Inclusion in IMF reserves can make yuan a global currency

  • B Sundaresan, Hindustan Times
  • Updated: Nov 18, 2015 00:08 IST
A customer counts Chinese Yuan notes at a market in Beijing. (Reuters File Photo)

HT explains the nuances of yuan’s inclusion in IMF’s currency basket. The IMF’s endorsement would help China in making yuan a global currency and that has political significance.

What is special drawing rights?

SDR is an international reserve asset, which was created by the International Monetary Fund (IMF) in 1969 to support the Bretton Woods exchange rate system — in which every currency was pegged to the US dollar, which was in turn pegged to gold. This was done because the IMF felt that the supply of US dollars and gold “proved inadequate to support world trade.

How does SDR work?

IMF allots every member country a certain number of SDRs depending on its quota, which is calculated by the Fund based on a country’s GDP, openness, economic stability and reserve assets. For instance, the US has been allocated over 35 billion SDRs while India has almost 4 billion. As on October 31, the IMF had allocated a total 204.1 billion SDRs ($281 billion or Rs 18.54 lakh crore) among 188 countries. (1 SDR is equivalent to $1.38).

SDR is neither a currency, so you cannot buy anything with it, nor a claim on the IMF, which means you cannot exchange the SDRs with the IMF for dollars or rupees. SDRs can only be exchanged by a country with currencies of member countries at an exchange rate determined by the IMF.

How is SDR’s value calculated?

The IMF calculates the value of SDR using the US dollar, euro, yen and pound — collectively called the SDR basket — on the basis of their daily exchange rate on the London currency exchange. Each of the four currencies is given a weightage based on their importance in world trade. Since the US dollar is the most used currency in the world, it has the highest weight.

Where does China stand in this?

The IMF reviews the composition of this basket every five years to reflect changed circumstances in world finances. The review is based on two conditions — the export and the freely-usable criteria. The yuan ticks the first criterion as since 2010, China’s share in world’s exports has gone up 7.5% annually.

But, it is ranked seventh in the list of currencies in terms of its share in global assets in 2014. In fact, the Australian and Canadian dollar are ahead of the yuan. However, their shares in the global assets have fallen or remained constant, while yuan’s grew 67% in a year. Therefore, the IMF staff in their paper to the bank’s chief Christine Lagarde noted that the RMB meets both the criteria, a recommendation which Lagarde has “supported”.

What will China gain if it becomes a part of the SDR basket?

In terms of size not much. China’s forex reserves of $3.5 trillion are over 12 times the size the total SDR allocation. However, the IMF’s endorsement would help China in making yuan a global currency and that has political significance. The Economist noted that “The dollar’s political leverage will dissipate as the yuan goes global”. This means that the US will not be able to impose trade sanctions as they may turn to China for help.

So, can the yuan be considered on par with the dollar?

Not yet. Firstly, the inclusion is subject to approval of IMF’s executive board, which will meet on November 30 to decide on the matter. The countries representing the SDR basket – US, Euro zone, Japan and UK – have over 50% voting rights on the board and yuan’s inclusion needs a 70% vote in favour, which in itself is difficult. And even if China gets into the basket it has a long way to go before it can match the share the dollar in global usage. Over 120 countries maintain assets in US dollar and while only 38 do so in RMB.

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