The Special Drawing Rights (SDR) is an international reserve asset, created by the IMF in 1969 to supplement member countries’ official reserves. Its value is based on a basket, which currently consists of four key international currencies, the USD, the EUR, the GBP and the JPY. The IMF reviews the currency composition of the SDR basket every five years guided by several long-standing principles aiming at enhancing the attractiveness of the SDR as a reserve asset. IMF’s criteria for the SDR basket currencies are: 1) the “major trading country” criterion, specifically the currency is to be issued by IMF members (or by monetary unions that include IMF members), whose exports of goods and services during the five-year period ending 12 months before the effective date of the revision had the largest value1; and 2) the “free usable” criterion (FU), namely the currency is to be widely used to make payments for international transactions and to be widely traded in the principal exchange markets2. In the 2010 review of the SDR basket, the RMB was deemed to be a currency meeting the “major trading country” criterion. But there were some shortages in the RMB in terms of the FU criterion. In the almost five years after last review, the RMB has made a phenomenal growth in international use and trade. So what are the prospects for the RMB in the review in 2015?
Discussions and studies on the criteria for the SDR basket currencies
There were some misunderstandings over the criteria for the SDR basket currencies in these years. For example, the United States Former Treasury Secretary Timothy Geithner once expressed his view that convertibility is a precondition for a currency to be added into the SDR basket. This is wrong. There are only two criteria for the SDR basket currencies according to the IMF. Convertibility is not a criterion or a prerequisite although it is important for any currency being a reserve one. To clarify the criteria for the SDR basket currencies, the IMF staff made a study in September 2011: it reconfirmed the FU “widely used” and “widely traded” criteria and proposed a revision of the indicators of the FU according to the improvement of data availability and the development of financial markets. At the same time, it proposed an alternative to the FU, which is the “reserve asset criterion” (RAC).
The revised indicators of the FU are:1) the currency composition of reserves (possible supplementary indicator: number of countries holding a currency in their reserves), 2) the currency denomination of international banking liabilities and 3) the currency denomination of international debt securities, for assessing the “widely used” criterion, and 4) the volume of transactions in foreign exchange spot markets (possible supplementary indicator: the bid-offer spreads) for assessing the “widely traded” criterion. The indicators of the RAC are similar for indicator 1), the same for indicator 4), while for indicators 2) and 3) it selects the volume of transactions in foreign exchange derivatives markets and over the counter derivatives trade, and the appropriate market based interest rate instrument to replace respectively the currency de nomination of international banking liabilities and international debt securities in the FU3. Executive Directors of the IMF broadly concurred that the revised indicators should be important factors in the assessment of the FU and some of them were open to exploring alternatives to the FU, such as the RAC4. The 2015 review of the SDR basket may not adopt the RAC because it might need an eighty-five percent majority of the total voting power according to our understanding of Section 2 Articles XV of IMF’s articles of agreement5. So we will assess whether the RMB meets IMF’s criteria in terms of the revised FU indicators.
Does the RMB meet the FU?
In terms of official reserves, more and more countries (or regions) are considering making or already have made the RMB one of their reserve assets denomination currencies. Such as the UK, Nigeria, Belarus, Malaysia, Australia, South Korea, Chile and so on6. Although there is no RMB statistics in the IMF COFER (Currency Composition of Official Exchange Reserves), the RMB is already the 7th largest reserve currency according to the People’s Bank of China7. Since the 6th and the 7th largest currencies, AUD and CHF, accounted for 1.90% and 0.27% in allocated reserves in the IMF COFER in the 2nd quarter of 2014 respectively, the RMB might account for 0.27% to 1.90% in reserves. Considering the 47.39% of unallocated reserves in IMF COFER, there might be missing value bias. Besides, according to the Balance of Payments and International Investment Position Manual, “Deposits (in foreign exchange) acquired by the central bank initiating the arrangement are treated as reserve assets because the exchange provides the central bank with assets that can be used to meet the economy’s balance of payments financing needs and other related purposes”. As a result, central bank swap arrangements can be regarded as supplements for reserve assets although the amount of it can’t be equivalent to that of reserves. In the recent three years, RMB swap arrangements have seen a significant accumulation. The People’s Bank of China maintains currency swap arrangements with 28 countries or regions, reaching a total amount of 3.1 trillion Yuan.
In terms of international debt securities, the amount outstanding in the RMB is 110 billion dollars in the 2nd quarter of 2014, ranking 9th of the world. While the amounts in the basket currencies, the EUR, the USD, the GPB and the JPY, are 10,108 billion dollars, 8,525 billion dollars, 2,309 billion dollars and 512 billion dollars. The amount in the JPY, the 4th currency in international debt securities, is 4.7 times of that denominated in RMB. Although the use of the RMB is still less than that of basket currencies in terms of amounts outstanding, its growth is phenomenal. From the first time of a non-zero value, 0.26 billion dollars in the BIS statistics in the 4th quarter of 2005, to 110.2 billion dollars in the 2nd quarter of 2014, there was a growth of 423.8 times and a quarterly rate of 19.5%. According to the quarterly rate of the last 4 years8, 16.1%, the amount outstanding of international debt securities denominated in the RMB will reach the level of that in the JPY by the end of 2016.
In view of the net issuing of international debt securities, according to the statistics of the BIS, the average quarterly amount denominated in the RMB is 5.99 billion dollars from the 3rd quarter of 2010 to the 2nd quarter of 2014, exceeding that in EUR, in GBP and in JPY in the same period, which are 2.42 billion dollars, 2.24 billion dollars and -6.80 billion dollars respectively. Besides, RMB-denominated money market instruments increased from 0.9 million dollars, the first non-zero data in the BIS statistics recorded in the 3rd quarter of 2010, to 29.56 billion dollars in the 2nd quarter of 2014. It expanded 33,018 times in 4 years with a yearly rate of about 13.5 times. The RMB has been the 4th largest denomination currency in international money market instruments, exceeding the JPY from the 2nd quarter of 2013. In terms of foreign exchange spot markets, the turnover of the RMB has had a rapid growth in recent years. The average daily exchange volume was 33.95 billion dollars, ranking 11th in the world, in April 2013, while the turnover of the USD, the EUR, the JPY and the GBP was 1,691.24 billion dollars, 754.28 billion dollars, 612.34 billion dollars and 226.74 billion dollars respectively in the same period. Besides, nearly 90% of the RMB transactions were traded against the USD, reaching 30.49 billion dollars. The international trade of the RMB is expected to increase with the start of direct transactions between the RMB and other currencies.
Although there is a discrepancy between the RMB and the SDR basket currencies in international foreign exchange spot transactions from the perspective of absolute value, the share of the RMB is increasing quickly. It grew by 11 times from 0.07% of total in 2004 to 0.83% in 2013 and nearly 3 times from 2010 to 2013. According to this rate, the RMB may account for 7.47% of international foreign exchange spot transactions in the 2019 survey of foreign exchange by the BIS. In general, 1) although there is no RMB statistics in the IMF’s COFER, RMB is already the 7th largest reserve currency according to the People’s Bank of China. 2) The RMB ranks 9th in the amount outstanding of international debt securities, and the amount denominated in the RMB will nearly reach the level of that in JPY at the end of 2016, based on current growth. It ranks 4th in the amount outstanding of international money market instruments just following close behind the USD, the EUR and the GBP. 3) The daily turnover of the RMB ranks 11th in foreign exchange spot markets and will exceed the current level of the GBP in the 2019 survey of exchange markets by the BIS in light of the increase rate at which the share of the RMB grew from 2010 to 2013. Therefore, the RMB basically meets the FU for the SDR basket currencies according to the available data.
The significance of including the RMB into the SDR basket
Besides the wider and wider international use and trade of the RMB which was illustrated above to support the point of adding RMB into the SDR basket, the inclusion of the RMB will improve the representativeness and stability of the SDR. Considering that the RMB is not fully floating, there are some arguments that the inclusion of the RMB into the SDR basket is pointless and it may ultimately reinforce the role of the USD in the SDR basket and have no help for enhancing the representativeness of the SDR. These concerns are reasonable to some extent and it would be much more helpful for the representativeness of the SDR if the RMB were fully floating. But the RMB is not anchored to the USD or the SDR now. 1) China is implementing a managed floating exchange-rate system based on supply and demand in the market and with reference to a basket of currencies. This basket includes 20 currencies with about half of them issued by developed countries and another half or so issued by emerging countries. They are not the same to the currencies included in the SDR basket. 2) The correlation between the RMB and the USD has decreased sharply since the inception of review of exchange rate formation mechanism in 2005. The correlation between the RMB and the USD, and between the RMB and the EUR is -0.138 and 0.028, respectively, which is lower than those between the GBP and the USD, and between the GBP and the EUR, which were 0.196 and 0.118, respectively. As a result, the inclusion of the RMB into the SDR basket will contribute to improve representativeness and stability of the SDR under current conditions. Firstly, the introduction of RMB will improve the representativeness of the SDR in terms of GDP. In 1980, the GDP of the SDR currencies issuers accounted for more than 60% of the global GDP. Currently, the currencies in the SDR basket are the USD, the EUR, the GBP and the JPY. The proportion of these countries in respect of GDP keeps falling, reaching a new low of 40% in 2012. If the RMB would be added into the SDR basket, the GDP representativeness of the SDR currency countries would have been enhanced to about 55%, and the descending trend would have been largely relieved. Secondly, the introduction of the RMB will strengthen the stability of the SDR in terms of exchange rate. With the falling representativeness of the SDR and the taking-off of emerging economies since 1981, the stability of the SDR fell. The average variances of the GBP, the EUR, the USD, the JPY, the RUB and the INR in the period from November 2008 to September 2014 were 2.7 times, 2.2 times, 1.4 times, 1.2 times, 11.8 times and 3.0 times comparing the data in the period from June 2003 to September 2008, respectively. The inclusion of the RMB into the SDR basket can strengthen the stability of it. Had the RMB been added in 2010, based on relevant calculation of the IMF, the proportion of RMB in the SDR basket would have reached 12%, exceeding that of the JPY and the GBP, while the proportion of the USD, the EUR, the GBP and the JPY would have been 37%, 33%, 10%, and 8% respectively. From January 1, 2011 to September 30, 2014, if the value of the SDR had been calculated with the above proportion structure, despite certain concession in the stability of the SDR to the EUR and the JPY, the fluctuation9 between the SDR and the RMB, the USD and the GBP would have seen a decrease of 13%, 21% and 7% respectively.
Conclusion
Ultimately, we concluded that the RMB basically meets the FU for SDR basket currencies and the inclusion of it will improve the representativeness and stability of the SDR. So, the introduction of RMB is in accordance with IMF’s long-standing principle in reviews of the SDR basket of enhancing the attractiveness of the SDR as a reserve asset. Besides, the introduction of the RMB into the SDR basket will be beneficial to the progress of the RMB internationalization and contribute to reforming the international monetary system towards a stable direction by reinforcing the role of SDR in it. Thus, we suggest that the RMB should be added into the SDR basket in 2015.
1 It refers to the five years before the inclusion into SDR basket. I.e. if 2010 is the evaluation year for SDR currency basket, the ranking in goods and service exporting
volume for previous five years from 2005 to 2009 issuing country of the currency (or currency union) will be examined
2 See the Articles XXX(f) of Articles of agreement of International monetary fund, “A freely usable currency means a member’s currency that the Fund determines (i)
is, in fact, widely used to make payments for international transactions, and (ii) is widely traded in the principal exchange markets”, p. 61
3 See “Criteria for Broadening the SDR Currency Basket [R]”, International Monetary Fund, September 23, 2011a
4 See “IMF Executive Board Discusses Criteria for Broadening the SDR Currency Basket [R]”, Public Information Notice (PIN), International Monetary Fund, No.
11/137, November 11, 2011c
5 See Articles of Agreement of International Monetary Fund, “The method of valuation of the special drawing right shall be determined by the Fund by a seventy
percent majority of the total voting power, provided, however, that an eighty-five percent majority of the total voting power shall be required for a change in the
principle of valuation or a fundamental change in the application of the principle in effect”, p. 40
6 See “Why the reserve role of RMB is inevitable?” China Economic Net, Oct. 14th, 2014
http://finance.ce.cn/rolling/201410/14/t20141014_3692859.shtml
7 See “The Vice President of Central Bank of China released that the RMB has become the seventh largest reserve currency”, China’s Economy, 21st Oct 2014,
http://finance.ce.cn/rolling/201410/21/t20141021_3742517.shtml
8 From the 3rd quarter of 2010 to the 2nd quarter of 2014
9 The fluctuation here refers to the time-series standard deviation of relevant currencies in regarding the SDR as the base currency