The International Monetary Fund’s (IMF) Executive Board meets on Monday to discuss a staff proposal to include China’s yuan, or renminbi as it’s also known, in an exclusive group of currencies that make up the basket of the IMF’s Special Drawing Rights (SDR).
The prospects of inclusion, which will represent public acknowledgement of China’s heft in the global economy, look pretty high given that the U.S., a major investor in the fund, has backed the move, as has the IMF’s Managing Director Christine Lagarde.
Here’s what you need to know about why this change matters to global markets.
So, what exactly is the SDR?
The SDR is a type of international reserve asset that the IMF created in 1969 to buttress the Bretton Woods system of fixed exchange rates that was established at the end of World War II.
Back then, countries could use gold holdings and widely accepted currencies to buy their local currencies overseas in order to maintain their exchange rates. But the supply of gold and the dollar could not keep pace with the growth in world trade or new developments in financial markets. So the IMF created an asset that could be exchanged for freely usable currencies.
Countries are allocated SDRs in proportion to the IMF quotas they pay. They can use SDRs to make payments for future quota increases, to settle debts they owe to the IMF, which uses SDRs as a system of account, or to rebalance their reserves.
The importance of SDRs waned somewhat after the Bretton Woods system collapsed in 1973 and countries let their currencies move more freely in line with market forces. Still, SDRs came in handy during the global financial crisis when they helped supplement member countries’ official reserves. As of September 2015, SDRs worth $204.1 billion had been created and allocated to IMF’s members. This number is equivalent to about $280 billion.
Currently, the value of an SDR is based on a basket of four currencies: the euro, Japanese yen, pound sterling, and the dollar. At Monday’s meeting, a decision will be made on whether the yuan should be added to this group.
It’s important to note that the SDR is not a currency nor a claim on the IMF. Instead, holders of SDRs can exchange them for currencies that make up the basket, through deals with other SDR holders.