China's currency gets the IMF stamp of approval as it enters a new normal

China’s RMB has been deemed “no longer undervalued” by the International Monetary Fund. This is a milestone for the Chinese government, which is keen to bolster domestic consumption and make the RMB a global currency. It is also significant in relations with the US, which has long-criticised Beijing’s currency policy for being undervalued, making it unfairly competitive in the global economy.

The RMB has been appreciating in value for a number of years – 30% in real terms since 2010. But this is the first time that an important international organisation has declared that the Chinese currency has appreciated sufficiently. The IMF view was immediately shared by some government officials and influential experts in the US, including Nicholas Lardy, a well-known scholar on the issue.

A look at China’s latest trade figures supports the idea that their currency is at fair value and represent the shifting nature of the Chinese economy. In the first four months of 2015, the volume of China’s international trade contracted sharply by over 7% and in April, the volume of exports dropped by more than 6%. This marks a stunning turnaround for a country where exports had been growing by more than 20% a year in the first decade of the 21st century.

Of course, other factors have affected this poor performance in world trade. Domestically, the costs of production have risen and there has been need for structural changes in the Chinese economy, to upgrade its industry and control pollution. And there has been a slump in global demand since the global financial crisis. But the growing strength of the RMB has also played a role and the fact that China is looking to shift away from having an export-led economy.

The steady rise of the RMB against the US$ over the last decade in nominal terms.XE.com

This should be good news for China’s trading partner critics such as the US senators who recently passed a bill taking aim at “egregious and prevalent” currency manipulation by foreign countries. What was formerly a thorn in the side of trade discussions between the US and China should no longer be such an issue going forward.

Important gesture

China will see the IMF’s statement as an important gesture of support for its effort to make RMB a global currency, particularly to have it included in the international “special drawing rights” (SDR) basket. The SDR is an international reserve asset whose value is based on a basket of four key international currencies. The present members of the SDR basket include the US dollar, the pound sterling, the Euro and Japanese yen.

China is keen to be included in this basket and has an increasingly strong case for it. China has been the world’s second largest economy based on GDP after the US since 2010 and the world’s largest economy based on purchasing power parity. Its current GDP is twice as large as Japan’s and almost four times as large as the UK’s. In addition, China is currently the world’s largest exporter of goods and foreign exchange reserves.

GDP of US, China, Japan and the UK.World Bank

So there is a logical and powerful reason for the RMB to become a new member of the SDR basket. And according to the IMF’s first deputy managing director, the question is not whether it will be, but when the RMB will be included.

With its economy struggling to reach the 7% growth target for the year, China faces a challenge going forward of maintaining the stability of the RMB exchange rate while boosting growth. Any monetary and fiscal policy shifts will have to take this into account as further appreciation of the RMB might suppress exports too drastically and it won’t devalue it because it wants to see it included in the SDR basket. But it is all part of transitioning to a new economic normal – even if it means slower growth.

Shujie Yao does not work for, consult to, own shares in or receive funding from any company or organisation that would benefit from this article, and has no relevant affiliations.