At the end of 2015, the IMF (International Monetary Fund) officially confirmed that RMB, the currency of the People’s Republic of China, was to be included in its SDR (Special Drawing Rights) basket beginning Oct. 2016. Before the RMB, there were four currencies in this Special Drawing Rights basket: the US dollar (41.9%), the Euro (37.4%), the British Pound (11.3%) and the Japanese Yen (9.4%). The RMB will be given the weighting of 10.92%, which will decrease the proportions of other currencies (Yen will drop to 8.3% and the Pound will drop to 8.1%) and will list the RMB as the third highest weighted currency in the basket. The Special Drawing Rights (XDR or SDR) is a supplement of the IMF’s general drawing rights and foreign exchange reserve assets, which is an international type of monetary reserve currency allocated to countries by the IMF. SDR baskets are used as a reserve by countries and also as a unit account by some international organizations. In the 2009 global financial crisis, the IMF allocated 182.6 billion SDR to member countries in order to provide liquidity in the global economic system and alleviate the impact of the crisis. So what’s the impact of including a new currency (the RMB) in the SDR basket? For now, RMB foreign exchange reserves only occupy 1% of global foreign exchange reserves. Even though the RMB will weigh 10.92% in the SDR basket, it does not mean that other countries will spontaneously increase their RMB reserves to the same rate. However, it should give the market a strong signal that RMB internationalization is gradually on track. For China, the direct benefits of RMB internationalization are likely due to the increase of RMB demand and the inflow of foreign investment (including those on the “One Belt, One Road” strategy) to boost the growth of China’s economy. Also, the internationalization will alleviate the spillover effect of US and other countries’ monetary policies on the RMB; The global currency market is tightly linked with commodity prices and since some part of commodity prices can be strongly linked with the RMB in the future, the stability of the RMB should increase.However, the impact of including the RMB to the SDR on the US dollar and other currencies is subtle in the short term. Until Sept. 2015, the total amount of SDR allocated to all IMF member countries is 204 billion, which only counts for 2.4% global foreign exchange reserves. The scale of reserving and exchanging SDR is relatively small. So the simulation of increasing RMB reserves is comparatively weak.There are also challenges facing China’s government. Since China’s government will give the global market some control of the RMB exchange rate, it raises the concern of potential RMB devaluation. So if the capital inflow is too fast and floating is too much, the trust on the RMB will decrease and China’s government will have to intervene again, to some extent, in order to stabilize the currency. This article was written by Sarah Jinrong Zhang. Please send an email to [email protected] to get in touch. Photo Credit: Arshaun Darabnia.