China entered the financial big leagues this week with the decision by the International Monetary Fund to include the renminbi (RMB) or yuan, in its basket of reserve currencies. The decision is both recognition of the increasing role that the RMB plays in international finance as well as a vote of confidence in China's economic reforms. China is assuming greater weight in the international economy — as the world's second-largest economy it must — but its economy remains more closed than that of many of the other reserve currencies. The IMF move is intended to nudge China toward further liberalization as much as to reward Beijing's past performance. It does not, however, signal a vastly increased role for the Chinese currency in the international financial system.
The IMF established special drawing rights (SDRs) in 1969 as a way of increasing global liquidity. At that time, many countries tied the value of their currency to the dollar. But the only way for them to get dollars was to have the U.S. government print more — a process that risked undermining the value of the greenback. The SDR — a basket of currencies that are traded worldwide and will thus be recognized as having value in a crisis — gives member countries access to another ready currency in the event of a balance of payments crisis.
A currency must meet two criteria to qualify for inclusion in the SDR basket: It must be widely used and freely available. By that criteria, the dollar, the yen, the euro and the British pound qualify. An SDR's value is based on a weighted average of those currencies and is reviewed every five years. The last change in the value of the basket was in 2000 when the euro replaced the German mark and the French franc.