The International Monetary Fund's announcement Monday, that the Chinese yuan would be included in its Special Drawing Rights basket, was well heralded and prompted little reaction in world financial markets.
Analysts had long stressed that being part of the SDR basket had not had much benefit for other currencies such as yen and sterling, and that the IMF move to include China was largely symbolic.
However, at the same time, the yuan's inclusion in the basket is historic and does open other doors for China, they said.
"The key medium-term benefit is that China will be able to issue liabilities in its own currency," which will help to mitigate funding risks, Morgan Stanley strategists said. "Moreover, the benefits of further financial reform and improvement of capital allocation will also be clear positives."
Still, "in the near term, the continued liberalization of China's capital account, financial markets and interest rates, coupled with the anticipated Fed lift-off in December, will likely intensify the challenges that policy will face in managing the trilemma," which could mean that real Chinese interest rates "stay higher than warranted," the strategists said.
In terms of CNY assets becoming a greater part of global indices, Morgan Stanley (N:MS) noted that SDR status, while not a criterion for "CNY bonds joining GBI-EM or A-Shares joining MSCI ACWI," the yuan's inclusion in the SDR basket "could help on issues like market access and liquidity, factors which index providers consider for membership."
MS expects partial inclusion "with a low initial inclusion factor" of China A-shares in the MSCI benchmarks by May 2017, with A-shares making up 1% of the MSCI EM index at that time.
On fixed income, the strategists pointed out that while the volume of CNY onshore bonds outstanding is sizable, with China debt securities ranking fourth in the world in terms of outstanding amount, "the ultimate share of CNY bonds in global indices if/when they join the benchmarks is likely to be small" given "the market's relative size."
Paul Gruenwald, Asia Pacific chief economist at Standard and Poors, sees SDR inclusion as only a "critical first step" for China and the yuan.
"The big task facing the Chinese authorities is to convince the private sector to hold yuan for reasons other than trade facilitation," he said.
Currently, the yuan is primarily "a trade currency, with minimal private holdings for store-of-value reasons," he said.
And while global central banks do hold yuan sometimes in sizable amounts, such as the Bank of Korea, not a surprise given that China is Korea's chief trading partner, "liquidity is guaranteed for official sector trades under the PBOC's bilateral swap agreements with various central banks," Gruenwald said.
"No such guarantees exist for the private sector, which is therefore at the mercy of any market interventions by the authorities," he said.
As for the yuan potentially being increasing used as a reserve currency going forward, "reserve currencies are seen as safe havens," with "traders flocking to such currencies in times of market stress," Gruenwald said.
"So if the yuan is perceived as a reserve currency, it will strengthen during such volatile times, much like the Japanese yen in Asia does now, while the rest of the currencies either weaken and/or their central banks sustain reserve losses," he said.
The notion of the yuan as safe-haven seems "far-fetched" at the moment, with private markets needing a much greater degree of trust in the PBOC, Gruenwald said.
In the wake of Monday's IMF announcement, market players continued to watch yuan trading action against the dollar, with many expecting a weaker yuan going forward as the currency becomes more freely tradable and Chinese investors move monies abroad.
The People's Bank of China set the yuan central parity rate versus the dollar at CNY6.3973 Tuesday compared to CNY6.3962 Monday and USD/CNY saw a range of CNY6.3973 to CNY3.9999.
Overnight, PBOC Deputy Gov. Yi Gang said at a press briefing that it is not necessary to worry about yuan deprecation following its inclusion into SDR and repeated there is no basis for continuous yuan depreciation.
"I will respect the decisive role of market demand and supply as possible. But when volatility exceeds a certain range ... then the PBOC will intervene decisively and appropriately," said Yi, who is also the head of the State Administration of Foreign Exchange.
He said two-way yuan movement is inevitable during exchange-rate reform, noting the yuan's volatility against the U.S. dollar has been small when compared with the euro, British pound, yen and emerging-economy currencies.
"It will be normal to see bigger two-way volatility," Yi said. See further details on MNI Main Wire at 7:16 am ET.
Stephen Jen, managing partner at SLJ Macro, maintained his view that USD/CNY should move higher from current levels, but has become "less sure about the timing."
He offered three reasons for why Beijing might want to keep the currency relatively stable against the dollar.
"President Xi, while visiting Washington DC late summer, already said that the RMB would remain stable," and "If he said so, I doubt that he would go back on his words during this calendar year," Jen said.
Also, with the IMF Board just approving CNY inclusion of the CNY in the SDR basket," it would be strange for BJ to then devalue the currency as soon as they get into the SDR," he said.
"Finally, China's trade balance is running at its historical highs, and capital outflows have been stopped," so "What is the rationale for a deval right here right now?" Jen asked.
In a statement on Monday's board discussion, the IMF said, "Directors noted the substantial increase in the international use and trading of the renminbi (RMB) since the last review, across all the indicators used to inform the assessment."
"They agreed that the RMB can now be considered 'in fact, widely used to make payments for international transactions' and 'widely traded in the principal exchange markets,'" the IMF said. See MNI mainwire story at 12:31 p.m. ET for further details.