The International Monetary Fund (IMF) took a significant step in 2016 by including the Chinese renminbi (RMB) into its Special Drawing Rights (SDR) basket. This decision, effective from October 1, marked a pivotal moment in the global financial landscape, acknowledging China’s growing economic influence and the increasing international use of its currency. Joining established currencies like the U.S. dollar, euro, Japanese yen, and British pound, the Yuan Renminbi Euro inclusion in the SDR basket signifies a shift towards a more diversified and representative international reserve system.
To understand the implications of this change, it’s essential to delve into the workings of the SDR and the criteria for currency inclusion. In an interview, Siddharth Tiwari, Director of the IMF’s Strategy, Policy, and Review Department, and Andrew Tweedie, Director of the IMF’s Finance Department, provided valuable insights into the rationale and consequences of the renminbi’s addition to this prestigious basket.
What the Renminbi’s SDR Inclusion Means for China
According to Tiwari, the inclusion of the renminbi in the SDR basket is a landmark achievement for China. It signifies the successful integration of the Chinese economy into the global financial system. The IMF’s recognition of the RMB as “freely usable” is a testament to China’s expanding role in international trade and the substantial growth in the renminbi’s global usage and trading. This decision also acknowledges the significant reforms undertaken by China in its monetary, foreign exchange, and financial systems. These reforms have been crucial in liberalizing, integrating, and enhancing the infrastructure of China’s financial markets, paving the way for greater international acceptance of the yuan renminbi euro.
Furthermore, while not a formal requirement for SDR inclusion, transparency in data disclosure is generally expected from issuers of reserve currencies. China has demonstrated a commitment to higher transparency standards by taking positive steps to improve data disclosure and actively participate in multilateral data initiatives. This includes reporting the currency composition of its reserves to the IMF. Ongoing collaboration with the Bank for International Settlements on reporting Chinese banking sector statistics further strengthens the credibility and acceptance of the RMB among official holders of foreign exchange reserves.
Criteria for SDR Basket Inclusion
Tweedie clarified the two primary criteria that govern the inclusion of a currency in the SDR basket.
Firstly, the export criterion mandates that currencies in the basket must be issued by the world’s leading exporters. This criterion, in place since the 1970s, ensures that the SDR basket comprises currencies from member countries or currency unions that play a central role in the global economy. This naturally includes major players like the Eurozone, represented by the euro, and now China, with the yuan renminbi.
Secondly, the “freely usable” criterion, introduced in 2000, requires that currencies in the SDR basket be deemed by the IMF as widely used for international transaction payments and actively traded in major exchange markets. This criterion recognizes the increasing importance of financial transactions in the global economic system. The yuan renminbi euro, alongside other SDR currencies, meets this requirement, signifying their global acceptance and usability.
Impact on the International Monetary System
Tiwari highlighted several benefits of the renminbi’s inclusion for the international monetary system.
Firstly, it consolidates the internationalization process of the RMB. The journey of a currency towards internationalization necessitates robust market and institutional development. This includes fostering deep and liquid financial markets, achieving a certain degree of capital account openness, ensuring predictable macroeconomic outcomes, establishing strong and credible institutions, and safeguarding market integrity through a reliable rule of law. By strengthening the RMB’s internationalization, the inclusion in the SDR basket contributes to the overall stability and strength of both the Chinese and global economies.
Secondly, the inclusion enhances the attractiveness of the RMB as an international reserve asset. This contributes to the diversification of global reserve assets, reducing reliance on a limited number of currencies and promoting a more balanced international monetary system. The yuan renminbi euro, along with other SDR currencies, offers diversification options for central banks and other reserve holders worldwide.
Motivation Behind the SDR Basket Change
The IMF Executive Board’s decision to include the RMB was part of the regular Review of the Method of Valuation of the SDR, conducted every five years. These reviews assess the selection criteria, the currencies included, the weighting methodology, and the basket composition. The increasing significance of the Chinese economy and the conclusions of the 2010 and subsequent reviews paved the way for the 2015 review to focus on determining the RMB’s eligibility for inclusion. The thorough analysis conducted by the IMF staff, considering the development of financial markets, led the Executive Board to conclude that the RMB now met the “freely usable” criteria as defined in the IMF’s Articles of Agreement.
Impact on the SDR Itself
Tweedie emphasized that the RMB’s inclusion is not only significant for China but also for the SDR itself. It marks the first addition of a new currency to the basket since the euro replaced the French franc and Deutsche mark in 1999. This inclusion diversifies the SDR basket further, making its composition more reflective of the world’s major currencies. Consequently, it is expected to enhance the SDR’s appeal as an international reserve asset. The presence of yuan renminbi euro, alongside other major global currencies, strengthens the SDR’s role in the international financial system.
Implications for the IMF
The determination of the RMB as “freely usable” has implications for China’s rights and obligations within the IMF and impacts the Fund’s financial operations.
As an issuer of a freely usable currency, China is now expected to provide its own currency in IMF lending operations and receive RMB in repayments to the Fund. This means that borrowing members, when selected to transact with China, will receive RMB and will need to repay in RMB. Furthermore, China is obligated to cooperate and make its best efforts to assist in exchanging RMB into another freely usable currency if requested by borrowers, similar to the obligations of other freely usable currency issuers like the Eurozone with the euro. This contrasts with members whose currencies are not deemed freely usable, who are required to exchange their currencies for a freely usable currency when providing resources in IMF financial operations.
Additionally, currencies in the SDR basket, including yuan renminbi euro, must have suitable exchange rates for SDR valuation and a suitable reference interest rate. IMF member countries, their agents, and other SDR holders must have adequate access to instruments denominated in freely usable currencies for reserve management and hedging purposes.
In conclusion, the inclusion of the yuan renminbi into the IMF’s SDR basket is a landmark event with far-reaching implications. It signifies China’s rise as a major global economic power, enhances the SDR’s representativeness and attractiveness, and strengthens the international monetary system. The presence of yuan renminbi euro within this basket alongside other key currencies reflects a more multi-polar and diversified global financial order.
