Posted by: mulrickillion | November 14, 2011

Criteria for Broadening the SDR Currency Basket

International Monetary Fund (IMF)

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

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.

[An excerpt from the IMF Policy Paper reads]:

8. In recent years, a new set of considerations for SDR basket selection relating to a stable evolution of the international monetary system (IMS) has received attention. Interest in the SDR has been boosted by the global debate over reform of the IMS and the SDR‘s role in it. While there continue to be divergences of views regarding the precise role the SDR can play in the IMS, there is a broad consensus that the composition of the SDR basket is an important parameter. Therefore, the adoption of clear rules regarding the valuation of the SDR could contribute to a smooth evolution of the IMS.

9. Global economic developments suggest possible benefits of greater plurality in the IMS, with possible implications for the SDR basket. The role of large emerging market countries in the global economy has increased dramatically in recent years, reflected most notably in their increasing trade integration and their large and growing contributions to global growth. However, real economic developments have proceeded much faster than developments in currency and financial markets. Although some emerging market currencies show potential for becoming international currencies, their role in the IMS lags far behind their real economic weight, partly reflecting inertia and network externalities, and partly also insufficient supply of relevant assets. Nevertheless, growing interest in non-SDR currency assets is evident in financial flows and trading volumes, and has been accompanied by improvements in the quality and credibility of macroeconomic policy frameworks. The composition of the SDR basket could take into account these developments, provided the relevant currencies also possess the requisite characteristics that would preserve the role of the SDR as a reserve asset. In some cases, this will require issuers of candidate currencies to pursue further policy reforms that deepen their financial sectors and support the international use of their currencies.

10. Setting a criteria–based path for broadening the composition of the SDR basket could play a useful role in the smooth evolution of the IMS. It could provide the issuers of candidate currencies with an incentive to accelerate the prerequisite policy reforms. It could also facilitate acceptance and use of these currencies as reserve assets, with diversification benefits for users. From there on, a dynamic conducive to further financial deepening and additional reforms that encourage a wider role of these currencies could emerge, which could contribute to a smooth evolution of the IMS. . . .

>>Read the full Policy Paper here (092311.pdf).


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