Yuan’s Inclusion in SDR Basket
In December 2015, IMF has approved Chinese Renminbi (Yuan) to be included in the SDR currency basket. Here is a brief backgrounder on the same.
What is a Special Drawing Right (SDR)?
SDR was created by the IMF in 1969 as a supplementary international reserve asset. Technically SDR is not a currency. The value of SDR is based on the basket of the four major currencies – US Dollar, Euro, UK Pound and Japanese Yen. From 1st October 2016, Yuan will be the fifth currency in the basket. The IMF members who hold the SDR are allowed to freely exchange their SDR with any of the four currencies in the IMF’s basket. Generally countries exchange their SDR with four major currencies to meet their trade needs with other countries. As of November 30, 2015, 204.1 billion SDRs had been created and allocated to members (equivalent to about $285 billion).
What are the requirements for SDR basket inclusion?
There are two formal requirements for SDR basket inclusion: being a large exporter and having a currency that is freely usable. In case of China, it is the World’s largest exporter. But Yuan had failed to meet the ‘freely usable’ criterion the last time it was assessed, in 2010. But over the past few years, China has improved the Yuan’s accessibility.
Freely usable is not understood as fully convertible. It refers to whether a currency is widely used in international transactions and whether it is widely traded in global markets. Full convertibility would help a currency meet these standards but is not a prerequisite. Now yuan is not fully convertible. Though China has placed restrictions on capital flows, yuan is qualified as freely usable currency. Major economies like the US, UK and Germany said they will support the inclusion of yuan in SDR basket. As a prerequisite China also opened a yuan trading
Why China wants Yuan into SDR basket?
There are several reasons as follows:
- Lower borrowing costs: Internationalization of Yuan helps the Chinese companies venture abroad and reduces their borrowing costs.
- Price settler: Inclusion of Yuan in SDR basket helps it to become a price settler of international commodities from oil to iron ore.
- Yuan demand: Inclusion in SDR basket will attract more official buyers for the Yuan. Already several central banks invested in Yuan.
- Global prestige and multi-polar world: Inclusion of Yuan in SDR basket means recognition of China’s rise in international arena. China also wants to replace the hegemony of US by moving toward multi-polar world. In the past also China had called for use of SDR as an alternative to dollar.
- Reform driver: It would allow reformers within the Chinese government to argue for the country’s shift toward a more market-based economy. Growing international use of the Yuan helps the Chinese central bank’s efforts to loosen restrictions on cross-border capital flows and to free up the country’s financial system.
Will it lead to more transparency in the value of Renminbi?
As a prerequisite to inclusion of Yuan in SDR basket, China opened its first offshore Renminbi centre in London. The London Renminbi is expected to become the benchmark for SDR. While China can manipulate the Renminbi value, there is little chance of doing it as the value has to be aligned with the integrity of SDR.
How will Renminbi’s addition impact India and other countries?
The opinion among the experts is divided on the inclusion of Yuan in SDR basket. It is described as everything from a symbolic move to the dawn of a new era. Several countries which have trade relationship with China will start using Yuan as the medium of payment. However, the Yuan’s SDR inclusion may convince investors very little in holding Yuan-denominated assets and securities. That will depend more on the China’s structural economic reforms. Analysts are of the opinion that now the global economy would be more exposed to the China’s economy.
India like other countries will have the option of holding forex reserves in Yuan. Indian importers may be exposed to the Yuan- rupee exchange rate risk. China may demand the Indian traders to pay in Yuan. But now the ability of China to manipulate its exchange rate has become more restricted. This will help India as it will lessen the problem with the China’s devalued currency.
Conclusion
Yuan’s new status as an international reserve asset is a sign of recognition of the progress that China has achieved in opening up its markets and internationalizing the use of the Yuan. The goal of achieving this status has helped China to focus on financial reforms, in a similar way that joining the World Trade Organization in 2001 facilitated earlier reforms.
