for the complete report.
INTERNATIONAL MONETARY FUND
Criteria for Broadening the SDR Currency Basket
Prepared by the Finance and Strategy, Policy, and Review Departments
(In consultation with other departments)
Approved by Andrew Tweedie and Reza Moghadam
September 23, 2011
Contents Page
Executive Summary ............................................3
I. Introduction .....................................................4
II. Background ................................................5
A. SDR Valuation Principles and Current Criteria ......5
B. SDR and the International Monetary System ....7
III. Freely Usable Currency ...............................8
A. Definition, Underlying Principles, and Past Application .........8
B. Potential Indicators Going Forward .................9
IV. A Possible New Tailored Criterion................19
V. Comparison of Indicators and Scenario Analysis ....23
VI. Exports Criterion ............................24
VII. Number of Currencies ............28
VIII. Concluding Remarks and Issues for Discussion ........30
Tables
1. International Debt Securities・Currency Composition, 2001・2011・Top 25 Currencies .17
2. Global Foreign Exchange Market Turnover・Currency Composition ...............................18
3. Global Foreign Exchange Derivatives Market Turnover・Currency Composition, 2010 ..21
4. Comparison of Possible Indicators for the Freely Usable Currency Criterion and the Reserve Asset Criterion ...........................................................................................................23
5. Exports and Financial Inflows: Top-20 Exporters ...............................................................29 2
Figures
1. Composition of Foreign Exchange Reserves: 2001 and 2011 .............................................14
2. International Banking Liabilities・Currency Composition (2000-2011) ............................15
Boxes
1. Principles Guiding SDR Valuation Decisions .......................................................................6
2. Assessing Freely Usable Currencies ....................................................................................11
3. Currency Composition of Official Foreign Exchange Reserves (COFER) .........................13
4. Inertia in the International Use of Currencies ......................................................................16
5. Trends in the Use of Currencies: Scenario Analysis ...........................................................26
Appendixes
I. Scenario Analysis ..................................35
II. Data Issues......................................43
Appendix Tables
1. Countries Holding More than 5 percent of their Foreign Exchange Reserves in Each Currency ............32
2. Average Daily Foreign Exchange Spreads between Spot Bid and Ask Quotations against the US Dollar in New York ......33
3. Over-The-Counter (OTC) Derivatives: Currency Composition, 2001・10 ......34
I1. Illustrative Scenarios: Global Foreign Exchange Market Turnover (Methodology 1) ......37
I2. Illustrative Scenarios: Derivative Transactions (Methodology 1) ......38
I3. Illustrative Scenarios: International Debt Securities (Methodology 1) ......39
I4. Illustrative Scenarios: Global Foreign Exchange Market Turnover (Methodology 2) ......40
I5. Illustrative Scenarios: Derivative Transactions (Methodology 2) .........................41
I6. Illustrative Scenarios: International Debt Securities (Methodology 2) ...................42 3
Executive Summary
This paper discusses a number of reform options for the eligibility criteria for the SDR currency basket.
It responds to a request by the Executive Board, and to calls by the IMFC and the G-20 Ministers for developing a criteria-based path to broaden the composition of the basket. The paper is guided by long-standing principles underlying SDR valuation and by considerations related to a stable evolution of the international monetary system.
The paper explores the pros and cons of maintaining the current "freely usable currency" criterion, and clarifies indicators for assessing it.
The freely usable concept and its two key elements・currencies should be ―widely used‖and ―widely traded‖are set out in the Articles and serve important operational purposes. A formal requirement for a currency to be freely usable was adopted for SDR valuation only in 2000, although considerations relating to this concept had been taken into account earlier. Indicators for assessing freely usable currencies were first discussed in 1977, and are updated to reflect subsequent developments in financial markets and data availability. The paper suggests as indicators for ―wide use‖the currency composition of foreign exchange reserves, international debt securities, and international bank liabilities; and for ―wide trading‖it proposes foreign exchange spot market turnover.
As an alternative to the freely usable criterion, the paper discusses a new criterion tailored explicitly to the reserve asset characteristics of the SDR.
This reserve asset criterion would be based on three key characteristics: liquidity in foreign exchange markets; hedgeability; and availability of appropriate interest rate instruments. Four indicators are proposed to assess these characteristics: currency composition of foreign exchange reserves, spot and derivatives market turnover, and an appropriate market-based interest rate instrument.
Scenario analysis suggests that the possible new criterion, while safeguarding the reserve characteristics of the SDR, may provide scope to broaden the SDR basket within a shorter time frame.
Reflecting to some extent inertia and network externalities that influence the ―wide use‖of currencies, meeting the possible new criterion, while challenging, may be achievable for some currencies within a shorter time period.
Issues related to a size-related criterion, and to the number of basket currencies are also examined.
The paper concludes that, while it would be desirable in principle to augment exports with financial flows, current data limitations suggest that it may be appropriate to maintain exports as the size criterion at this stage. The paper also argues that there are merits in not pre-judging the number of currencies in the SDR basket. The issue of whether a new currency would replace or be added to existing SDR basket currencies could be assessed on a case-by-case basis. 4
I. INTRODUCTION1
1 This paper was prepared by Messrs. Kumar, De Broeck, Rossi, Kohler, Rodriguez, Perez, and Ms. Bacall (all FIN) and Ms. Mateos y Lago, Ms. Maziad, and Mr. Wang (all SPR).
2 The Acting Chair’s Summing Up, Review of the Method of Valuation of the SDR (11/17/2010) http://www.imf.org/external/np/sec/pn/2010/pn10149.htm.
3 The Chairman’s Summing Up, Enhancing International Monetary Stability—A Role for the SDR? (2/04/2011) http://www.imf.org/external/np/sec/pn/2011/pn1122.htm.
1. At their April 2011 meetings, the IMFC and the G-20 Ministers called for further work on a criteria-based path to broaden the composition of the SDR basket.
This followed earlier Board endorsement of a work program on issues relating to SDR valuation and the SDR interest rate basket.2 Directors have also noted that expanding the SDR basket to major emerging market currencies under appropriate conditions, and based on transparent criteria, could further expand the role of the SDR in the international monetary system (IMS).3
2. Against this background, this paper reviews the eligibility criteria for the SDR currency basket.
Since the 2000 decision on SDR basket composition, the basket consists of the four currencies that are: (i) issued by Fund members (or monetary unions that included Fund members) which are the largest exporters, and (ii) have been determined by the Fund to be ―freely usable‖(FU). While exports have played a role since the adoption of the SDR basket formula in 1974, the requirement for a currency to be freely usable・a concept that lies at the core of the Fund・s operations since the Second Amendment of the Articles in 1978・was added as a formal criterion only in 2000.
3. The paper discusses reform options for the eligibility criteria as well as indicators to assess them. Building on the informal Board briefing in July and a note prepared for the G-20 last month, it discusses the existing FU criterion and a potential new alternative criterion・tailored to preserve the reserve asset status of the SDR and one that could help promote a smooth evolution of the IMS. The paper also explores indicators that could be considered to assess these two criteria. In addition, it reviews issues relating to the current export criterion, which provides a size-based condition for SDR basket inclusion, and to the number of currencies in the SDR basket. More operational issues, notably those related to currency weights in the SDR basket and the SDR interest rate, will be covered in a subsequent paper.
4. The paper is organized as follows. After providing background in Section II, Section III discusses the concept of a freely usable currency and potential indicators to assess this criterion. Section IV describes a possible alternative to the FU criterion for SDR basket selection, and Section V compares the indicators under the freely usable criterion and the possible new alternative criterion. Sections VI and VII discuss issues relating to the exports
5
criterion and the number of currencies in the SDR basket, respectively. Section VIII provides concluding remarks and issues for discussion.
II. BACKGROUND
A. SDR Valuation Principles and Current Criteria
5. SDR valuation has been guided by several long-standing principles. These principles aim to enhance the attractiveness of the SDR as a reserve asset (Box 1). Based on these principles, regular 5-yearly reviews of the SDR basket have been conducted, covering the currencies to be included in the SDR basket and the weights of those currencies. The reviews have been based on criteria adopted by the Executive Board, which the Board has the authority to modify.4
6. In practice, there has been a high degree of stability in the method of SDR valuation. As the SDR valuation principles have remained broadly unchanged since the SDR basket・s inception, revisions in the valuation method have been linked to major changes in the roles of currencies in the world economy. These included the current criteria for SDR valuation, which were adopted in 2000 following the introduction of the euro. The 2000 decision, in turn, modified criteria that had been in place since 1980, when the SDR valuation basket was streamlined from 16 to 5 currencies.5 The high degree of stability also reflects concerns about the effect of changes in the SDR basket valuation framework and the SDR basket composition on official users of SDR. In particular, SDR users have stressed to staff that changes in the basket affect their risk exposure until portfolios or hedging activities can be rebalanced to reflect a new basket.
4 Article XV, Section 2, provides: ―The method of valuation of the special drawing right shall be determined by the Fund by a seventy percent majority of the total voting power, provided, however, that an eighty-five percent majority of the total voting power shall be required for a change in the principle of valuation or a fundamental change in the application of the principle in effect.‖
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5 Decision No. 12281-(00/98) G/S October 11, 2000. 6 Box 1. Principles Guiding SDR Valuation Decisions While not stated in any decision of the Fund, a number of broad principles have guided Board decisions on the valuation of the SDR since the 1970s with the aim of enhancing the attractiveness of the SDR as a reserve asset. According to these principles, the SDR・s value should be stable in terms of the major currencies, and the currencies included in the basket should be representative of those used in international transactions. In addition: the relative weights of currencies included in the basket should reflect their relative importance in the world’s trading and financial system; the composition of the SDR currency basket should be stable and change only as a result of significant developments from one review to the next; and there should be continuity in the method of SDR valuation such that revisions in the method of valuation occur only as a result of major changes in the roles of currencies in the world economy. |
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