150622 fx watch a q&a on the yuan's sdr inclusion

FX Watch A Q&A on the yuan’s SDR inclusion

Group Economics Macro & Financial Markets Research Roy Teo +65 6597 8616, Arjen van Dijkhuizen, +31 20 628 8052

22 June 2015 

In late 2015, the IMF will decide on the composition and valuation of the SDR basket. In the last SDR review in 2010, the

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In our view, the likelihood that the CNY will qualify for SDR inclusion has risen compared to 2010, given its increased use

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Still, we have doubts about whether SDR inclusion will already take place this year, as the IMF might want to see more

IMF concluded that the CNY did not meet the criteria of being a freely usable currency. in global trade and finance. In fact, as confirmed by the IMF, SDR inclusion is more a matter of ‘when’ than ‘if’. progress (or more commitments) regarding the liberalisation of the capital account and the exchange rate regime.

However, in case of a ‘no’ this year, we do not think that China would have to wait for another five years per se. 

The yuan inclusion in the SDR basket is not expected to have material impact on our slightly bearish view on the yuan

Background

Is there a case for CNY to be included in the SDR basket?

In late 2015, the Executive Board of the IMF will decide on the

Yes. In our view, the yuan has come closer to meeting the

composition and valuation of the Special Drawing Right (SDR).

criteria for SDR inclusion. We would like to highlight that

According to IMF regulation, the currencies and their weights

determining whether a currency is ‘freely usable’ remains a

in the SDR valuation basket are reviewed every five years,

matter of subjective judgment.

unless the Board decides otherwise. At the last SDR review in 2010, the IMF concluded that the CNY did not meet the criteria

Still, referring to the criteria mentioned by the IMF, there are

of being a ‘freely usable currency’.

some observations to be made showing that the yuan’s role in international trade, payments and finance has increased

China has already been aiming for years to get the yuan

sharply since 2010 (see Box 2 for more details):

included in the SDR basket, as it wants to support the

-

globalisation of the currency and strengthen its economic and geopolitical clout. The authorities hold the view that SDR inclusion would facilitate the further use of their currency in

arrangements with 30 countries; -

According to the BIS, the CNY is now the 4th largest currency in international money market instruments.

foreign trade and finance. China has even set a formal target for inclusion of the yuan in the SDR for this year.

The number of central banks that invest in the CNY has risen to around 60, while the PBoC has currency swap

-

Regarding the denomination of international debt securities, the CNY is ranked 9th and its share is expected to rise further in the coming years.

What are the criteria for inclusion in the SDR basket?

The IMF Special Drawing Right (SDR, see box 1) basket

-

currencies currently included in the SDR basket).

determined by the IMF for SDR basket composition are: 1) the size of country’s exports of goods and services during

In terms of daily FX market turnover, it is expected that the CNY will rank number 5 in 2016 (after the four

consists of the four major traded currencies. The criteria as -

The CNY is also the 5th most active used currency

the five-year period ending 12 months before the revision date:

globally in global payments in April 2015, according to

2) the currency must be ‘ freely usable’. According to the IMF’s

SWIFT, after the four SDR basket currencies.

Articles of Agreement, a freely usable currency is a member’s currency that the Fund determines a) is widely used to make

Is CNY inclusion in the SDR basket likely in 2015?

payments for international transactions and b) is widely traded

We have some doubts. We believe there is a high likelihood

in the principal exchange markets.

that the yuan will be included in the SDR basket in the coming years, but it is hard to tell currently whether that will already

During the last review in November 2010, the IMF Board

occur this year. IMF Managing director Lagarde and other key

concluded that “although China has become the third-largest

officials have recently stated that RMB inclusion is a question

exporter of goods and services on a five-year average basis

of ‘when, not if”. During a recent G7 meeting, German Finance

and has taken steps to facilitate international use of its

Minister Schaüble stated that ‘we are in full agreement on the

currency, the Chinese renminbi does not currently meet the

goal, but it would not be good to rush it’. It may well be that the

criteria to be a freely usable currency and would therefore not

IMF Board, partly influenced by the US, will ask China to

be included in the SDR basket at this time”.

further liberalise its exchange rate regime and its capital account as a precondition for yuan inclusion in the SDR basket.

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FX Watch - A Q&A on the yuan’s y SDR inclusion - 22 Jun ne 2015

e basket composition is in principle reviewed every five The

Would W SDR inclusion impactt our yuan view?

yea ars by the Execcutive Board, but b mind the ad dditional phrase e

We W do not think that the inclusiion of the yuan n in the SDR

‘unless the Board ds decides othe erwise’. We thin nk that should

ba asket will materially change oour slightly bearish view on the

e yuan not be in ncluded in this year’s review, China would n not the

yu uan. An increas se in central baanks’ demand for f the yuan ass a

nee ed to wait for another five yea ars to be includ ded.

re eserve currency y will be small ((the SDR quota represents le ess than 3% of total global reservees) and gradual. We see a riskk of

usion in SDR basket?

Can the US veto the CNY inclu

otential net outflows from Chi na as domestic c investors see ek po

g approval is ne eeded to incorp porate a curren ncy No. A 70% voting

op pportunities abroad as the ca pital account will w be graduallyy

o the SDR while other decisio ons require 85% % approval by into

lib beralised. We also a expect som me weakening of the yuan ass a

IMF F member state es. Hence, the e US with aboutt 17% of voting g

re esult of the wide ening divergennce in monetary y policy betwee en

righ hts does not ha ave the veto po ower to the yua an being includ ded

the US (we expe ect the Fed lift-ooff in Septemb ber) and China (we

in the t SDR baske et.

xpect ongoing measured monnetary easing to keep growth ex clo ose to the 2015 5 target of 7%)). Furthermore the currency iss no

Willl CNY interna ationalisation profit from SD DR inclusion? ?

longer undervalu ued and a wea ker exchange rate will help to o

Yes s. While inclusion of the yuan n in the SDR ba asket would

upport exports which has beeen weak since the t beginning of o su

facilitate the further use of the currency in international trade

this year. On balance we mainttain our 2015 and a 2016 year

and d finance, this iissue is partly symbolic. s Therre are smaller

en nd yuan forecasts of 6.30 andd 6.40.

currrencies such a as the Swiss fra anc, which are not included in n the e SDR basket b but have a glob bal reserve currrency status.

Bo ox 1: Special Drawing Righ hts

Still, although incllusion of the yu uan in the SDR R basket is not a pre e-requisite of be eing a reserve currency, it wo ould support itss

In 1969, the Spe ecial Drawing R Right (SDR) wa as created by th he

furtther use in inte ernational trade e and finance, as a it would makke

international com mmunity to suppport the expan nsion of world

the e yuan a more iinternationally recognised currrency and

tra ade and financial developmennt in the form of o a new

enh hance its statuss as reserve cu urrency. It will also a make the

international reserve asset undder the auspice es of the IMF. At A

SD DR basket more e representative of global trad de and enhancce

that time, gold and the US dollaar were seen as a providing

the e stability of the e SDR basket given g the yuan’’s low correlatio on

inadequate supp port.

with h the US dollarr and euro.

SD DR is neither a currency nor a claim on the IMF. Rather, itt is Wh hat steps is Ch hina taking in the meantime e?

a potential claim on the freely uusable currenc cies of IMF

Witth an eye on po ossible yuan in nclusion in the SDR S basket, th he

members.

Chinese authoritie es stated earlie er this year that they aim to ach hieve yuan con nvertibility unde er the capital ac ccount, even

Initially, the value of the Speciaal Drawing Right was defined d as

tho ough full curren ncy convertibilitty is not a prere equisite for SD R

eq quivalent to 0.8 888671 grams oof fine gold – which w at the tim me,

inclusion. The autthorities have already a made some s steps

wa as also equivalent to one dolllar. After the co ollapse of the

tow wards financial liberalisation, such s as setting g up a long-

Brretton Woods system s in 19733, the SDR was s redefined as a

awa aited deposit in nsurance syste em and grant more m freedom to o

ba asket of currencies consistingg of the euro, th he yen, the US S

sett deposit rates. However, the authorities will probably keep p

do ollar and the po ound sterling.

on managing the opening up of the capital acc count carefully, al systemic riskks attached to it. given the potentia

In 2010, the weig ghts of the currrencies in the SDR S basket we ere re evised based on the value of tthe exports of goods g and

nor Zhou has referred r to changing regulatio on Still, PBoC govern

se ervices, and the e amount of resserves denominated in the

reg garding exchan nge rate controls, the liberalisa ation of both

re espective currencies that weree held by otherr members of th he

inw ward and outwa ard-bound investment and the e opening up oof

IM MF. The IMF may allocate SD DRs to memberr countries in

bon nd, equity and other financial markets to foreign investors..

prroportion to the eir IMF quotas.

Earrlier this month h, the PBoC published a report on yuan

So ource: IMF

inte ernationalisatio on, announcing g some measurres to promote cap pital account lib beralisation and d yuan converttibility. The autthorities want to o stimulate fore eign institutions s (beyond d cen ntral banks) to invest in China a’s interbank bo ond market and

Bo ox 2: What is a Freely usab ble (FU) curren ncy?

to issue CNY bon nds and allow more m Chinese institutions to e the restriction ns on CNY bon nd borrrow CNY overrseas and ease issu uance.

Ac ccording to the e IMF the follow wing criteria are e used.

Widely W used to make m paymentss for international transaction ns:

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FX Watch - A Q&A on the yuan’s y SDR inclusion - 22 Jun ne 2015

Currency compossition of official reserve holdin ngs

su upport infrastructure developm ment across the continent, is

Currency denomination of intern national bankin ng liabilities

ex xpected to facilitate wider usaage of the yuan n.

Currency denomination of intern national debt se ecurities Wid dely traded in ffinancial marke ets:

In addition, as China C has comm mitted to increa ase the

A deep d and broad d foreign excha ange market is necessary

co onvertibility of the yuan underr the capital account, we expe ect

(vo olume of spot and derivative transactions)

vo olume in the yu uan to increasee. The CNY is also a the 5th mo ost

Min nimal transactio on costs are de esired (Bid-ask k spread)

ac ctive used curre ency globally inn global payme ents in April 20 015, ac ccording to SW WIFT, after the ffour SDR bask ket currencies.

1a: Currency com mposition of offiicial reserve ho oldings

Th his compares to a rank of 17 in 2011. Moreo over, almost a

Bas sed on the IMF F composition of o foreign exchange reservess

third of payments in Asia Paciffic with China and a Hong Kong g in

(CO OFER) report in n March 2015, the USD and the t EUR rema ins

Ap pril are now ma ade in yuan, a steep rise from m 7% two yearss

the e two largest reserve currencies, accounting g for around 63 %

ag go. The yuan has also surpasssed the euro as a the second-

and d 22% of total ((allocated) officcial foreign currency reservess

most used currency in trade finnance in Octob ber 2013. Last but b

as of end 2014. N Note that not all countries repo ort to COFER,

no ot least, the PB BoC has currenncy swap arrangements with 28 2

as it is a voluntaryy excercise. He ence the perce entage of

co ountries with a value of more than CNY 3tn.

una allocated reserrves has risen over o the years from 45% in 201 12 to above 47 7% in 2014. As such it is diffic cult to ascertain n

2b b: Average tran nsaction costs (bid-ask spread)

the e precise share of the yuan in reserve holdin ngs. However,

Th he average transaction costs of the yuan is higher than the e

acc cording to the P People’s Bank of China, the CNY C is the 7th

major currencies s, based on eleectronic platforms bid-offer

larg gest reserve cu urrency. There are more than n 60 central

sp preads. However, with daily tuurnover in the yuan y likely to

ban nks globally tha at invest in the yuan. China also has curren cy

increase further, the average trransaction costs in the yuan is i

swa ap agreementss with 30 counttries, totaling about 3.14 billio on

ex xpected to decline.

yua an (USD 500 m million) as of Ap pril this year.

So ource: IMF

1b: Currency denomination of in nternational banking liabilitiess The e BIS statisticss show that the yuan is the 4th h largest den nominated currrency in interna ational money market

Bo ox 3: Freely usable versus Reserve Asse et criteria

insttruments, exce eeding the Japa anese yen from m 2013 Q2.

Mo oreover, the PB BoC has announced certain measures m which h

Att the april 2011 meeting, the IIMFC and G20 0 Ministers calle ed

would promote yu uan denomination of internatio onal banking

for further work to t broaden the composition of o the SDR basket.

liab bilities (see belo ow).

Th here is a propo osed alternativee to the freely usable u (FU) crriterion, which is the reserve aasset criterion (RAC). Still, the

1c: Currency com mposition of inte ernational debtt securities

RA AC criterion might not be adoopted as it migh ht need a 85%

Acc cording to the IIMF, offshore yuan y bonds outtstanding at en nd

majority of total votes. v

of 2013 2 was CNY Y 490bn, having g risen almost five fold from CN NY 100bn in 2010. The Shang ghai Developm ment and

FU U and RAC sim milarities

Research Founda ation stated tha at the amount of o international

1.

Currency compositionn of reserves

deb bt securities ou utstanding in yu uan is USD 110 0bn in 2014 Q2 2,

2.

Volume e of transactionns in foreign ex xchange spot

ran nked 9th globally. In our view it is clear that the t yuan

marketts

den nominated share of internatio onal debt securrities is expecte ed to increase in the coming years,, as China will further promote e

FU U and RAC diffferences

the e use of the yua an in international finance.

1.

FU: Cu urrency denomiination of international bankin ng liabilitie es and internattional debt secu urities

2a: Foreign excha ange market tu urnover

2.

RAC: Volume V of transsactions in fore eign exchange

The e average dailyy turnover of th he CNY (USD 120bn) 1 was

derivative markets annd over the cou unter derivative es

ran nked 9th globally in April 2013 3, according to the BIS.

trade. Appropriate A maarket based intterest rate

How wever, based o on the growth rate r in the pastt decade, it is like ely that the yua an may challeng ge the Australian dollar (USD D 462 2bn) as the 5th h most traded currency c in the next triennial BIS S survey in 201 16, just behind the four SDR basket b currrencies (USD, EUR, JPY and d GBP). Indeed d, the China led d Asian Infrastructu ure Investment Bank (AIIB), which w aims to

instrum ment So ource: IMF

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FX Watch - A Q&A on the yuan’s y SDR inclusion - 22 Jun ne 2015

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