SDR and Internationalization of RMB

Zhou Shijian



SDR and Internationalization of RMB

Zhou Shijian

Zhou Shijian is a senior research fellow with the Center for US-China Relations, Tsinghua University.

A fter careful deliberation, the Executive Board of the International Monetary Fund (IMF) judged the Chinese renminbi (RMB) to be a “freely usable currency”on November 30, 2015 and confirmed its inclusion in its Special Drawing Rights (SDR) currency basket from October 1, 2016. This decision means that the RMB has become one of the major reserve currencies in international finance. It has greatly improved the international status of the RMB, boosted confidence in the RMB’s internationalization and recognized the integration of the Chinese economy into the global financial system. The decision also marks a milestone in the development of the international monetary and financial system, given that the RMB is the first currency of an emerging market country to be officially recognized by the international community as a freely usable currency in the almost 50 years since the IMF’s SDR basket was established. The RMB’s inclusion into the SDR currency basket also shows that the IMF has advanced with the times and is making continuous efforts to push forward the development of the international monetary and financial system.

The SDR was created in 1969 as a supplementary international reserve asset under the Bretton Woods System (under the system, the dollar was pegged to gold and other currencies pegged to the dollar). After experiencing a postwar economic boom, the stacked dollars in the safe vaults in central banks around the world gradually shattered people’s confidence in the dollar’s ability to maintain its parity with gold. Therefore, the international community decided to establish a new international reserve asset, the SDR, to supplement official reserves (commonly known as paper gold) of memberparties. In addition, the SDR is an accounting unit of the IMF and other international organizations. Although SDRs do not represent actual money, they can be exchanged for freely useable currencies and used for international payments of current or capital accounts through the arrangements of the IMF or voluntary exchange arrangements among member countries. It is obvious that the SDR plays a significant role in stabilizing the international financial order and supplementing foreign exchange reserves.

According to the original design vision, the SDR basket of currencies should include as many international currencies as possible, so that the weighted price of the currency basket will be stable and less susceptible to the influence of the market trends of a single currency or the financial policy changes of the issuing country. Therefore, the currency basket originally contained 16 currencies, including the US dollar, Japanese yen, Canadian dollar, Australian dollar, South African rand and 11 European currencies such as the German mark, British pound, French franc, Italian lira, Dutch guilder, Belgian franc, Spanish Peseta, Austrian schilling, Swedish kronor and Norwegian krone. According to the announced rules of the IMF, these 16 currencies were selected because each had more than 1 percent share of the world’s total exports of goods and services in the five years before 1972. On September 18, 1980, the Executive Directors of the IMF adopted a resolution and stipulated that since January 1, 1986, the basket, with eligibility giving to those currencies which ranked as the top five in the exports and service trade outputs in the first five years, was to be narrowed down to five members, i.e., the US dollar, the German mark, the French franc, the British pound and the Japanese yen. When the euro was introduced in 1999, it replaced the mark and franc and the basket was then composed of the US dollar, the euro, British pound and Japanese yen.1“IMF Determines New Currency Weights for SDR Valuation Basket,”IMF Press Release No. 10/434, November 15, 2010, https://www.imf.org/external/np/sec/pr/2010/pr10434.htm.

This decision means that the RMB has become one of the major reserve currencies in international finance.

The composition of the SDR basket is reviewed every five years by the Executive Board of the IMF based on two criteria. The first is the export criterion, which means the SDR basket comprises currencies that are issued by members or monetary unions whose exports have the greatest values over the preceding five-year period. The second is the “freely usable currency”criterion, which reflects the importance of financial transactions for the purposes of valuing the SDR basket. According to the formal stipulations of the IMF’s Articles of Agreement, a “freely usable”currency is a currency that is widely used to make payments for international transactions, and is widely traded in the principal exchange markets. The concept of a freely usable currency concerns the actual international use and trading of currencies, and is different from whether a currency is either freely floating or fully convertible. During the review conducted by the Executive Board in 2010, it was decided the RMB had met the export criterion, but not yet met the freely usable criterion, and thus was not included in the SDR basket. By the end of 2015, the RMB had become the world’s second-largest trade financing currency, the fourth-largest payment currency, the sixth-largest lending money of international banks and the seventh-largest international reserve currency, thus meeting all criteria for inclusion in the SDR basket.

This reform of the SDR currency basket reflects the consideration of these two criteria and the growing economic strength of China, with the RMB weighing 10.92 percent and ranking third, after the US dollar and the euro, which weigh 41.73 percent and 30.93 percent respectively, but ahead of the Japanese yen and the British pound, which weigh 8.33 percent and 8.09 percent respectively.2“Factsheet–Special Drawing Right (SDR),”IMF, November 30, 2015, http://www.imf.org/external/np/ exr/facts/sdr.htm.In 2014, China’s export volume of goods amounted to $2,343 billion, ranking first in the world and accounting for 12.4 percent of world’s total exports, while Japan exported $684 billion, ranking fourth in the world and accounting for 3.6 percent of world’s total exports, and the UK exported $507 billion, ranking tenth in the world andaccounting for 2.7 percent of the world’s total exports.3“List of Countries by Exports,”April 16, 2015, http://www.qqjjsj.com/lssj/59405.html.As for the total economic output measured by GDP in 2014, China’s was $10.38 trillion, ranking second in the world and accounting for 13.4 percent of the world’s economic aggregate, while Japan was $4.62 trillion, ranking third and accounting for 6.0 percent of the world’s total output and the UK was $2.94 trillion, ranking fifth and accounting for 3.8 percent of the world’s total.4According to the world GDP rankings released by the IMF on April 14, 2015.

The Chinese government has attached great importance to the RMB’s inclusion in the SDR basket. As early as the G20 summit on September 5, 2013, President Xi Jinping pointed out that “a stable and risk-resisting international monetary system should be set up, and the composition of the SDR basket should be reformed…China will strive to deepen the marketized reform of its interest rate and exchange rate regimes, strengthen the exchange rate elasticity of the RMB, and gradually make the RMB capital account freely convertible.”On March 23, 2015, Premier Li Keqiang met with Christine Lagarde, managing director of the IMF, to discuss the RMB’s inclusion in the SDR currency basket. On November 3, Lagarde said in a statement that IMF experts believed the RMB met the “freely usable”criterion and suggested the inclusion of the RMB into the SDR basket. She said she welcomed this suggestion. At a BRICS leaders’ meeting on the sidelines of the G20 summit on November 15, President Xi Jinping pointed out that “the International Monetary Fund has finished the Special Drawing Rights review report, which explicitly supports the RMB applies to the ‘freely usable’ standard and suggests the RMB’s inclusion in the SDR basket. China welcomes this and believes that it will improve the international monetary system, safeguard global financial stability and achieve win-win results.”

Major European countries held a positive attitude toward the inclusion of the RMB into the SDR basket. The leaders of France, Germany, the United Kingdom and Italy all made remarks supporting the inclusion of the RMB, and their attitude was closely related to the positive role China played in the European Union’s debt crisis. When the eurozone debt crisisbroke out in 2012, which pushed the euro to the verge of collapse, China stood behind the euro. In a visit to Ireland on February 18, 2012, then Vice-President Xi Jinping made it clear that “China does not support negatively talking of and short-selling Europe,”and “China will continue supporting in its own way what the European Union (EU), the European Central Bank (ECB) and the IMF have done to solve the European debt issues.”The Chinese government suited its actions to its words. In the first half of 2012, China contributed $43 billion to the $461 billion special funds raised by the IMF to solve the debt crisis, accounting for nearly 10 percent of the total funds. In addition, China’s central bank continued to buy euro bonds to help alleviate the eurozone crisis. Concerning the governing philosophy of international finance, both China and EU countries advocate and support the diversification of the international finance system. On February 15,2012, Herman Van Rompuy, president of the European Council, pointed out that “nobody wants to live in a world ruled by a single currency, and this is an important reason why the euro matters to China.”For this same principle, the EU countries supported the RMB’s inclusion in the SDR basket to contain the dominance of the US dollar. Having learned a lesson from the Asian Infrastructure Investment Bank (AIIB), the governments of the United States and Japan did not oppose the RMB’s inclusion in the SDR basket.

Christine Lagarde, managing director of the IMF, announces the inclusion of the Chinese renminbi in the IMF’s SDR currency basket at a news conference, Washington, Nov. 30, 2015.

China’s strong economic growth is the most important factor for the RMB’s smooth inclusion into the SDR basket. In 2009, China surpassed Germany to become the world’s largest exporter of goods. China’s volume of imports and exports surpassed that of the United States to rank first in the world for the first time in 2013. China’s export volume of goods accounted for 12.4 percent of the world’s total in 2014, and this proportion was expected to rise to 13.4 percent in 2015, which would rank China first for seven consecutive years. China’s foreign investment also maintained rapid growth momentum. Since 2012, China has remained the world’s thirdlargest investor country after the United States and Japan. According to the 2014 World Investment Report published by the United Nations Conference on Trade and Development (UNCTAD) on September 5, 2015, by the end of 2014 China’s foreign direct investment totaled $882.6 billion, rising from the 17th in 2011 to eighth in the FDI rankings. In 2015, China’s foreign investment amounted to $118 billion and the cumulative investments for the first time exceeded $1 trillion. During the Asia Pacific Economic Conference summit on October 8, 2014, President Xi Jinping announced that China’s outbound investment would reach $1.25 trillion within the next 10 years.

The RMB is also more and more widely used in the world. From December, 2008 to the end of October, 2015, the People’s Bank of China signed bilateral currency swap agreements with the central banks or monetary authorities of 33 countries and regions, with a total value of more than $3.3 trillion. The international acceptance of the RMB has substantially increased, greatly promoting its internationalization.

In 2014, the value of China’s foreign trade settled in RMB was 6.65 trillion yuan, accounting for 25.16 percent of its total trade and this was expected to increase to around 30 percent in 2015. Currently, the scale of offshore RMB is expanding, with offshore RMB deposits exceeding more than 2.8 trillion yuan. China UnionPay is now in use in 150 countries and regions. And, by the end of November 15, 2015, the RMB had been incorporated into the national foreign exchange reserves of 51 countries, including the United Kingdom and Russia. After the RMB’s inclusion in the IMF’s SDR basket of currencies on October 1, 2016, it can be expected that more countries will include the RMB into their foreign exchange reserves.

The comments by Mr. Shih Chi-ping, a well-known financial commentator of Phoenix TV may illustrate the significance of RMB’s inclusion in the SDR basket. “Since New China was founded, there have been three milestones in its foreign affairs,”he said. “These are joining the United Nations, joining the World Trade Organization and joining the SDR. On October 25, 1971, China restored its legitimate membership in the UN and that was a milestone in the international political field. On December 10, 2001, China joined the World Trade Organization, marking a milestone in the field of international trade; on November 30, 2015, China joined the SDR currency basket, another milestone in international finance field.”The RMB’s inclusion in the SDR currency basket is an affirmation of China’s economic development and the achievements brought about by its reform and opening-up. In addition, it shows the recognition by the international community of China’s ever-increasing economic importance and its role in the global financial market. China will continue to advance its strategic layout to comprehensively deepen reform and accelerate the push for financial reform and further opening-up in a bid to make greater contributions to global economic growth, maintaining financial stability and improving economic governance.