Yuan starts on long slog to reserve currency status

By Alan Wheatley, China Economics Editor - Analysis

BEIJING (Reuters) - It's time for markets to take a deep breath: the yuan will not become a reserve currency, let alone dethrone the dollar, this year, next year or any time soon.

Will China's currency be increasingly used to settle trade in Asia and, who knows, maybe even to denominate commodities? Yes.

Does China worry that lax U.S. monetary and fiscal policy will debase the dollar, today's dominant global currency, and with it a chunk of its $1.95 trillion stockpile of reserves? Yes.

Does China want to enhance the legitimacy of the International Monetary Fund -- and gain more clout in the process -- by adding the yuan to the basket of currencies that make up the Special Drawing Right, the fund's virtual currency? Yes.

Expect to hear more on these subjects at this week's Group of Eight summit in Italy, which President Hu Jintao will attend.

But conflating these considerations into the conclusion that China is ready, economically or politically, to do what is needed to turn the yuan, also known as the renminbi (RMB), into a reserve currency is wide off the mark.

"The renminbi will clearly internationalize significantly over the next 5-10 years. Over a longer period (10-20 years) it may emerge as a secondary reserve currency like the Japanese yen, although this is not certain.

"For it to replace the dollar as the main global reserve currency would require many decades and a combination of improbable events," wrote Arthur Kroeber in the China Economic Quarterly, a journal he edits.

Kroeber rightly draws a distinction between facilitating the use of the yuan as an international currency for current account purposes such as trade and tourism and enabling its use on the capital account for portfolio investment and reserve holdings.

For that, China would have to scrap capital controls: central banks and other foreigners would have to be able to invest freely in onshore yuan financial assets such as stocks, bonds and bank deposits and to freely repatriate their capital.

For foreigners to hold yuan on a large scale, Kroeber writes, they would also have to be convinced China's markets are trustworthy and fairly free of rigging by the government.

"Technical difficulties aside, this will require a significant retreat from the current state-dominated model of credit allocation. This cannot happen quickly," he concludes.

LOTS OF DOUBTS

Brendan Kelly, an analyst with Pacific Forum CSIS in Honolulu, agreed that completely eliminating capital controls was a policy transformation that would clash with the ruling Communist Party's craving for control.

"Investors would also likely require significant reforms in the rule of law, raising the question of whether an authoritarian government could ever gain the trust required to be a reserve nation," he wrote in a study.