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What is the IMF’s Special Drawing Rights?

By Peter Rudegeair
December 9, 2010

Ever since the governor of China’s central bank, Zhou Xiaochuan, called for an IMF quasi-currency called Special Drawing Rights to replace the dollar as the global reserve currency, speculation has swirled over whether SDRs could play this role. Reuters IMF Correspondent Lesley Wroughton explains what the SDR is, why it was created and what it’s purpose is:

WHAT IS THE SDR?

The SDR was created by the IMF in 1969 to support the Bretton Woods fixed exchange rate system. Countries participating in this system needed official reserves — gold and the U.S. dollar — that could be used when needed to purchase their local currency in foreign exchange markets, as required to maintain its exchange rate.

But the international supply of the two reserve assets was not enough to support growing world trade and financial developments. The international community decided to create the SDR as a new international reserve asset under the auspices of the IMF.

It is not a currency. It can be held and used by member countries, the IMF and certain designated official entities called “prescribed holders.” SDRs can be traded for one of the “freely usable” currencies through voluntary trading arrangements among official SDR holders, and there is also a backstop system to ensure the liquidity of the SDR for countries with balance of payments needs.

These official SDRs cannot be held, for example, by private entities or individuals, but the private sector can denominate bonds and deposits in SDRs. They serve as the unit of account of the IMF and other global institutions, like the Bank for International Settlement.

WHY IS THE UPCOMING SDR REVIEW OF INTEREST?

The meteoric rise of emerging market economies such as China, India and Brazil has prompted increased debate over whether the world needs a reformed monetary system, in which currencies such as the Chinese yuan play a more prominent role.

China is now the world’s second-largest economy, although its currency is not convertible on the capital account and therefore it is barely used outside China.

In March 2009, Chinese central bank governor Zhou Xiaochuan suggested the dollar could give way as the premier reserve currency to a beefed-up SDR.

Russia too has called for the expansion of the SDR to include its currency, the ruble, plus the yuan and gold.

More recently, Brazil’s Central Bank President Henrique Meirelles on Thursday said he favored replacing the U.S. dollar as the world’s reserve currency with the SDR.

France, which takes over the rotating chair of the Group of 20 major economies next week, wants to make global monetary reforms the focus of its presidency. A thorny issue, according to French officials, is the diversification away from the dominance of the dollar.

The upcoming SDR review would be an opportunity to expand or alter the composition of currencies that make up the SDR basket.

Read more here.

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