Simply put: Dragon now in basket, how will SDR change?

From October 1, 2016, China’s Renminbi will be the fifth currency in the IMF’s Reserve Currency basket. Indian Express explains how the rules of global trade may change for India and the world as a result.

Written by Sandeep Singh | Updated: December 2, 2015 5:10:44 am
From October 1, 2016, China’s Renminbi will be the fifth currency in the IMF’s Reserve Currency basket. From October 1, 2016, China’s Renminbi will be the fifth currency in the IMF’s Reserve Currency basket.

In its most recent five-yearly review of the basket that makes up its (SDR), the executive board of the International Monetary Fund (IMF) has decided to include the Chinese Renminbi (RMB) among the world’s elite currencies. From October 1, 2016, the RMB will join the US Dollar, Euro, UK Pound and Japanese Yen in the SDR basket.

What is SDR?

It is an interest-bearing international reserve asset created by the IMF in 1969 to supplement official reserves of member countries. Official reserves in the form of gold or widely accepted foreign currencies are used to purchase the domestic currency in foreign exchange markets so that the exchange rate is maintained. However, as the supply of the two key reserve assets (gold and Dollar) proved inadequate for supporting the expansion of world trade and financial flows, it was decided to create a new international reserve asset backed by the IMF.

SDR is neither a currency nor a claim on the IMF. It is a potential claim on the freely usable currencies of IMF members, which holders of SDRs can obtain in exchange for their SDRs. Its value is based on the basket of the four major currencies — currently, 1 SDR is trading at around INR 91.50. The fifth currency, RMB, will be added to the basket on October 1, 2016.

SDRs allow member countries to cut the reliance on more expensive debt to build reserves. A total of $ 182.6 billion was allocated to 186 countries in 2009; India was allocated $ 3.29 billion. SDR interest rate is determined as a weighted average of the interest rates on short-term financial instruments in the markets of the currencies in the SDR basket. As of November 30, 2015, 204.1 billion SDRs — equivalent to about $ 285 billion — had been created and allocated to members.

QWhat does the addition of the Renminbi to SDR mean?

Going forward, the value of SDR will be based on a weighted average value of the basket of currencies that will also include the Renminbi. China is the world’s second largest economy, and its share in gobal trade is rising; the inclusion of the Renminbi will enhance the attractiveness of the SDR by diversifying the basket and making it more representative of the world’s major currencies. It will also allow countries to get Renminbis in exchange for their SDRs in case that os required.

Will it lead to more transparency in the value of Renminbi?

Economists say that as a prerequisite, China was required to have an offshore Renminbi centre. Offshore RMB trade was opened in London, and the London RMB is expected to become the benchmark for SDR. While its value can still be manipulated, there is very little chance of that happening — as the value has to be aligned with the integrity of SDR. It is expected that China will be more predictable in how it manages its currency, as it will have to maintain a policy framework that facilitates operations for IMF, its members and other SDR users in their currencies.

“An offshore exchange supported by the home country can still be influenced, but Chinese policymakers have been sending signals that they will have a market determined exchange rate. Also, with an offshore exchange, the Renminbi is likely to be more transparent, and one gets to know who is participating in the trade. It is a positive signal,” said a former Deputy Governor of the Reserve Bank of India.

How will Renminbi’s addition impact India and other countries?

Several countries have a trade deficit with China, and need the Yuan; on the other hand, many countries in Africa have a trade surplus with China, and have been accumulating Yuan. Renminbi’s addition to SDR will allow these countries to trade in the currency.

While it may not mean much, India (and other countries) will have the option of holding forex reserves in RMB. Also, the RMB will become a free-float currency (which is a requirement) — and traders buying goods from China will have the additional flexibility of getting Yuan from the market, a market expert said.

While the impact of the Renminbi’s inclusion may not be sudden, Indian importers may be exposed to the RMB-INR exchange rate risk, another market expert said. “China is a big trading partner and we do not have bargaining power against them. So there may be a case that going forward they may ask Indian traders to pay in RMB and that may expose Indian traders to a RMB-INR exchange rate risk at the secondary level,” said Jamal Mecklai, MD and CEO of Mecklai Financial Services.

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