May 2015

10 May 2015

IMF SDR valuation review

The IMF is due to hold the first reading of the 2015 SDR valuation review during May. The five-yearly SDR review appears to be a more interesting affair than usual. The inclusion of the renminbi into the SDR basket is being considered in earnest. It would be the first meaningful innovation of the SDR since the early 1980s (Chart). China has lobbied intensively to have the renminbi included in the SDR basket. The inclusion of the renminbi is considered highly likely or at a minimum the adoption of a roadmap for prompt inclusion. Support for renminbi inclusion though is not clear amid alleged resistance by one of the IMF largest member countries. There are some indications that the May reading may be postponed possibly suggesting that the deliberations have become more complex than thought.

In April, the International Monetary and Financial Committee (IMFC), the steering body of the IMF, called for “collective efforts to strengthen the international monetary system and facilitate further integration of dynamic emerging markets.” The integration of emerging markets currencies into the international monetary system constitutes the frontier of international monetary developments. It remains to be seen if the IMF uses the SDR review as an opportunity to offer a broader role for the SDR. While some countries may call for more SDR allocations, this seems unlikely at the current juncture.

The SDR review will likely balance continuity versus representativeness. The former would aim to reinforce the conventional role of the SDR as a reserve asset. The latter would shift emphasis towards inclusiveness and address older concerns that the SDR should not unduly reinforce the status of the largest IMF member countries and needs to incorporate emerging markets. Current SDR basket inclusion are largely based on an assessment of currency usage amid the currency denomination of trade in goods and services and financial markets transactions and transaction volumes in the principal foreign exchange markets. The IMF needs to assess whether those criteria remain adequate given that the SDR has never been a proper reserve asset.

The inclusion of the renminbi would allow China to assume a direct stake in the international monetary system. It would be a critical element as part of China’s aim to promote renminbi internationalisation. While the latter will ultimately depend on China’s monetary policy framework, actual implementation and further announced measures to allow more international renminbi usage appear forthcoming. Central banks will also play a key role in the adoption of the renminbi and SDR basket inclusion is considered to support central bank renminbi adoption. So far, only US$13.2 billion are held as reserve assets denominated in renminbi (June 2014, IMF).

While the SDR has not and is unlikely to play in the near future a meaningful role in financial markets, the SDR could serve as an important signal that the international monetary system is due to change. Eventually, this could have significant implications for the demand and supply of currencies used in international transactions. As such the SDR could restore some of its former glory. It would also address the need for change of the international monetary system where a more diversified SDR basket could adopt a more forward looking role in line with the considerable diversification of the international economy.

SDR historic basket composition

Economic forecast

The IMF revealed in April its semi-annual World Economic Outlook (WEO) offering the latest projections for world GDP. It represents undoubtedly one of the most closely watched economic projections. Yet, it also serves as a reminder of how difficult economic projections are. The IMF, similar to most others, has often been wrong, missed major turning points and has now recently overestimated growth continuously. Economic projections should therefore be handled with care.

The April WEO projections show that the world economy is forecast to expand by 3.9 percent in 2015 and 3.8 percent in 2016. Advanced economies are projected to grow 2.3 percent and 2.4 percent and emerging markets 5.3 percent and 4.7 percent. This is line with the average growth outcome in 2000-13 excluding 2008 and 2009. While advanced economies are seen to expand slightly, the IMF projects emerging markets economies to slow further from an average of 5.8 percent in 2010-13. China is projected to continue to slow to 6 percent by 2017 from an average of 8.8 percent in 2010-13.

The IMF has consistently overestimated projected output since 2010 in particular for advanced economies (Chart). The positive bias suggests that the IMF struggles to identify the factors containing advanced economies’ growth. This could indicate underlying structural transformations that dominate cyclical developments in the short-term, are hard to quantify and do not allow advanced economies to escape their relatively sluggish growth performance.

China and emerging markets are forecast to continue to grow faster than advanced economies now projected to represent 47 percent of world GDP by 2020. However, in the past, the IMF has significantly underestimated emerging markets’ growth performance and their resilience during the crisis. The future trajectory though will depend on whether emerging markets manage to contain rising vulnerabilities (see below Countries Vulnerability Indicator).

IMF WEO economic projections

Central bank lending to governments

Central Banks historically were often established to finance governments in particular to wage wars. Since in particular the 1970s and 1980s, significant limits or outright restrictions on government lending were imposed on most central banks largely to strengthen central banks’ independence and ability to fight inflation. The start of large-scale government debt purchases by the ECB in March serves as a reminder how much central banks have moved into a different direction and how important they have become in bankrolling governments.

Central bank lending to governments has at least two dimensions: National and international lending. The former emerged mostly since 2008 with the global financial and economic crisis and adoption of “quantitative easing” by the U.S. Federal Reserve and the Bank of England. The latter rose to significance already since the early 2000s amid the rapid accumulation of central bank foreign exchange reserves, mostly invested in advanced economies treasury securities. Both mean that the share of central bank lending to governments in proportion to total outstanding debt has reached considerable amounts.

Central bank government securities purchases have been substantial and unprecedented in modern central banking times: The Bank of Japan holds about 35 percent of the total Japan Government Bonds (JGBs) outstanding; the Bank of England through the Asset Purchase Facility holds 35 percent of conventional gilts outstanding; and the Federal Reserve holds 20 percent of total U.S. Treasury marketable debt outstanding. The Federal Reserve, Bank of Japan and Bank of England hold US$5,270 billion of their respective governments’ debts (March 2015) representing 26 percent (weighted) of total benchmark government securities outstanding.

Central bank foreign exchange reserves have similarly increased to unprecedented levels from US$2,000 billion in 2000 to US$11,600 billion in 2014. Disclosure of central banks holdings of government securities as part of foreign exchange reserves remains limited and is often confidential. To estimate, government securities holdings, the currency composition of foreign exchange reserves as published by the IMF (COFER) is used as a proxy amid the assumption that central banks normally invest a very high proportion of reserves in government securities.

The combination of national and international central bank government lending shows that central bank holdings of government debt represents substantial portion of total government debt or in proportion to benchmark government debt (Chart): U.S. treasury marketable debt 77 percent; JGBs straight bonds 42 percent and Gilts 63 percent. Using the same approach to estimate central bank foreign exchange reserve holdings in German and French long-dated government securities, central banks represent already, excluding ECB purchases, 83 percent of Bundesanleihen, Bundesobligationen, OATs, BTANs and BTFs.

The high proportion of central bank lending to governments undermines central bank independence. Even foreign central banks may find it difficult to trade foreign exchange reserves freely if it may adversely affect the issuing country. The high proportion of central banks in key fixed income markets also undermines price discovery and price formation in these markets as central banks and private market participants may not pursue similar objectives. Central banks foreign exchange reserves have become very big and central banks’ quantitative easing policies have widely expanding central banks’ treasury market interventions. It is hard to see how so much central bank lending has remained consistent with the basic notion of markets.

U.S. and Euro area monetary base and eurodollar

CIGI T20│tepav Conference: Prioritizing international monetary and financial corporation, Ottawa 3-5 May—Summing-up

The summing-up is based on personal notes only and does not aim to offer a comprehensive account of the conference proceedings.

The conference aimed to provide input for the G20 agenda focusing on international financial, regulatory and environmental issues with a broad based participation of representatives from governments and central banks, IMF, academia and think tanks and former Prime Minister of Canada Paul Martin. The conference featured three keynote addresses on currency wars; strengthening the multilateral institutions; and the financial safety net; and was divided into six sessions: Turkey’s G20 Agenda; Enhancing Special Drawing Rights in a reformed international monetary system; Macroeconomic imbalances and macroprudential regulation; Managing severe sovereign debt crises; Structural financial reforms on global finance; Addressing environmental and sustainability risks through financial regulatory reforms.

Main takeaways:

Country vulnerability indicator

The slowdown in global economic growth has revealed countries’ underlying vulnerabilities. The country vulnerability indicator, a simple linear combination of economic growth, inflation, fiscal deficit, government debt and current account balance, uses the latest IMF World Economic data to show level and change of economic vulnerabilities for the 50 largest economies (for the methodology, see Countries' economic vulnerabilities (update), 22 October 2013). Economic conditions have on average improved but the distribution of relative vulnerabilities has changed significantly since April 2013 shifting from advanced economies to emerging markets. In Europe notably, there has been a significant decline in the vulnerability indicator including in Greece and Portugal. In emerging markets, Argentina and Brazil in particular show a significant increase in their vulnerability indicators. The aggregated vulnerability indicator for emerging markets has surpassed, being more vulnerable, that of advanced economies for the first time since 2003.

Table with indicators available on request.

Vulnerability indicator

Aggregate vulnerability indicator