The International Monetary Fund reviews its basket every five years. Inclusion of currencies in the basket of Special Drawing Rights (SDR) means that foreign capital markets are easily accessible.
What is Special Drawing Rights or SDR?
SDR was created by IMF in 1969 as is considered an ‘international asset reserve‘. SDR gained importance in 2009 since it provided liquidity to the global financial system. An inclusion in the reserve currency basket allows the domestic currency to become freely usable.
The value of the basket is determined in US dollar and is daily updated on IMF website. With the inclusion of Yuan , new weightage formula is adopted and is as follows:
- U.S. dollar: 41.73 percent
- Euro: 30.93 percent
- Chinese renminbi: 10.92 percent
- Japanese yen: 8.33 percent
- Pound sterling: 8.09 percent
Yuan’s inclusion in IMF currency basket is a relief to China’s economy. China is on its transition path from a more state governed economy to a more market oriented one. The inclusion also marks the entry of the first emerging market in a group of developed ones.
A quick look at China’s transition this year
This year, China took some important steps like establishment of BRICS bank in Shanghai and AIIB in Beijing that worried nations of US and Japan. To many economists, it felt as if China was going to be the leader amongst emerging markets, especially in infrastructural development.
But before any of these goals could even be set, China’s economy started showing troubling signs. The stock market crash in China raised some important questions, eventually leading to a surprise devaluation of its domestic currency, the Yuan. This strengthened the belief that officials in China could resort to reforms that could be damaging to global market, particularly emerging ones.
China’s surprise devaluation on August 11 was said to be a free market practice in order to remain at par with market exchanges. But this move has been at a cost of more than $5 trillion that have so far been wiped off on global stock prices. Following the black Monday on August 24th, many doubts were cleared about the ailing economic health of the world’s second largest economy. While the developing country sent out waves of worries across the stock markets of Eurozone and US, global investor confidence in Chinese markets started to fade away gradually from both domestic and international markets. As contagion started to spread across stronger economies, the resistance to China’s fall by developed nations was put to test. While developed markets may not be adversely affected (except worries regarding China’s next surprise move), emerging markets could either be facing a full-blown crisis or a calculation that went terribly wrong.
But in October, IMF’s announcement of including Yuan in the SDR basket, showed that China may be far from witnessing a full blown crisis. Undoubtedly, the economy is struggling to change from a state-driven economy to a more market oriented one, but the gradual shift is seen as a positive sign by many economists.
Here are some quick facts about the renminbi’s inclusion in the Special Drawing Rights basket:
- China is the world’s second largest economy and contributes 16.86% to world GDP (at PPP).
- China had been lobbying to include Yuan in the global reserve currency basket of IMF.
- On August 11, 2015, China lowered the value of its domestic currency, the Yuan.
- June-July-August have been turbulent periods for the Chinese stock markets and the global markets.
- With inclusion of Yuan as freely usable currency, China has gained access to international markets.
- According to analysts at Nomura, Japanese bank, Yuan is likely to become one of the three leading international currencies along with US Dollar and Euro.
- So far, the inclusion of China’s currency has got mixed reactions.
- The other currencies included in SDR basket are the US dollar, the euro, Japanese yen and pound sterling.
- Yuan is the fifth currency making China the first emerging market to be included with developed nations.
- The transition may be tough but in the long run China may emerge as a very influential economy.
In a speech, the Managing Director of the IMF, Christine Lagarde called the inclusion “an important milestone in the integration of the Chinese economy into the global financial system.” The inclusion of Yuan could highlight the growing impact of the emerging market in the global economy. The transition of the country may be a long one and may take years. But it looks like the developed markets have tried to embrace China’s attempt from an emerging market to a more advanced one by inclusion in the SDR basket.