Will the AIIB Use SDR as the Currency of Settlement

Economics, Premium POM, Sample PoM

By JC Collins

It is interesting that the countries which have joined the Asian Infrastructure Investment Bank (AIIB) are now the same countries which are supporting the inclusion of the Chinese currency in the basket composition of the Special Drawing Right of the IMF.

The currency of settlement which will be used by the AIIB has been widely speculated over the last few weeks and months. There has been talk of an AIIB currency basket, and the discussion around using the USD as the currency of settlement.

A unique AIIB specific currency basket is likely a non-starter as the time and negotiations required to construct and implement such a regional currency basket will not align with the operational timeframes of the AIIB itself.

The USD could be used as the currency of settlement in the early stages of operation, and this has been the message which has been communicated by the AIIB and some members over the last month. But considering the transition away from the unipolar dollar framework towards the multilateral framework for the international monetary system, using the dollar in the long-term will only continue the deficiencies which are present today.

The angle of including the RMB in the SDR composition is a leading indicator of the direction in which not just the AIIB, but other development banks and international institutions, are leading when it comes to asset denomination and means of settlement.

With the inclusion of the RMB in the SDR basket the amount of Chinese currency held in the foreign reserves of central banks will increase even further and renminbi hedging by international institutions will become common.

Already today RMB denominated reserves in central banks equals $100 billion. This amount is more than the reserves denominated in Swiss francs, and is equal to the reserves denominated in Canadian and Australian dollars. It is expected that RMB denominated reserves will soon close in on the amounts denominated in Japanese yen and British pounds.

The European Central Bank has also stated its intent to add renminbi denominated assets to its official reserves. A reduction in euro denominated currency in other central banks could in fact be exchanged for RMB currency as the European countries become more involved with the AIIB and its infrastructure development projects.

The usage of the USD as the currency of settlement in the AIIB could be taken as a negotiation “give and take” with China and the IMF on the inclusion of the RMB in the SDR basket. The US doesn’t attempt to stop the addition of the RMB in the upcoming unofficial and official reviews in exchange for having the USD as the currency of settlement used in the AIIB.

The problem with this conclusion is that any adjustments to the SDR composition only requires a 70% vote on the Executive Board of the IMF. This falls well below the 85% which would allow the United States to leverage its veto power.

What we can consider is that the broader agreements between the United States and the International Monetary Fund, including China and other AIIB members, and central banks around the world who are increasing RMB reserves, will allow for the temporary utilization of the USD as the currency of settlement in the AIIB, as well as other development banks, until such a time as the SDR composition is adjusted and fully implemented, on January 1, 2016.

The USD, euro, and renminbi will be the largest percentage of the SDR composition, and the three together will offer the broadest stability and represent the largest economic regions. The reduction in reliance on the dollar as the primary reserve currency will lead the march towards this broader stability which is much needed. The SDR is the method to deliver both the stability and liquidity which will be required moving forward. – JC