China close to join IMF’s Reserve Currency Basket

Special Drawing Rights (SDR) plays an important role in the global financial system. Technically it constitutes an international reserve asset that helps maintain balance between countries with big external liabilities and those flush with cash. In practice, they are more marginal, as countries largely rely on capital markets and hard currencies to cover their obligations, according to the editorial of the current (July-September 2015 issue) News Bulletin of International Chamber of Commerce-Bangladesh (ICCB) released today.

The International Monetary Fund (IMF) will consider including China’s currency (known alternately as the Yuan/ Renminbi/ RMB) in the basket of currencies that make up its Special Bulletin Cover July-SeptemberDrawing Rights (SDRs), which was created about 50 years ago largely as substitutes for disappearing gold reserves. Currently, the SDR currency basket includes the U.S. Dollar, British Pound Sterling, Japanese Yen and European Euro.

In March, IMF Managing Director Christine Lagarde mentioned that inclusion of the Chinese Yuan in SDR basket is “not a matter of if, but when.” The Chinese Yuan may become the fifth currency in the IMF’s special drawing rights basket by October 2016. The Fund, which reviews the special drawing rights (SDR) valuation basket every five years, has said it is extending the evaluation time by nine months from 31 December to 30 September, 2016, deferring the widely-anticipated addition of the Chinese Yuan to its benchmark currency basket. It may be mentioned that the U.S. dollar and the Euro presently account for almost 80% of the SDR basket.

The People’s Bank of China (PBoC), devalued its currency (Yuan) twice on 11 and 12 August, every time by 1.9% against the US Dollar. Analysts largely interpreted the devaluation as a sign Beijing is keen to make its exports more competitive as the nation’s economy slows down. However, the IMF might ask China to further reform its currency policies to meet the criteria for the SDR, as an earlier staff report found that the Yuan was not commonly used in international debt securities and was thinly traded in North America, despite its wider use in the Asian region.

Two criteria determine whether a currency can be part of the SDR. Its issuing country must be a major exporter, and the currency must be freely usable. No one disputes that China meets the first criterion. Over the past five years, its exports averaged 11% of the global total. Thus China is behind the European Union and America but well ahead of Japan and Britain.

However, across a range of indicators, the Renminbi is now exhibiting a significant degree of international use and trading. At the same time, the four freely usable currencies (already in the SDR) generally rank ahead of the Renminbi, according to IMF report. The report calls on China to increase foreign access to its onshore stock and bond markets, especially government bonds.

Presently, the RMB is the 5th most used currency in global payments and close to 25% of China’s trade is now settled in RMB, compared to less than 5% in 2011. Inclusion of the RMB in the SDR would also make the Yuan an official reserve currency, obliging all governments to carry some exposure to the Yuan. The Asian countries will greatly benefit from the inclusion Yuan as SDR as it will allow international trade using Yuan instead of converting into US$/ British£/ European € or Japanese ¥.