF Board might consider all these factors while taking the final decision on yuan. (IPA Service)