On October 1, China's RMB was included in the Special Drawing Right (SDR), an international reserve asset created by the International Monetary Fund in 1969, seven years after Chinese central bank governor Zhou Xiaochuan initially voiced the idea to an unenthusiastic global audience.
But Governor Zhou has much to celebrate today, as the RMB has made significant progress in its internationalization and the push for the SDR to play a more important role in global finance has moved on forcefully.
Last month, the World Bank just issued a landmark 500 million SDR-denominated bond in the Chinese market, a first in 35 years.
That is why we'd like to share a speech made by Zhang Tao, deputy managing director at the International Monetary Fund, on this topic at the second China Finance 40-PIIE China Economic Forum yesterday in Washington, DC.
Here you can see what the Chinese government has done, what it hopes to become the future of the SDR and our monetary system.
Good morning, ladies and gentlemen. I am very thankful for the invitation to speak today at the Peterson Institute. You are one of the world’s leading think tanks on the international economy. I am also very pleased to be able to join my friends and colleagues from the China Finance 40 Forum. Welcome to Washington!
Today I will speak to a topic central to the IMF and integral to the link between China and the international monetary system: the historic inclusion of the renminbi in the Fund’s basket of SDR currencies.
With this step, the renminbi joins the dollar, euro, yen, and pound sterling in playing a central role in the financial operations of the IMF. Inclusion in the SDR basket also has deeper significance for China and the global economy. So in the time I have today I would like to highlight the importance of this initiative, beginning with some background on the Fund’s action—and the steps China took to reach this stage.
As most of you know, the Special Drawing Right is an international reserve asset that can supplement the reserve assets of the Fund’s member countries. It was created by the IMF in 1969 at a time when the supply of two key assets—gold and the U.S. dollar—was insufficient to support the expansion of world trade and financial flows.
The composition of the SDR basket has shifted over time, from 16 currencies in 1974 down to four before the renminbi was added on Saturday. Decisions on its composition are part of a regular five-year review by the Executive Board. In November 2015, the Executive Board of the IMF decided to expand the SDR basket and include the renminbi, effective on October 1, 2016.
Based on the established framework by the IMF, the renminbi’s inclusion in the SDR basket reflected the size of China’s exports and the emergence of the renminbi as a freely usable international currency; that is to say, as defined in the Fund’s Articles of Agreement, the currency has been deemed to be widely used to make payments for international transactions and widely traded in principal exchange markets.
The inclusion of the Renminbi thus 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:
For instance, last year, in the lead up to the completion of the SDR Review, the Chinese authorities took a broad set of measures that allow the IMF, its membership, and other SDR users to have unrestricted access to onshore foreign exchange and fixed-income markets. This allows them to perform Fund-related and reserve management transactions in RMB.
In the months following the 2015 review, there have been notable developments in preparation for the SDR expansion: for example, China had begun to report a representative portfolio of the composition of its reserves on a partial basis, and had committed to gradually increasing to full coverage in two to three years. Also, along with London and 20 other centers, New York was added as a clearing center for the renminbi, which placed the currency at the heart of principal international markets.
Most importantly, the Chinese authorities have worked diligently, together with the Fund and its members, to prepare for conducting operations using the RMB and to facilitate a smooth transition to the new SDR basket.
So what major changes will occur now that the Chinese currency is in the SDR basket?
This inclusion also means RMB has now become a freely usable currency. This means that members now may receive the currency in their transactions, receiving disbursements and making repayments in RMB. And as an issuer of a freely usable currency, China will be expected to collaborate with the Fund and other members on what we call a “best effort basis” to exchange renminbi into other freely usable currencies in the context of such Fund-related transactions. This obligation could be particularly relevant at times of market stress. So, in essence, the renminbi becomes integral to a future crisis response.
This is the first time in history that the number of currencies in the SDR basket has increased. The inclusion of the RMB also makes the composition of the SDR basket more representative of the currencies being traded in the world. The RMB’s inclusion will make it more attractive as an international currency, contributing to greater risk diversification. All of these will help spread and better manage global risks.
The inclusion of the renminbi in the SDR basket also will strongly support China’s continued efforts to reform its monetary, foreign exchange, and financial systems. It will help facilitate the country’s increased integration in the global financial community.
In this regard, inclusion should help consolidate the process of renminbi internationalization, a theme that this seminar will explore in greater depth. Experience shows that currency internationalization can encourage the development of deeper and more liquid financial markets. It can deliver more predictable macroeconomic outcomes, assist the development of strong and credible institutions, and secure the integrity of the markets.
Of course, these will not be overnight achievements, but they can be crucial for China’s continued emergence as a source of economic growth and financial stability. The continuation and deepening of reform efforts, with appropriate safeguards, are essential to support the growth and stability of China and the global economy.
So what of the future of the SDR?
Many of you will have noted that the G20 leaders at the Hangzhou summit supported an “ongoing examination of the broader use of the SDR”, including issuance of SDR-denominated bonds and broader reporting in SDR terms. This is the work the Fund is now undertaking.
In this regard, it was important to see that the World Bank’s IBRD issued a landmark 500 million SDR-denominated bond in the Chinese market last month, a first in 35 years. It was the first tranche of what could be a two billion SDR issuance program.
These developments are first steps. There is a long way to go to achieve the purposes and goals I have outlined— global risk diversification, Chinese financial reform, renminbi internationalization and improved stability of the international monetary and financial system. But there is reason for confidence that the inclusion of the RMB in the SDR basket can, in time, make a difference in our closely connected global economy. As for the Fund, this milestone proves that we stand ready to adapt to change in the global economy.
Before I conclude, let me wish we will have a successful discussion. However, I have to run to another event of the annual meetings, and I will have to miss the opportunity to listen to my fellow speakers and hear the views from this impressive audience. I would very much like to continue this dialogue when future opportunities arise.
Thank you.