China’s renminbi joins the SDR – a basic guide

PUBLISHED : Friday, 30 September, 2016, 8:18pm
UPDATED : Friday, 30 September, 2016, 8:18pm

What is SDR?

Special drawing right, or SDR, is an international currency reserve to supplement IMF member countries’ official reserves. It was created by the International Monetary Fund (IMF) in 1969 to allow countries to purchase their domestic currencies in foreign exchange markets so that they could maintain exchange rates and encourage world trade. In 2009, SDR allocations helped increase liquidity and supplement member countries’ official reserves as they dealt with the global financial crisis.

Which currencies are in the SDR basket?

The US dollar, the euro, Japanese yen and pound sterling make up the SDR basket. It’s been that way since 1999, when the euro replaced the German Deutsche mark and the French franc.

Who can use SDRs?

IMF members are allocated SDRs. Members can sell them to other member countries, but SDRs cannot be traded on private markets. When a country uses its SDR allocation, it is usually given the SDR equivalent value of one of the major currencies. During the 1997 Asian financial crisis, South Korea mainly received US dollars, and more recently, Greece has been given mainly euro amid its debt crisis.

How are SDR currencies and their weighted values determined?

The inclusion of the yuan in October doesn’t mean it will always be in the SDR basket. Every five years, the IMF reevaluates the currencies in the SDR basket and their weighted values, based on the country’s exports and a composite financial indicator. The decision to add the yuan to the basket was made after the IMF’s November 2015 meeting, and both currencies and weightings won’t be reexamined until the next IMF meeting in September 2021. Right now, the US dollar, euro, renminbi, yen, and pound sterling are weighted at 41.73 per cent, 30.93 per cent, 10.92 per cent, 8.33 per cent, and 8.09 per cent respectively.

What was the last currency to be added to the basket?

The euro was the most recent addition to the basket, joining in January 1999 upon its creation, with an initial weighting of 32 per cent of one SDR.

After its launch, the euro strengthened against the pound from 1.42 euros to a high of 1.7 euros in late 2000. Since then, it has weakened against the pound to 1.17 euros.

Before the euro, the share of US dollars in foreign currency reserves was steadily rising, spiking from 59 per cent in 1995 to 71 per cent in 1999. The introduction of the euro reversed that trend, and the proportion of the European currency in foreign reserves has largely increased to make up a high of US$344.3 billion in 2016.

When did the IMF decide to include China?

In November last year, IMF managing director Christine Lagarde said the yuan satisfied the IMF’s two main criteria for inclusion into the basket: that it is “widely used” and “freely usable”. In December 2015, the fund’s executive board announced yuan would be included, making it the fifth currency in the basket and marking its growing use and trade.

What will the yuan’s addition to the SDR basket mean for China?

Analysts say the inclusion is symbolically significant – but the actual impact on the currency and capital flow might not be dramatic. The People’s Bank of China says the inclusion is an acknowledgment of China’s recent economic development, reform, and opening up to the world. Credit Suisse says it is a “seal of approval” of the currency and a commitment from China to “free use” of the renminbi – at least for IMF member central banks. Credit Suisse estimates the yuan’s inclusion could bring between US$150 billion and US$200 billion in additional capital inflows to China over the next couple of years.