Q and A on 2015 SDR Review
November 30, 2015
IMF’s Executive Board Completes Review of SDR Basket, Includes Chinese Renminbi
The Executive Board of the International Monetary Fund (IMF) today completed the regular five-yearly review of the basket of currencies that make up the Special Drawing Right (SDR). A key focus of the Board review was whether the Chinese renminbi (RMB) met the existing criteria to be included in the basket. The Board today decided that the RMB met all existing criteria and, effective October 1, 2016 the RMB is determined to be a freely usable currency and will be included in the SDR basket as a fifth currency, along with the U.S. dollar, the euro, the Japanese yen and the British pound. Launching the new SDR basket on October 1, 2016 will provide sufficient lead time for the Fund, its members and other SDR users to adjust to these changes.
At the conclusion of the meeting, Ms. Christine Lagarde, Managing Director of the IMF, stated:
“The Executive Board's decision to include the RMB in the SDR basket is an important milestone in the integration of the Chinese economy into the global financial system. It is also a recognition of the progress that the Chinese authorities have made in the past years in reforming China’s monetary and financial systems. The continuation and deepening of these efforts will bring about a more robust international monetary and financial system, which in turn will support the growth and stability of China and the global economy.”
The value of the SDR will be based on a weighted average of the values of the basket of currencies comprising the U.S. dollar, euro, the Chinese renminbi, Japanese yen, and British pound. The inclusion of the RMB will enhance the attractiveness of the SDR by diversifying the basket and making it more representative of the world’s major currencies. The SDR interest rate will continue to be determined as a weighted average of the interest rates on short-term financial instruments in the markets of the currencies in the SDR basket. Authorities of all currencies represented in the SDR basket, which now includes the Chinese authorities, are expected to maintain a policy framework that facilitates operations for the IMF, its membership and other SDR users in their currencies. The paper presented to the Board will be released soon.
- Question 1. What is the SDR?
- Question 2. What does an SDR review typically cover?
- Question 3. What are the criteria for SDR basket inclusion?
- Question 4. How do you define a freely usable currency?
- Question 5. What was the focus and outcome of the 2015 SDR review?
- Question 6. Why did the IMF staff recommend the inclusion of the Chinese renminbi into the SDR basket of currencies?
- Question 7. Why did the Board support the inclusion of the Chinese renminbi in the SDR basket?
- Question 8. When will the Chinese renminbi be officially included into the SDR basket?
- Question 9. Why will the Chinese renminbi only become freely usable on October 1, 2016?
- Question 10. Why has the weighting formula been changed and what are the major changes?
- Question 11. What are the new weights of each currency in the SDR basket?
- Question 12. What are the implications of the inclusion of the RMB into the SDR basket for the SDR itself and for the IMF operations?
- Question 13. How will the Chinese renminbi’s inclusion impact the global monetary system and the financial system in general?
- Question 14. What are the implications of the inclusion of the Chinese renminbi into the SDR basket of currencies for the renminbi and for China?
- Question 15. What are the implications of the RMB’s inclusion in the SDR interest rate basket?
Q1. What is the SDR?
The Special Drawing Right (SDR) is an international reserve asset, created by the IMF in 1969 to supplement its member countries’ official reserves. Its value is currently based on a basket of four major currencies (U.S. dollar, euro, Japanese yen, and pound sterling). The basket will be expanded to include the Chinese renminbi (RMB) as the fifth currency, starting on October 1, 2016 once the new basket of currencies takes effect.
SDRs are allocated to IMF members from time to time, based on each country’s quota in the Fund. A total of 204.1 billion SDRs have been allocated to date, most recently in 2009 when SDR 182.6 billion was allocated.
The SDR is neither a currency, nor a claim on the IMF. Rather, it is a potential claim on the freely usable currencies of IMF members. Holders of SDRs can obtain these currencies in exchange for their SDRs in two ways: first, through the arrangement of voluntary exchanges between members; and second, by the IMF designating members with strong external positions to purchase SDRs from members with weak external positions.
In addition to its role as a supplementary reserve asset, the SDR serves as the unit of account of the IMF and some other international organizations. It is also used in the IMF’s financing arrangements with its member countries.
Q2. What does an SDR review typically cover?
The composition of the SDR basket is typically reviewed every five years by the Executive Board to enhance the attractiveness of the SDR as a reserve asset. These reviews cover the key elements of the method of valuation of the SDR and seek to ensure that the valuation reflects the relative importance of currencies in the global trading and financial system. This includes the criteria used in selecting SDR basket currencies, the number of currencies in the basket, and the methodology for determining currency weights. The financial instruments comprising the SDR interest rate basket are also covered.
In the review concluded in November 2015, the Executive Board decided that the Chinese renminbi is determined to be a freely usable currency, effective October 1, 2016, and will then be included in the SDR basket as a fifth currency, along with the U.S. dollar, euro, Japanese yen and pound sterling. The weighting formula was also revised to address longstanding shortcomings.
Q3. What are the criteria for SDR basket inclusion?
The current criteria for inclusion were adopted by the IMF’s Executive Board in 2000. They established that the SDR basket comprises the four (expanded to five, effective October 1, 2016) currencies that are issued by members or monetary unions whose exports had the largest value over a five-year period, and have been determined by the IMF to be "freely usable".
The export criterion, which acts as a “gateway,” aims to ensure that currencies that qualify for the basket are those issued by members or monetary unions that play a central role in the global economy. This criterion has been part of the SDR valuation methodology since the 1970s.
The requirement for currencies in the SDR basket to also be freely usable was incorporated in 2000 to allow the currency selection criteria to formally reflect the importance of financial transactions.
The Decision adopted by the Board at the 2015 SDR Review reconfirmed the existing two substantive criteria (exports and freely usable) while expanding the size of the basket from 4 to 5 currencies effective on October 1, 2016. In doing so, the Board considered that a five-currency basket would be both more stable and more representative, while the administrative burden of a larger basket would be manageable.
Q4.How do you define a freely usable currency?
A “freely usable” currency is defined in the IMF’s Articles of Agreement as a member’s currency that the Fund determines is, in fact, 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.
A currency can be widely used and widely traded even if it is subject to some capital account restrictions (in the past, currencies such as the pound sterling and Japanese yen were determined freely usable when some capital account restrictions were in place). On the other hand, a currency that is fully convertible may not necessarily be widely used and widely traded.
The freely usable concept plays a central role in the IMF’s financial operations. In particular, members receiving Fund financial assistance have the right to receive such assistance in a freely usable currency. Indeed, IMF lending operations are, in practice, conducted in freely usable currencies or SDRs, and in the latter case, borrowing members have the right to exchange SDRs into freely usable currencies. In the financial operations context, the freely usable concept seeks to ensure that a member can use the currency received from the IMF either directly or indirectly (by exchanging it into another currency without disadvantage) to address a balance of payments financing need.
Q5. What was the focus and outcome of the 2015 SDR review?
The IMF recently concluded the quinquennial review of the SDR currency basket. As China continues to meet the export criterion for SDR inclusion, the review focused on assessing whether the Chinese renminbi (RMB) could be determined to be a freely usable currency, which is the other criterion for inclusion in the basket. This criterion requires an Executive Board determination that the currency is, in fact, widely used to make payments for international transactions and widely traded in the principal exchange markets.
The Executive Board at its meeting on November 30, 2015 decided that, effective October 1, 2016, the Chinese renminbi is determined to be a freely usable currency and will be included in the SDR basket, as a fifth currency, along with the U.S. dollar, euro, Japanese yen and pound sterling. The weights of the currencies in the SDR basket were also revised in line with a new weighting formula based on the value of the issuers’ exports, the amount of reserves denominated in the respective currencies that were held by other members of the IMF, foreign exchange turnover, and international bank liabilities and international debt securities denominated in the respective currencies.
Q6. Why did the IMF staff recommend the inclusion of the Chinese renminbi into the SDR basket of currencies?
Increasing international use and trading. Since the last SDR review in 2010, the use of the Chinese renminbi (RMB) in international payments has risen substantially. In addition, RMB activity in foreign exchange markets covering two of the three major trading time zones has increased significantly and can accommodate transactions of the magnitude involved in IMF operations. This provided, in the judgment of staff, a basis for the RMB to be considered “widely used” to make payments for international transactions and “widely traded” in the principal exchange markets.
Operational considerations. While operational issues are not formal requirements for SDR inclusion, staff’s assessment that the IMF, its members, and other SDR users are now able to conduct operations in RMB without substantial impediments means there are reasonable assurances that IMF related operations can be conducted smoothly. This is the direct result of recent reforms implemented by the authorities, principally their decision to grant full access for official reserve managers and their agents to the onshore fixed-income and foreign exchange markets. The authorities have also undertaken key reforms to advance their broader agenda to support the international use of the RMB and strengthen macro-financial stability, such as full liberalization of domestic interest rates, steps toward a more market-determined exchange rate, and implementation of a new cross-border interbank payment system.
Complementary steps to enhance data disclosure. While data disclosure is not a formal criterion for a currency’s inclusion in the SDR basket, issuers of these currencies generally meet high transparency standards. The authorities have recently taken very welcome steps to increase data disclosure and enhance their commitment to multilateral data initiatives.
Q7. Why did the Board support the inclusion of the Chinese renminbi in the SDR basket?
The decision on whether the RMB should be determined a freely usable currency and included in the SDR basket rested with the IMF’s Executive Board. Since there are no pre-set thresholds or benchmarks, the decision ultimately required policy judgment by the Executive Board, framed by the definition of freely usable under the IMF’s Articles of Agreement and informed by quantitative indicators.
The report prepared by staff provided a rigorous technical assessment with a clear recommendation in order to inform Executive Directors.
The Board endorsed staff’s analysis and recommendation to determine the Chinese renminbi freely usable and include it in the SDR basket, as a fifth currency, along with the U.S. dollar, euro, Japanese yen and pound sterling, effective October 1, 2016.
Q8. When will the Chinese renminbi be officially included into the SDR basket?
The new basket including the Chinese renminbi will take effect on October 1, 2016.
The Executive Board previously extended the current basket to end-September 2016 in response to feedback from SDR users. The decision reflected the desire to avoid changes in the basket at the end of the calendar year (when trading volumes are low), facilitate the continued smooth functioning of SDR-related operations amid a higher than-usual level of uncertainty generated by the ongoing SDR review, and to allow sufficient lead time to adjust in the event that a new currency is added to the SDR basket.
Q9. Why will the Chinese renminbi only become freely usable on October 1, 2016?
The Chinese renminbi (RMB) has met all conditions and operational requirements for being determined freely usable and to be added in the SDR basket. However, if the Fund’s determination of free usability was to become effective as of the date of the review (November 30, 2015), it would allow the immediate use of the RMB as a freely usable currency in Fund financial transactions, when the Fund and its members are not yet operationally ready. The delayed inclusion of the RMB in the SDR basket also allows SDR users time to adjust their operations. Therefore, the Fund’s determination of the RMB as a freely usable currency and the RMB’s inclusion in the SDR basket will only come into effect on October 1, 2016.
Q10. Why has the weighting formula been changed and what are the major changes?
The Executive Board has long recognized the shortcomings of the previous method for determining currency weights in the SDR basket, in particular, the relatively low weight and narrow scope of financial variables, and the endogenous weighting of flows (exports) and stocks (reserves).
At the conclusion of the 2010 SDR Basket review, Directors welcomed a work program that would, among others, consider the relative roles of trade and financial indicators.
The new formula endorsed by the Board is one of the two alternatives presented in the 2010 Review and expands the share and representativeness of the financial variables and moves away from the endogenous weights implied by the old formula. In the new formula, exports and the financial variable are given equal weight and the coverage of the financial indicator has been expanded to better capture different financial transactions.
Q11. What are the new weights of each currency in the SDR basket?
Under the new formula, the respective weights of the SDR currencies are: 41.73% for the U.S. dollar; 30.93% for euro; 10.92% for the Chinese renminbi; 8.33% for the Japanese yen; and 8.09% for the pound sterling. This basket of currencies will take effect on October 1, 2016.
After these weights are used on September 30, 2016 to establish the new fixed amounts of currencies that comprise the SDR basket, the share of each currency in the valuation of the SDR on any particular day going forward will depend on the exchange rates prevailing on that day.
Q12. What are the implications of the inclusion of the RMB into the SDR basket for the SDR itself and for the IMF operations?
The inclusion of the Chinese renminbi (RMB) is the first major change to the SDR basket composition since 1980 when the basket size was reduced from 16 to 5 currencies (also, in 1999, the euro replaced the Deutsche mark and the French franc).
The RMB’s inclusion will enhance the attractiveness of the SDR as an international reserve asset. It diversifies the basket and makes its composition more representative of the world’s major currencies.
Operationally, the inclusion of the RMB into the SDR basket means that an RMB instrument will be included in the calculation of the SDR interest rate, along with changes to the procedures for exchange of currency between China and the Fund. It will also impact the conduct of future Fund transactions which can be carried out in RMB once the determination of the RMB as a freely usable currency becomes effective on October 1, 2016.
Q13. How will the Chinese renminbi’s inclusion impact the global monetary system and the financial system in general?
Put into a broader context, the inclusion of the Chinese renminbi (RMB) in the SDR basket could be seen as an important milestone in the process of China’s global financial integration. It also recognizes and reinforces China’s continuing reform progress.
As this integration continues and further deepens, and is paralleled in other emerging market economies, it could bring about a more robust international monetary and financial system, which in turn would support the growth and stability of the global economy.
The RMB’s inclusion will also enhance the attractiveness of the SDR as an international reserve asset, as it diversifies the basket and makes its composition more representative of the world’s major currencies.
Q14. What are the implications of the inclusion of the Chinese renminbi into the SDR basket of currencies for the renminbi and for China?
The inclusion recognizes a significant increase in the internationalization of the Chinese renminbi (RMB) in recent years, underpinned by policy reforms to achieve China’s transition to an increasingly open and market-based economy.
Inclusion in the basket will also support the already increasing use and trading of the RMB internationally.
Q15. What are the implications of the RMB’s inclusion in the SDR interest rate basket?
The RMB will be added to the basket on October 1, 2016, and its impact on the SDR interest rate will depend on the rates prevailing at that time. This effect is uncertain; nevertheless, since the interest rates in China are currently above the other rates in the SDR interest rate basket, it is likely that the SDR interest rate would rise when the RMB is included in the basket.
The various effects of a likely higher SDR interest rate on Fund borrowers, creditors, and the Fund’s own income position will be considered in the context of the next review of the Fund’s income position that is scheduled for April 2016.