An employee arranges yuan banknotes at the Korea Exchange Bank headquarters in Seoul. China’s escalating intervention in its collapsing stock market is tarnishing policy makers’ efforts to establish the yuan as an official reserve currency.

Bloomberg/Hong Kong


China’s escalating intervention in its collapsing stock market – after months of quiescence while equities surged – is tarnishing policy makers’ efforts to establish the yuan as an official reserve currency.
An outflow of capital from China earlier this year already exposed the dangers to officials of a full dismantling of cross- border capital controls. The appetite to let domestic investors put more funds overseas won’t be helped by the 34% plunge in the Shanghai Composite Index since June 12.
Yet greater openness and fewer restrictions on use of the yuan are what’s needed for the currency to qualify to join the dollar, euro, pound and yen in the International Monetary Fund’s reserve-currency basket, known as the SDR.
While central banks and governments in the world’s top developed nations also intervened in recent years to prop up asset markets, the magnitude of the official presence in China’s markets has been highlighted in the stock-market debacle. Initial public offerings have been frozen, state-backed bodies told to buy shares, and corporate directors banned from selling any of their stakes for six months.
“Beijing is running a big risk of losing credibility,” said Stephen L Jen, managing partner and co-founder of SLJ Macro Partners in London and a former IMF economist. With regard to ambitions for reserve-currency status, “this is also a setback for China as a key requirement is market transparency and stability,” he said.
China’s heavy hand has also been visible in the bond market – which has rallied as stocks slumped. Yields show little differentiation among provinces with varying levels of borrowing due to perceptions of state support amid a government-backed debt swap.
And while China has allowed some small companies to default this year, boosting expectations risk was becoming more accurately priced, moves to support the stock market in recent days has undercut such efforts to erode moral hazard.
“Recent interventions in the equity market were hugely damaging to China’s effort to build a deep, liquid financial market,” said Victor Shih, a professor at the University of California at San Diego who studies China’s politics and finance. “The current episode may well be a test of China’s ability to manage financial distress.”
Winning inclusion in the IMF’s so-called special drawing rights basket, or SDR, is a top priority for China’s leadership this year and has been spearheaded by People’s Bank of China Governor Zhou Xiaochuan.
Along the way, government and central bank officials have promised to speed up financial market reforms to satisfy the IMF’s rules around inclusion.
Reserve currency status could spur as much as 6.2tn yuan of net purchases of China’s onshore bonds by the end of 2020, Standard Chartered estimates.
But the interventions to shore up slumping stock prices test the credibility of policy makers’ pledges to let markets play a decisive role in the economy.
The PBoC said in a statement Wednesday it will provide ample liquidity to help the stock market, its first direct communication amid the rout.
“The chances of becoming part of the SDR has declined as a result of the market slump and government involvement,” said Dariusz Kowalczyk, a Hong Kong-based strategist at Credit Agricole CIB. He said policy makers may be less motivated to push through pro-market reforms after the slump.
Zhou in March made a high-profile effort to bolster China’s chances of inclusion in the SDR basket when he lobbied IMF Managing Director Christine Lagarde at a public forum in Beijing. A day later Premier Li Keqiang promised to speed up financial market reforms to help win inclusion in the SDR.
To admit the yuan to the SDR basket, the IMF has to deem it “freely usable.” The currency is convertible for transactions such as trade and tourism while the capital account, which measures inflows and outflows of capital, remains largely restricted.
Steps to free the use of the yuan have already included allowing foreign investors to trade Shanghai-listed stocks through a link with Hong Kong’s exchange and giving overseas funds greater access to stocks and bonds.
To be sure, central banks are also responsible for financial and market stability and monetary authorities around the world often intervene to smooth out market volatility. Euro area nations implemented temporary short-selling bans during the region’s debt crisis in a bid to stem panic selling.