Christine Lagarde and the SDR Basket

November 17, 2015 10:45 AM

International Monetary Fund (IMF) managing director Christine Lagarde has thrown her personal support behind China’s long-time campaign for the inclusion of its currency, the yuan or renminbi, among the small basket of currencies that are used to value the IMF’s special drawing rights (SDR).[1]   On November 13, the IMF issued a statement in which Lagarde endorsed the IMF staff findings that the renminbi had met the criteria for inclusion in the basket.

What was extraordinary about Lagarde’s statement was not her position on this highly political issue, which was a poorly kept secret, but that the statement was released without providing any supporting evidence.  While acknowledging that the IMF executive board will make the formal decision on November 30, it appears that the managing director is trying to preempt the decision. For example, the Bloomberg headline read “Yuan Set to Join IMF Basket in Step toward Currency Big Leagues.”

On August 3, 2015, the IMF released a meticulous, comprehensive staff paper reviewing the method of valuation of the SDR [pdf]. That paper did not reach a conclusion or recommendation. My reading of the evidence in the paper was that the renminbi is not sufficiently freely usable or operationally accessible to be included in the SDR basket.

What has changed since mid-July when this earlier paper was completed and circulated to the IMF executive board? Outsiders do not know.  The evidence presented in the new staff paper will not be released until after the executive board considers this matter on November 30. That is an unfortunate lack of transparency. There is no reason not to release the staff paper now.

In the earlier assessment, the renminbi did not consistently rank with any of the other currencies that now make up the SDR basket on any of the criteria for freely usable currencies: widely traded and widely used.  It is unlikely that in the ensuing four months these data have changed significantly, in particular because they are averaged over periods as long as five years in order to establish the permanence of any trends.

In mid-July, the renminbi also did not satisfy the requirements for it to be fairly used by IMF members in transactions with the Fund.  In the intervening period, the Chinese authorities have liberalized access by foreign official investors to the market for renminbi assets, adjusted the procedure for setting the fixing rate for the renminbi in the onshore market so that it trades more closely with the rate in the offshore market, and introduced a three-month treasury bill to be used for the representative rate for calculating the SDR interest rate.  This is progress, but these new procedures have no established track record.

Christine Lagarde appears to have decided to give the Chinese authorities the political trophy of inclusion of their currency in the SDR basket and to take personal credit for this action. She has announced her position on the SDR basket two weeks in advance of its review by the executive board.  Thereby, she has exerted pressure on the members of the executive board and on officials in the capitals of the countries they represent to agree with her.

It is one thing for the IMF managing director to preannounce a position on relatively routine matters such as Fund programs with Ukraine or Pakistan. Board decisions on such matters are based on well-defined criteria and past practice. It is quite another thing for the managing director to preannounce a position on a matter as important as adding a currency to the SDR basket when this has never been done before.

For many the SDR and its valuation are of second- or third-order importance, but this step clearly is very important to the Chinese authorities. It is also of some note that the role of the SDR in the international monetary system is enshrined in the IMF articles of agreement (article VIII, section 7): “Each member undertakes to collaborate . . . with the objectives of . . . making the special drawing right the principal reserve asset in the international monetary system.”  That has not happened.  Lagarde’s apparent lack of principle in following transparent procedures on the currency composition of the SDR basket is one more nail in the SDR’s coffin.

Note

[1] The SDR is an international reserve asset issued by the IMF to its members. It is neither a currency nor a claim on the IMF. It is a potential claim on the currencies of IMF members that are freely usable, which is one of the criteria for inclusion in the SDR basket. Its value is determined by specific amounts of currencies, presently four (euro, pound sterling, US dollar, and yen).  The same weights are used to set the interest rate on the SDR based on short-term interest rates in the basket currencies.

Comments

Vembar K Ranganathan

I fully agree with Edwin M Truman's comments.
Elimination of capital controls does not seem to be a criteria for inclusion of a currency in the SDR computation as per the IMF staff paper REVIEW OF THE METHOD OF THE VALUATION OF THE SDR—INITIAL CONSIDERATIONS, Aug 3, 2015. Even the criteria that “the currency must be widely traded in the principal exchange markets,” has been diluted by the following statement in the IMF document. “In order for a currency to be freely usable it must be widely traded in the principal exchange markets. During the drafting of this provision as part of the Second Amendment process it was recognized that a freely usable currency would not need to be widely traded in all exchange markets, but it had to be traded in more than one principal exchange market. The Fund’s identification of the principal exchange markets may evolve over time, taking into account both financial and technological developments (Annex II), Page 11.”Such dilution will not help in promoting SDR as a potential global reserve currency. At present, USD, EURO, Yen and Pound Sterling are freely traded, and satisfy both current and capital account convertibility. Until People’s Bank of China (PBOC) assures convertibility, I doubt just the inclusion of Yuan in SDR will make it any more valuable than it is now. I believe that a substantial demand for Yuan in international payment settlements will arise only upon absolute convertibility and active trading of Yuan in currency markets. I also believe that Convertibility is essential for China to reap the seigniorage advantage enjoyed by USD and other major currencies. It is heartening to see that China’s central bank since August 2015 has moved to let the Yuan/US$ exchange rate fluctuate plus/minus 2% against a peg in daily trading. China’s share in the global trade at close to 12% in 2014 is pretty significant, and it can easily embrace convertibility by steadily letting Yuan become a freely floating currency. I do not understand why IMF and its Managing Director are hastening to include RMB in SDR, before Yuan becomes a freely traded currency, with its value determined in exchange markets. This move does not help in promoting SDR as the truly international reserve currency. Vembar K Ranganathan
Corporate Consultant in Financial Risk Management
Irvington, NY 10533
Tel: (914) 591 7318 Cell: 914 406 0945
Vkr4@optonline.net

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