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Why China wants to Join SDR?

 

 

IMF's website has the following announcement:

The SDR is an international reserve asset, created by the IMF in 1969 to supplement its member countries’ official reserves. Its value is currently based on a basket of four major currencies, and the basket will be expanded to include the Chinese Renminbi (RMB) as the fifth currency, effective October 1, 2016. SDRs can be exchanged for freely usable currencies. As of November 30, 2015, 204.1 billion SDRs had been created and allocated to members (equivalent to about $285 billion).

Most of economists in the West believe that it is no big deal for China's RMB to be added as the 5th currency in SDR basket.  However, to China, it is a big deal. It has been the ambition of Xiaochuan Zhou, governor of the People's bank of China, to create a super-sovereign currency, challenging the status quo of U.S. dollar as both a sovereign and global currency.  By joining the elite club China hopes to boost people's confidence in its currency. 

Zhou Xiaochuan, gestures as he speaks during a news conference in Beijing on March 12, 2015. (Bloomberg)

zhou xiaochuan at a conference in March 2015 (Bloomberg)

 

Inclusion into the SDR basket may force China to finally figure out the relationship between RMB and Dollar.  It has been China's long-term pain of pegging its currency to U.S. dollar.  Although it has attempted to peg RMB to a basket of currencies instead of the single currency of dollar, China's central bank has not achieved much, so far. 

To comply with the requirement of IMF that RMB has to be usable and convertible, China has been gradually relaxing its control over the currency by letting the exchange rate fluctuate more.  Meanwhile, China has no choice but to let RMB move more freely.  China and U.S. economies are growing apart at this moment;  Slowing-down economy needs more liquidity to help companies out, while the U.S. is trying to curb inflation with a healthier economy.  It is getting more costly for China to tap into its foreign reserve in order to keep RMB from falling in value against dollar.  It is time for China to seriously consider discontinuing its peg to dollar and let market decide RMB's value.  

However, to end RMB's long-term tie with dollar will not be an easy journey.  China will have to address the exodus of capital out of the country due to investors' expectation of RMB's further depreciation.  The instability of its currency may also affect the currencies of some developing countries which are China's major trade partners, ultimately hurting their economies.  In the end, the rest of the world may all feel the pain. 

In this sense, it is a big deal. 

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