The global financial landscape is complex, with various instruments and mechanisms designed to facilitate international trade and financial stability. Among these, the Special Drawing Right (SDR) stands out as an international reserve asset created by the International Monetary Fund (IMF). While not a currency itself, the SDR’s value is determined by a basket of five major currencies: the US dollar, the euro, the Chinese renminbi (yuan), the Japanese yen, and the British pound sterling. Understanding the relationship between currencies like the Eur To Chinese Yuan within this basket is crucial to grasping the SDR’s role in the international monetary system.
What Exactly is the SDR?
The SDR is best described as an international reserve asset, not a conventional currency. Think of it as a supplementary foreign exchange reserve that can be used by IMF member countries. Its value isn’t fixed to a single currency but is calculated daily based on a weighted average of exchange rates of the five currencies included in its basket. These are the US dollar, the euro, the Chinese renminbi, the Japanese yen, and the British pound. This basket approach ensures the SDR’s value reflects the global importance of these major economies.
LEARN MORE Q&A on SDRs ONLINE COURSE ON SDRs
The Purpose Behind the SDR
The IMF established the SDR in 1969. Back then, the global monetary system was based on fixed exchange rates linked to gold, and the US dollar was the primary reserve currency. The SDR was conceived as a supplementary asset to bolster international liquidity. Initially, the SDR was defined as equivalent to a specific amount of gold, which was also equal to one US dollar at the time.
When the system of fixed exchange rates collapsed in 1973, the SDR’s definition evolved. It was then redefined to represent the value of a basket of leading world currencies. While not a currency itself, the SDR functions as an asset that countries holding it can exchange for actual currencies when needed. Furthermore, the SDR serves as the unit of account for the IMF and numerous other international organizations in their financial transactions.
Who is Eligible to Hold SDRs?
It’s important to note that SDRs are not accessible to individuals or private companies. Instead, SDRs are held by IMF member countries and the IMF itself. The IMF also has the authority to designate other entities as official holders, typically central banks and multilateral development banks. As of February 2023, there were 20 organizations recognized as prescribed holders. While both participating member countries and prescribed holders are authorized to trade SDRs, there are distinctions. Prescribed holders are not allocated SDRs and cannot request SDR exchanges through the designation process available to member countries.
Understanding SDR Value and Currency Weights
The value of the SDR in US dollar terms is calculated daily. This calculation is based on the spot exchange rates observed around noon in London. This daily valuation is publicly available on the IMF website.
To ensure the SDR basket remains relevant to the global economy, the IMF reviews its composition and currency weights every five years, or sooner if necessary. This review process assesses the relative importance of currencies in global trade and finance. A significant development in the 2015 review was the inclusion of the Chinese renminbi (RMB) into the SDR basket, recognizing the growing global role of the Chinese economy and its currency. The RMB officially joined the basket in October 2016, and the interest rate on Chinese Treasury bonds was incorporated into the calculation of SDR interest rates.
During these quinquennial reviews, the IMF re-evaluates the criteria for selecting currencies and the initial weights assigned to each currency in the SDR basket. While the currency amounts within the basket remain fixed for the five-year valuation period, their relative weights fluctuate daily based on exchange rate movements between the basket currencies, including changes in the EUR to Chinese Yuan exchange rate. The daily valuation of the SDR reflects these market fluctuations.
To be included in the SDR basket, a currency must meet two key criteria, demonstrating its significance in international transactions and global financial markets.
The Quinquennial SDR Valuation Review Process
In response to the urgent demands of the COVID-19 pandemic, the IMF Executive Board in March 2021 made the decision to extend the existing SDR valuation basket until July 31, 2022. This effectively adjusted the five-year cycle for SDR valuation reviews. The subsequent review, concluded in May 2022, reaffirmed the existing composition of currencies in the SDR basket but updated their respective weights. Historical data on these weights is available for review. The revised basket, reflecting these updated weights, came into effect on August 1, 2022.
LEARN MORE
General SDR Allocations and Global Liquidity
The IMF’s Articles of Agreement empower the institution to allocate SDRs to its member countries (but not to prescribed holders) under specific circumstances. There have been four general allocations of SDRs to date. The most recent, and largest, occurred in 2021, when the IMF Board of Governors approved a general allocation of approximately SDR 456 billion, equivalent to US$650 billion. This significant allocation aimed to inject liquidity into the global economy and assist countries in their response to the COVID-19 pandemic. Prior to this, a general allocation of around SDR 161 billion (US$250 billion equivalent) was made in 2009 to enhance liquidity during the global financial crisis.
General SDR allocations require broad consensus among IMF members. When a general allocation is approved, SDRs are distributed to member countries in proportion to their existing quota shares within the IMF.
LEARN MORE
Special One-Time SDR Allocation
In addition to general allocations, the IMF implemented a special one-time allocation of SDR 21.5 billion (approximately US$33 billion) in 2009. The purpose of this special allocation was to address historical inequities in SDR allocations. Countries that joined the IMF after 1981 – representing over one-fifth of the IMF membership at the time – had never received an SDR allocation. This one-time allocation aimed to rectify this situation and ensure broader participation in the SDR system.
Interest Rates and SDR Holdings
Does the IMF charge interest in relation to SDRs? Yes, the SDR interest rate, often referred to as SDRi, is a key component of the SDR system. It serves as the basis for calculating interest charges and payments for member countries. This includes interest on regular borrowing from the IMF and on SDR holdings.
The SDR interest rate is determined weekly and is based on a weighted average of short-term interest rates in the money markets of the currencies included in the SDR basket, including the euro and Chinese yuan. This ensures the SDR interest rate reflects prevailing conditions in major global money markets.
SDR ALLOCATIONS AND HOLDINGS
In conclusion, the SDR plays a vital role as a supplementary international reserve asset, and its value is intrinsically linked to a basket of major currencies, including the euro and Chinese yuan. Understanding the SDR, its valuation, and allocation mechanisms is essential for comprehending the workings of the international monetary system and the IMF’s role in promoting global financial stability.
This page was last updated in January 2023
