INTERNATIONAL FINANCIAL MANAGEMENT

PROJECT REPORT

INCLUSION OF CHINESE YUAN

IN SDR

SUBMITTED BY

1B Aakash Bhatnagar
24B Mohit Vashishta
28B P Sidhivi Raj
48B Vijayameenah K C
53B Yatharth Nathani

Under the Guidance of

Professor Rajeev Srivastava
 An Introduction to SDR: SPECIAL DRAWING RIGHTS
SDR (Special Drawing Rights) are supplementary foreign exchange reserves defined and maintained
by International monetary reserves.

SDR was created as a supplementary international reserves asset in the context of the Bretton
Woods fixed exchange rate system. The collapse of the Bretton woods system in 1973 and the shift
of major currencies to floating exchange rate regimes lessened the reliance on the SDR as a global
reserve asset. SDR plays a major role in providing liquidity and supplementing members’ countries
official reserves, as well as the case of the global financial crises.

SDR (Special Drawing Rights) is essentially an artificial currency instrument used by the IMF and is
built from a basket of important national currencies. The IMF uses SRDs for internal accounting
purpose. SDRs are allocated by the IMFs to its member countries and are backed by the full faith and
credit to its member countries governments. The makeup of the SDR is re-evaluated every five years.

The current makeup for the SDR is given by:

The SDR was formed with a vision of becoming a major element of international reserves, with gold
and reserve currencies forming a minor incremental component of these reserves

The Special Drawing Rights interest rate

The interest rate on SDR or SDRi provides the basis for calculating the interest rate that is charged to
members countries when they borrow from the IMF and paid to members for their remunerated
creditor positions in the IMF. It is also the interest paid to member countries in their own SDR
holdings and charged on their SDR allocation.

The SDRi is determined weekly based on a weightage average of representative interest rate on
short-term government debt instruments in the markets of the SDR basket currencies with a floor of
five basis points.
 Addition of currencies to the SDR
The SDR was initially defined as 0.88671 grams of fine gold, which was equivalent to 1 USD.
After the collapse of the Bretton Woods System, it was designated as a basket of currency.
The basket is drawn from currencies which are of relative importance in world trading and
the financial institutions and systems of the world. In order for a currency to be included in
the SDR, it has to meet two criteria. The first is that the country to which the currency
belongs, is a member of the IMF, and second is that the country should be among the most
important and largest trading nation among the members.

There are various uses and applications of SDR for the Governments of various countries.
Participating members and prescribed holders can buy and sell SDRs in the voluntary
market. If required, the IMF can also designate members to buy SDRs from other
participants and hence, it can be brought and kept as part of the foreign exchange reserves
by the central bank or central government of a nation.

An SDR allocation is among the cheapest methods for under developed (or developing)
countries to increase their international reserves, thereby allowing them to reduce
dependence on more expensive methods such as borrowings, or running current account
surpluses, which require a competitive advantage.

Additionally, the SDR is also used as a unit of account by several international financial
institutions, such as Asian Development Bank (ADB), Bank for International Settlements
(BIS), Islamic Development Bank, etc. The SDRs can be used to hedge against the volatility of
the exchange rate against the domestic currency.

SDRs are also used when a member country needs to borrow for non-concessional
purposes. The SDR interest rate (SDRi) is used to calculate the interest expenses, and is also
used to pay the member countries for their creditor positions. This interest rate is charged
on the SDR allocation to the countries.

Till 2015, only four currencies had been included in the currency basket of the Special
Drawing Rights. These were the US Dollar, The Japanese Ren, The Euro and the British
Pound Sterling. During the review in November 2015, it was decided that the Chinese
Renminbi (or Yuan) would be added to the basket of currencies, as China fulfilled the
conditions for its inclusion.

Chinese Yuan (Renminbi)

China’s currency Yuan pegs its currency to the U.S. dollar, its largest trade partner. China is not
unusual in doing this. Most countries tie their currency to either the U.S. dollar or the currency of
their largest trading partner. It keeps the local currency’s value stable, helping businesses and
investors to trade with confidence.

China’s central bank management of Yuan over the years

The People's Bank of China (PBOC) manages the yuan’s value so that it rises and falls along with the
dollar. The dollar's value fluctuates because it’s on a floating exchange rate. China switched from a
strictly fixed exchange rate in July 2005. So its currency is now more flexible but is still managed with
a close eye.

 China began to peg the RMB to the dollar in 1994 at about 8.28 yuan (the base unit of the RMB)
per dollar and kept the rate constant through July 2005, when, under pressure from its major
trading partners, it moved to a managed peg system and began to allow the RMB to gradually
appreciate over the next three years.

 In July 2008, China halted RMB appreciation because of the effects of the global economic crisis
on China’s exporters. It resumed RMB appreciation in June 2010.

 From July 2005 through June 2013, the RMB appreciated by 34% on a nominal basis against the
dollar and by 42% on a real (inflation-adjusted) basis.

 Since 2014, when the yuan reached an 18-year high, China has been lowering the value of its
currency.2 There are many reasons for that. In 2014, the dollar rose 15% against most major
currencies, dragging the yuan up with it. As a result, the yuan was overvalued compared with
other trading partners not pegged to the dollar.

 In 2015, the International Monetary Fund (IMF) designated the yuan as an official reserve
currency. The IMF required the yuan to be more driven by market forces. As China relaxed
controls, the yuan experienced greater market volatility. But the yuan didn’t rise, as many
thought it would. It fell, indicating that the market thought the yuan was overvalued.

 In 2019, China lowered the yuan’s value. It might have been trying to offset the rising cost of
tariffs imposed by President Trump's trade war. Later that year, the U.S. made its declaration
about China being a currency manipulator.
YUAN in SDR

The RMB's inclusion represents a major move forward in China's economic integration into the
global financial system.

This reflects China's growing importance on the global stage. It also emphasises China's success in
the monetary, foreign exchange, and financial systems. The renminbi's international presence is
likely to grow even further as a result of its inclusion in the SDR basket.

As we can see, the International Monetary Fund is continuously working to ensure that the SDR is
priced correctly and made up of the most appropriate currencies for its function.

It's easy to see how the SDR evolves with the ever-changing global economy, from changing 16-
currency baskets to 5-currency baskets to including the renminbi.

There are two criteria for inclusion in the basket. First, the country must be a ‘major trading
country’. On this point China definitely qualifies: its exports already exceed those of the United
States. The second criterion is the currency’s ‘freedom of use’. Any SDR currency should be widely
used for the payment of international transactions and traded in major foreign exchange markets.

Critics argue that the move is largely symbolic, and the yuan does not fully meet IMF reserve

currency criteria of being freely usable, or widely used to settle trade or widely traded in financial
markets.

The weights assigned in the SDR before and after the inclusion of SDR are as shown above.
Impact of inclusion of Chinese Yuan in the SDR Basket
Significance for China
This move signifies the integration of the Chinese economy into the global financial system.

By way of this inclusion, the IMF has determined that RMB is a freely usable currency. This shows
China’s increasing role in global trade and the substantial expansion in the international use and
trading of the renminbi.

Issuers of reserve currency are required to meet high transparency standards. In the backdrop of
accusations against China being a ‘currency manipulator’ this is very significant as the inclusion
recognizes the progress made in reforms to China’s monetary, foreign exchange, and financial
markets.

It should be noted that Chinese authorities have recently taken welcome steps to increase data
disclosure.

Significance for Renminbi

Although Renminbi is not widely used in international markets currently compared to the US Dollar
and other currencies in the basket. In 2010, China represented 11.4% of world trade, but the RMB
accounted for only 0.24% of world payments. The development of ‘dimsum’ bonds did not have any
significant impact.

This is however expected to change. Currently, Renminbi accounts for about 2% of global foreign
exchange reserve assets. But it could rise to between 5% and 10% by 2030, surpassing the levels of
the Japanese yen and British pound. Increased foreign investments in China is one of the key drivers
of this trend.

Inclusion in the basket also reaffirms that the Chinese yuan will play a bigger role in international
transactions and that it would be a popular reserve currency in the coming years.

Significance for SDR

 With the inclusion, SDR becomes more representative.
 This makes SDR more attractive