Why isn't the yuan rising despite IMF support?

'Yuan inclusion was Beijing's prestige project'
'Yuan inclusion was Beijing's prestige project'
MSCI China represents reality of the economy: MS
MSCI China represents reality of the economy: MS
China's economic transition will take time: Pro
China's economic transition will take time: Pro

The renminbi's status as a global reserve currency may be effectively guaranteed following formal backing by International Monetary Fund (IMF) staff, according to economists, but traders have yet to be convinced.

The yuan fell to an intra-day low of 6.379 per dollar on Monday, weaker than the central bank's midpoint rate of 6.375 and the previous session's closing quote of 6.374, as Friday's news failed to spark buying, surprising several analysts who expected short-term bullishness.

Last week, IMF staff members issued a paper to the Executive Board stating that the renminbi, also known as the yuan, met requirements to be a "freely usable" currency, proposing it should be included in the organization's Special Drawing Rights (SDR) basket as a fifth currency, alongside the U.S. dollar, euro, British pound and Japanese yen.

Chinese authorities have addressed all remaining operational issues identified in an initial analysis in July, said IMF director Christine Lagarde in a statement. The organization's final decision on the issue is expected on November 30.

Friday's positive remarks makes yuan inclusion more than an 80 percent likely, according to United Overseas Bank. Other banks issued equally bullish remarks, with TD Securities calling SDR acceptance "a done deal."

So, why aren't markets cheering?

Friday's news is an undeniable positive for the world's second-largest economy, but it may not be enough to trigger buying just yet.

"While SDR inclusion is an important milestone, it is not the end-game for the internationalization of the RMB. In the foreseeable future, China will have to continue to convince foreign institutions and individuals of the benefits of holding RMB denominated assets," Louis Kuijs, head of Asia economics, at the Royal Bank of Scotland (RBS), wrote in a report

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Until then, renminbi holdings by central banks, sovereign wealth funds and other market participants will only increase at a gradual pace, he warned.

Indeed, SDR inclusion will not immediately solve China's long-term structural issues, echoed a note by TD Securities.

"The inclusion doesn't in the near term materially change the currency fundamentals or fundamental demand conditions for the renminbi given capital account constraints and the fact that the existence of CNH [China's offshore yuan] for many years already has allowed reserve managers, and those who wish to hold the renminbi for portfolio investment purposes, to gain exposure to the currency."

There's also another reason behind the yuan's flat performance on Monday.

"The obvious issue is whether global reserve managers (who act on behalf of central banks) immediately buy yuan to take account of the new 'reserve' status and the inclusion in the SDR basket. The answer to this in my opinion is 'unlikely' and the impact of the yuan entering the basket is more symbolic," explained Chris Weston, IG's chief market strategist, in a morning note.

For now, reserve managers are awaiting the IMF's weighting for the yuan within the basket before buying, he said.

"It's this figure that will likely set expectations for future yuan purchases."

Tyrone Siu | Reuters

But estimates vary, with ING forecasting the Chinese currency to hold a 9 percent weight in the new SDR at the expense of the euro, yen, and pound. IG meanwhile says the percentage could top 10 percent.

Also underpinning Monday's weakness is the fact that reserve managers are generally slower to alter portfolios, compared to other market players such as hedge funds and pension funds, Weston said.

"In theory, global central banks would have around nine months to re-weight portfolios, but one can think back to 1999 and the introduction of the euro into the SDR. Here, reserve managers didn't really increase euro holdings until a few years later."

Plus, central banks already have sizeable yuan holdings so they don't need to enhance exposure at the moment, he concluded.

Friday's terror attacks in Paris could also be weighing on the currency, TD Securities warned.

"The macro situation dictates that the U.S. dollar may get a boost on risk aversion versus Asia due to the tragic events in Paris on Friday, which would mean pressure for the onshore and offshore yuan."

Indeed, the bulk of major Asian currencies fell against the greenback on Monday, with the exception of the safe-haven yen.