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SDR Basket Needs the Yuan
 NO. 46 NOVEMBER 12, 2015

The International Monetary Fund (IMF) will decide at the end of November whether to include the yuan in the Special Drawing Rights (SDR) basket. The market acknowledges that the yuan is capable of joining the currency basket. Once the IMF approves the inclusion, demand for yuan-nominated assets will be stimulated.

The SDR attracts unprecedented attention from the Chinese because of the yuan's increasing use in the international market. The SDR includes all the major world currencies--the U.S. dollar, euro, pound and Japanese yen--and represents the soft power of the IMF and a structure dominated by the Western world.

After the financial crisis of 2008 had a severe impact on the world economy, the Group of Seven (G7) failed in its rescue attempts and had to cooperate with emerging markets, turning it into the Group of 20 (G20). As the world's second largest economy, China acts as a main engine of the global economy. From BRICS (Brazil, Russia, India, China and South Africa) to G20, China and its currency play an increasingly important and responsible role.

In 2010, the IMF started quota reform and reviewed new currency weights for the SDR valuation basket. At that time, the world economy was in deep recession, so it was also a time when the SDR basket urgently needed the yuan. The reform and new currency weights were supported by most countries but blocked by the United States.

As the U.S. economy recovered, the White House was still unenthusiastic about pushing Congress to pass the IMF's reform plan. A decision on the yuan's inclusion in the SDR basket was then delayed to November of this year.

The good news is that the IMF has declared that the yuan has a fair valuation. With the establishment of the Asian Infrastructure Investment Bank, China's contribution to the global economy has been accepted by Europe, and major European countries are clearly in favor of the yuan's inclusion to the SDR basket.

During President Xi Jinping's visit to the United States at the end of September, China received conditional support from the United States for the yuan to join the SDR. When Premier Li Keqiang attended the Sixth Trilateral Summit in Seoul on November 1, Japan also gave conditional support to the yuan joining the SDR.

This conditional support has been achieved on the back of China's financial reforms and performance of the yuan. The market-oriented reform of interest rate has concluded, while the similar reform of the exchange rate is advancing. While the IMF and the global market are pushing forward reform of the yuan's exchange rate formation, the reform is also an internal demand for China to improve its economic governance.

The accelerating internationalization of the yuan has seen it overtake the Japanese yen to become the world's fourth largest payment currency, which is a further indication that the SDR currency basket needs the yuan.

The United States seeks to dominate the IMF, but the IMF recognizes the need to reform its organizational structure in order to ensure its global leadership. China is one of the leaders of the new international order, so the IMF and China, the SDR and the yuan, will share the same interests.

The yuan's inclusion in the SDR basket will signify confirmation by the international community that the yuan is an international currency. Its inclusion will also increase the IMF's global leadership.

Two conditions will however determine whether the yuan can be included in the SDR basket: the yuan's weight in international trade payment and its free convertibility. China has no problem in meeting the first requirement and is working to meet the second.

Political reasons could also block the yuan's inclusion in the SDR basket. Both the United States and Japan have given their conditional support, and they have 16.7 percent and 6.2 percent respectively of voting rights in the IMF. The United States can unilaterally veto major IMF decisions by requiring a majority of 85 percent.

Additionally, however, the IMF will take into consideration the time spent reviewing the status of currencies within the SDR every five years. The IMF will also play a key role in whether the yuan is included in the SDR and can make some compromises, such as adding a provisional review next year if the yuan is unable to be included in the SDR this year. All these efforts will be worthwhile.

This article is an edited excerpt of an article by Zhang Jingwei, a researcher with the Charhar Institute, and published in National Business Daily 

Copyedited by Calvin Palmer 

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