RARELY in their 46-year history have Special Drawing Rights commanded quite so many headlines. SDRs play a mostly arcane role in the global financial system. Technically they constitute an international reserve asset that helps maintain balance between countries with big external liabilities and those flush with cash. In practice, they are more marginal, as countries largely rely on capital markets and hard currencies to cover their obligations.
Now China, eager to make the yuan go global, has placed SDRs in the spotlight. The International Monetary Fund, which manages the SDRs, is conducting a five-yearly review of the basket of currencies that form its value. China wants it to bring the yuan into the basket.
That would be a big decision, meaning that the IMF has in effect recognised the yuan as a reserve currency, despite China’s extensive capital controls. It would not suddenly turn the yuan into a rival to the dollar (as we lay out in this week’s issue, that is still a long time off). But it would be a symbolic boost to its international standing, giving countries more confidence to add the yuan to their currency reserves. In a newly published staff paper, the IMF shows that the yuan is close to making the cut but may need a little goodwill from the directors deciding on it. The paper, which was discussed at an IMF board meeting last week, lays out the parameters for the formal SDR review that will take place later this year.
Two criteria determine whether a currency can be part of the SDR. Its issuing country must be a major exporter, and the currency must be freely usable. No one disputes that China meets the first criterion. Over the past five years, its exports averaged 11% of the global total. That places it behind the European Union and America but well ahead of Japan and Britain (the euro, dollar, yen and pound are the four currencies that currently make up the SDR).
The second criterion is the tricky one. If freely usable is understood as fully convertible, the yuan would not make the grade. China places caps on how much cash its residents can take out of the country; forces international companies to do extensive paperwork before bringing large sums in; and limits foreigners to strict quotas for investing in its capital markets.
But, as the IMF explains in its paper, freely usable means something else. It refers to whether a currency is widely used in international transactions and whether it is widely traded in global markets. Full convertibility would help a currency meet these standards but is not a prerequisite. In theory judging this ought to be clear-cut. Across a range of indicators considered by the IMF, the yuan seems to sit just outside the SDR club. In 2014 it ranked 7th among currencies in countries’ official reserve assets. It was the 8th-most used for both international debt securities and cross-border payments. As for trading, it ranked 11th in global currency spot markets.
However, if the yuan is judged based on its trajectory, rather than a snapshot of its current standing, the case for its inclusion in the SDR is much stronger. Its international use has grown rapidly in recent years, albeit from a low base. Consider the indicators outlined above. In 2014 it accounted for 1.1% of countries’ official reserve assets, up from 0.7% in 2013. Some 0.6% of international debt securities are now denominated in yuan, up from just 0.1% in 2010. For cross-border payments, 1% are conducted in yuan, up from 0.2% in 2012. International trading of the yuan has had a similar, if slightly slower, ascent: 0.8% of currency transactions in the global spot market involved yuan in 2013, up from 0.3% in 2010. Moreover, while capital controls make it difficult for ordinary foreign firms to invest in Chinese markets, the government has started to open its door more widely to other countries’ central banks.
Given uncertainties over interpretation of these indicators, and the flux in China’s own rules, the IMF staff paper does not make a definitive recommendation. “The ultimate assessment by the Board will involve a significant element of judgment”, it concludes. One major but unstated factor in this judgment is what impact admission to the SDR would have on China’s reform process. Growing international use of the yuan stems in large part from the Chinese central bank’s efforts to loosen, gradually but steadily, restrictions on cross-border capital flows and to free up the country’s financial system.
The central bank is widely, and rightly, seen as the most eager among China’s official institutions in pushing for economic reforms. Bringing the yuan into the SDR would give the bank a victory and strengthen its position in domestic debates, by showing that opening up the economy brings rewards. At a time when there are doubts about China’s commitment to reform, following its heavy-handed stockmarket intervention, that would be all the more valuable. With the yuan close to reserve-currency status on its own merits, the political argument may just be the clincher.
