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Friday, December 4, 2015

Making Yuan a Global Currency

Yuan or Chinese Renminbi (yes both the names are used for Chinese currency) is now going to be a global currency as IMF (International Monetary Fund) has given its nod for including Yuan in the SDR (Special Drawing Rights) basket which currently has four major currencies - USD, Euro, Yen and Pound. As this appears to be a hot topic for civil services examination, I have listed down the important points which one must know about Yuan, SDR,  SDR basket of currencies, and most importantly implications of Yuan becoming a global currency on world and specifically for India. Happy Reading!

Case for inclusion of Yuan in IMF's SDR basket

  • China is world's biggest exporter 
  • Currencies are included in SDR basket on the basis of two criterions 
  1. Currency's use in global transactions denoted by its share in reserves (freely usable)
  2. Country's importance in world trade (exports)
  • IMF reviews composition of SDR basket every 5 years to reflect changed circumstances in world finances
What are SDR's and how does SDR work?
  • SDR is an international reserve asset created by IMF in 1969 to support Bretton Woods Exchange Rate System - in which every currency was pegged to USD, which was in turn pegged to gold
  • This was done as IMF felt that supply of USD and gold was inadequate to support world trade
  • SDR is not a currency per se, instead it represents a claim to currency held by IMF member countries for which they may be exchanged
  • SDR are denoted by currency code XDR (important for prelims)
  • SDRs are allocated to countries by IMF depending on its quota which is calculated by IMF based on a country's -
  1. GDP
  2. Openness
  3. Economic Stability
  4. Reserve Assets
  • For instance US has been allocated ~35 billion SDRs as compared to India's ~4 billion SDRs
  • SDRs can only be exchanged by a country with currencies of member countries at an exchange rate determined by IMF
  • IMF calculates value of SDR using SDR basket on the basis of their daily exchange rate on London currency exchange
  • Each of the current 4 currencies in SDR basket is given weightage based on their importance in world trade (USD has the highest weightage)
Gains for China
  • China's forex reserves at $3.5 trillion are almost 12 times the size of total SDR allocation but IMF's endorsement would help China in making Yuan a global currency which has great geo-political significance
  • US Dollar's political leverage will dissipate to some extent as yuan becomes a global currency
  • US will also not be able to impose trade sanctions unilaterally as affected countries may turn to China for help
  • Still Yuan has a long way to go before it can match the share of US Dollar in global usage as over 120 countries maintain assets in USD while only around 38 do sos in Chinese Renminbi aka Yuan   
Significance for India
  • Ability of China to manipulate its exchange rate will get more restricted as yuan becomes part of SDR basket as India in the past had to deal not only with China's over capacity but also its artificially devalued currency 



Sonali Chakrabarti said...

Thanks for sharing this brilliant article. I hope all the IAS aspirant will highly be benefited once they go through this post.

Sonali Chakrabarti said...

Thanks for this wonderful article.