- The Chinese yuan was added to the IMF’s SDR basket on October 1, 2016.
- A currency’s inclusion in the SDR basket does not make it a “reserve currency;” that label is conferred by the market itself based on the currency’s use in global trade.
- Although the Chinese government has made broader use of the yuan in global transactions a priority, in practice the yuan has gained very little in terms of global acceptance.
The Chinese yuan was added to the International Monetary Fund’s (IMF) basket of currencies, called Special Drawing Rights (SDR), on October 1, 2016. The Chinese government has been very open in its desire to have the yuan viewed as a global currency. The inclusion of the yuan in the SDR is largely a symbolic move in this direction. However, being part of the SDR does not make the yuan a reserve currency. For the yuan to be a reserve currency, more trade would need to be conducted in it, and it would need to be used regularly in international finance. Despite the desire to have the yuan become more accepted globally, the amount of trade conducted in the currency has grown immaterially over the past few years.
WHAT IS AN SDR?
The IMF created SDRs to be used as a supplement to a country’s official reserve assets. Therefore, the SDR can only be held or used by IMF member countries, the IMF itself, and a handful of agencies like the European Central Bank or regional development banks. Furthermore, SDRs can only be exchanged for certain currencies. As a result, the SDR is only of limited use to central banks. Even then, the total issuance of SDRs ($318 billion) is a fraction of total central bank holdings ($17.8 trillion); less than 2% of global central bank assets are represented by SDRs. The weighting of the SDRs is fixed for five years and will be re-evaluated in 2021 [Figure 1]. SDRs do not trade on any exchange; trades are either conducted voluntarily between member countries, or the IMF may facilitate a transaction if necessary, though this rarely happens. Global investment banks do not generally track SDRs, nor convert currencies into SDRs, as they play no real role in global finance.
CURRENCY RESERVES OR RESERVE CURRENCY
SDRs represent a form of currency reserves. This is very different from a reserve currency. The U.S. dollar is the world’s primary reserve currency. Reserve status is not a designation conveyed by the IMF or any other organization. Reserve currencies are determined by their use in global trade transactions, particularly in transactions that do not involve the country of the reserve currency. The fact that when a Japanese company buys oil from a Brazilian one, the transaction is still performed using dollars is the most direct evidence that the U.S. dollar is the leading reserve currency. A country’s currency earns reserve status as the result of building trust within the global community, evidenced by a country’s currency having deep and liquid foreign exchange, bond, and derivative markets; as well as widespread acceptance as payment for international transactions. In addition, the country’s political, economic, and financial structures need to be seen as secure.