Due to the increasing scale of trade in China and the growth of the Chinese stock market, the in_uence of the Chinese economy has become greater than ever. As a reflection of this situation, the International Monetary Fund (IMF) decided to include the Yuan, the Chinese currency, in the Special Drawing Right (SDR) basket beginning in October 2016. This decision is meaningful because the Yuan accounts for the third largest quota, following the United States Dollar and the Euro. This inclusion is expected to spur various changes in the global economy. The Sungkyun Times (SKT) introduces the concept of the SDR, explores reasons for and the influences of including Yuan into the SDR basket, and also looks for some concerns that the international society may have regarding the inclusion.
What is the Special Drawing Right?
According to the Dictionary Reference, the SDR is a right that allows the withdrawal of international liquidity when a country’s international balance of payments is deteriorated. In an easier definition, SDR is a type of minus bank account in the global economy. Just like a minus bank account, countries that are members of the IMF can withdraw some international liquidity by using their SDR quota and exchange it into usable currency. SDR did not exist when the IMF was first established. The IMF was _rst founded in 1944, when the Bretton-Woods Agreement was made. This agreement announced the gold standard that matches the value of the US Dollar with gold. However, the supply and demand of the Dollar expanded, and the supply of gold was not enough to match the expanded demand for the Dollar. Moreover, as the supply of the Dollar increased, the deficit of current balance of dollars accumulated, and this deficit made the Dollar unstable. Therefore, it was inevitable for the IMF to create an alternative, and the SDR was first implemented.
The SDR is designated by the IMF, and it is contained in the SDR basket, which includes five powerful currencies - the US Dollar, Euro, Yuan, Yen, and Pound. To understand the SDR accurately, international liquidity must be adequately explained. International liquidity shows a country’s actual foreign currency reserves to pay for international trade compared to what they should pay for the international trade. In the global economy, foreign currency reserves are composed of actual foreign cash, gold, IMF reserve positions, and the SDR. As the composition of foreign reserves contains the SDR, holding enough SDR guarantees each country’s international liquidity, which increases the stability of that economy. Therefore, when the actual foreign currency reserves are far lower than the needed payment, the country would face a foreign exchange crisis. In this circumstance, the country asks the IMF to change their SDR quota into currencies that are in the SDR basket to make up the deficit. For example, the Korean government asked the IMF to implement a relief loan when Korea was suffering from the foreign exchange deficit in 1997. Moreover, the Korean government also requested the IMF to exchange its own Special Drawing Rights into actual foreign currency. Likewise, the SDR can be used when a country is in a desperate situation.
To further understand the SDR, the process of distributing the SDR quota to each country must be explained. The IMF has several ways to raise funds to manage the organization. Among them, the quota system accounts for most of the funds that the IMF needs. This system asks for a certain amount of money from the members of the IMF based on economic data that is renewed every five years. The amount that the IMF demands is based on the scale of economy that the country has. For example, if Korea accounts for 15 percent of the global economy, the IMF will ask Korea for 15 percent of the reserves for the IMF. After the contribution from each country, the IMF will then allocate countries a certain quota according to their contribution. For instance, if Korea contributes 15 percent of the IMF reserve, the IMF gives Korea a 15 percent quota of the SDR.
As the SDR is the right of withdrawing cash and is allocated as a quota, it has to be matched with real currency value. Thus, the IMF updates economic data every _ve years and makes a weighted average value of each currency based on the economic in_uences of the countries whose currencies are included in the SDR basket. After the valuation process, the IMF matches that value with the SDR. The weighted value graph starting from this October shows that the Dollar accounts for the largest amount of 41.73 percent. The Euro is occupying 30.93 percent and the third largest currency is the Yuan, 10.92 percent. Compared to the current SDR, the percentage of Japanese Yen and British Pound have diminished dramatically. This can be a re_ection of the countries’ in_uence in the global economy. Therefore, the inclusion of China in the SDR basket is quite a meaningful event.
How was the Yuan Admitted to the SDR Currency Basket?
Many people would have some abstract background information about the Yuan inclusion in the SDR currency basket. The main reasons for its inclusion are the policies of the Chinese government and the remarkable results. The Chinese government has always struggled to make their economy become a strong force and a global leader. To attain its goal, in 2015, the Chinese government set the internationalization of the Yuan as one of five big plans. In this internationalization plan, the Chinese government aimed for free convertibility of the Yuan and for its entry in the SDR basket. This is due to the scale of Chinese trade and the country’s stock market. Although China accounts for more than 11 percent in global trade market, as the key currency that should be used in international trade is the Dollar, Chinese traders have to pay their trade fee in dollars as well as the exchange commission fee, which is used when traders exchange the Yuan into the Dollar. As the scale of Chinese trade expands, the exchange commission payment has become a huge burden to the Chinese economy. Eventually, this intertwined currency relationship placed the Chinese economy under the control of the economy of the United States. Such a relationship not only increases the burden of the commission fee, but it can also lead the Chinese economy to be influenced by the exchange fluctuation of the US Dollar. For example, there was a huge economic crisis in 2008. This enormous crisis degraded the Dollar value and influenced countries all around the world. China was also affected by this global financial crisis and realized that it would not be stable to simply rely on the Dollar. Thus, China has continuously made efforts to resolve its dependency on the Dollar by increasing the power of its economy.
Not only has China made an effort to get out of the shade of the Dollar, but have they also planned to keep the country’s growth rate near seven percent. This effort is called the Baochi policy, which means - “to keep seven” - in the Chinese language. To fulfill the SDR basket standard of the IMF, a country should maintain steady economic growth for more than five years, and China maintained its growth rate near seven percent in over last five years. These efforts to qualify the prerequisites of the IMF helped China enter the global elite currency club.
Finally, as previously mentioned, the size of the Chinese economy and the influence of its political decisions have made it inevitable for the IMF to acknowledge the Chinese influence on the global economy. As the Chinese economy is largely controlled by its government, the political decisions of the Chinese government are crucial when predicting the Chinese economy. Thus, the IMF made a judgment to include the Yuan in the SDR basket in order to reflect the current status of the global economy.
Inclusion of the Yuan in the SDR basket is meaningful in various aspects. First, it is remarkable in that the Yuan is the first currency that has entered the SDR basket in last 15 years. In this aspect, the entry of the Yuan into the SDR basket is a monumental event in global economic history. Moreover, this change reflects the multilateral system of the global economy. Until recently, the global economic system could be defined solely by the lead of the United States. However, announcement of the IMF’s amended SDR basket composition surely confirms to people the possibility of the multilateral system. From the Chinese point of view, this inclusion implies symbolic significance in that it can guarantee their possibility to be a key currency, which is China’s definite goal. Moreover, entering the basket can increase the value of and the demand for the Yuan. This is because entering the SDR basket assures stability and convertibility of the currency. Eventually, a rise in currency value can encourage the usage of the Yuan in the global economy, where the previous usage of the Yuan was much less prevalent than its circulation in international trade.
Expected Change in the Global Economy and the Korean Economy
As the inclusion of the Chinese Yuan is an exceptional event in the global economy, economists all around the world state that it will generate several changes.
The most influential aspect will be the dramatic increase in demand for the Yuan. The Yuan was not considered as an important currency to hold because the Yuan did not have enough credibility and was not regarded stable. But as the IMF guarantees the credibility and stability of the Yuan, the Yuan holding in central banks all around the world is expected to keep increasing. In a recent survey of Hong Kong and Shanghai Bank Corporation (HSBC), international foreign exchange market managers predicted that the Yuan reserve will keep increasing, and it will account for around 10 percent of global foreign currency reserves, which is the same quota that the Chinese SDR has. The growth of the Yuan reserve will not only benefit China, but also enable some countries that have a large scale of trades with China to increase the stability of their international liquidity by retaining some alternative currency other than the Dollar and Euro. Also, China can build their economic independence as well. The dependence on the Dollar always caused big trouble for China. Entering the SDR currency basket gives the Yuan the position of a preparatory key currency. This position can help the Yuan be more freely used in global trades and stock markets, uninterrupted by high commission fees from usage of the Dollar. As payments using the Yuan increase, the risk from holding the Dollar will decrease, and finally, China can attain the goal that it aimed for: economic independence from the Dollar. Not only from the Chinese point of view, but also from that of other countries, this inclusion is meaningful in the world because the sole dominance system of the Dollar would be changed into a more diversified condition. It is certain that sole dominance has a huge risk in that the crisis of one powerful country’s economic failure can influence the whole global economy. However, as the inclusion of the Yuan split the potential risk from one powerful country to multiple countries, the possibility for such crisis will be diminished. Meanwhile, the United States worries that the growth of the Chinese economy can be a huge threat to their economy. The United States predicted this threat when China established the Asian Infrastructure Investment Bank (AIIB). In addition, the Yuan’s entrance to the SDR basket made the United States more insecure than before. Many economists predict that the United States is preparing to degrade the Dollar value and try to get comparative advantage in trade through a less expensive currency price.
The new SDR quotas are especially influential in the Korean economy. First, as Korea is close to China, there is potential to increase economic proximity. Korea and China only had $1.5 billion trade scales. As the result of the drastic growth of the Chinese economy, the scale grew to 4.4 billion in 2015. Since Korea is conducting a large amount of trades with China, the Yuan’s basket entrance encouraged the Korean government to expand trading more than the current amount. In addition, small and medium-sized Korean corporations are planning to extend their range into the Chinese market. This expansion is important because small-and-medium sized corporations have difficulties flourishing in Korea, but have better capital and resources than newly-growing native Chinese enterprises. This condition can be a good chance for Korean companies to get more competitive advantages in the global market, and this effort to enter the Chinese market corresponds with the demand of the Chinese market’s demand for the entry of overseas capital. Second, the Korean Central Bank will strive to secure enough of the Yuan currency because retaining the Yuan currency can give the central bank a sense of having more SDR and international liquidity than before. Consequently, the demand for the Yuan currency will increase, and Korea’s economic plan can be more influenced by the Yuan.
Concerns for Yuan’s Entry into the SDR basket
Even though positive expectations for the Yuan’s inclusion in the SDR basket are prevalent, there are many concerns about the inclusion as well. First, people are worrying about the low autonomy of the Chinese economy. As China is a communist country, its economic plan is largely controlled by government policies. As an example, the People’s Bank of China (PBOC) intervened in the collapse of the stock market last June, and the Chinese government made a sudden decision to degrade the value of their currency last August, creating chaos in the global financial market. Thus, China is now taking the 100th position in international transparency. This index shows that the Chinese economic system is not managed by autonomous economic decisions from the individuals. Moreover, this figure is comparatively low considering that China is economically a leading country in the world. The international society continues to question whether the Yuan is stable enough to enter the SDR basket because of China’s low autonomy and poor transparency ranking. The Wall Street Journal pointed out that the Chinese economy should interact more with the international society, or they will continue to receive international concerns about their foreign currency management and communication skills.
Some people question the real effectiveness of the SDR. This has always been an issue because the SDR is not actual cash or gold that can be used in trades or the stock market, but is rather only used when a country is at a great risk. In short, the SDR might not be as meaningful as most people speculate. Those people who devalue the SDR warn others that the expectations about the Yuan’s entry can be overrated.
The inclusion of the Yuan in the SDR currency basket is a monumental event that deserves international attention. It is an obvious implication of the diversification of the global economy. On the other hand, people have to be aware of the stability of the Yuan. Although China has a high GDP growth rate, the growing rate keeps decreasing. The high GDP index shows that the stability is hard to maintain. Moreover, the effectiveness of the SDR system should be examined precisely.