The Peoples Bank of China raised its Required Reserve Ratio or RRR by an additional 50 basis points on Friday for the second time in two weeks. The PBC stated that the move was intended "to strengthen liquidity management and appropriately control supplies of money and credit."

The RRR hike sends a signal to Chinese banks to decrease lending and indicates how serious the central bank is on its policy for tightening rates. In addition, the move will help increase the value of the Yuan and to stem the level of inflation, which according to recent releases topped the 4.4 percent level in October, a two year high fueled mainly by higher food prices.

Stronger Yuan Helps in Combating Chinese Inflation

A stronger local currency would give the Chinese people increased purchasing power and would make international imports cheaper, thereby stemming inflation in China to a certain degree. In addition, both the European Union and the United States have demanded that the Chinese allow their currency to appreciate versus the Dollar.

In addition to raising reserve requirements, the Chinese government announced additional measures to fight inflation. According to the official Chinese news agency, Xinhua, these measures include:

• Increasing vegetable planting efforts

• Cutting road tolls for vehicles transporting agricultural products

• Reducing costs for power

The Chinese will also require local governments to temporarily disburse subsidies to the poor and increase allowances for economically challenged students and student canteens.

The IMF Adjusts SDR Weighting

Last week, the International Monetary Fund or IMF adjusted the weighting on its Special Drawing Rights that are used by the IMF for internal accounting purposes. SDRs came into the spotlight last year after Russia and China both proposed replacing the U.S. Dollar as the primary reserve currency.

The announced SDR weighting changes will take effect on January 1^st, 2011, and the last time the weightings were adjusted was in 2005. They are typically readjusted every five years.

Although formerly being tied to the dollar value of gold, since July of 1974, the Special Drawing Rights have consisted of a form of artificial basket currency based on a weighted set of major currencies. From 1981, the basket consisted of five currencies that included the now obsolete German Mark and French Franc, that were both replaced with the Euro upon its introduction in 1999.

In order of their current weightings, the SDR basket currently includes the U.S. Dollar, the Euro, the Pound Sterling, and the Japanese Yen. The weightings of each currency component in the SDR are based on the levels of trade that an included country has within the global economy. The previous currency weightings for the SDRs were 44% for the U.S. Dollar, 34% for the Euro and 11% for both the Pound Sterling and the Japanese Yen.

The changes to the weighting of the SDRs have the U.S. Dollar's weighting reduced to 41.9% from 44%, and the Japanese Yen's weighting reduced to 9.4% from 11%. On the other hand, the weighting for the Euro was increased significantly to 37.4% from 34%, while the Pound Sterling's weighting was also boosted slightly from 11% to 11.3%.

The IMF's most recent weighting adjustments clearly indicate the continuing decline in favor of the U.S. Dollar and the Japanese Yen as reserve currencies. Most of the fall in those currencies was taken up by readjusting the SDR's weighting more towards the Euro and Sterling in its new valuation calculation.

While the SDR weightings currently have rather little impact on exchange rates, they do further illustrate the increasing importance of the Euro relative to the U.S. Dollar.

Chinese Yuan Continues Being Excluded as a Reserve Currency

Despite the size of the Chinese economy and the importance of the Chinese Yuan or Remnimbi in international trade, the IMF continues to omit the Yuan as a reserve currency. The persistent reason given by the IMF for this large omission consists of the fact that the Yuan is not a freely traded currency due to its peg to the U.S. Dollar and hence it is not "freely usable".

Nevertheless the People's Bank of China has recently bowed to international pressure to diminish the strength of the Yuan's Dollar peg and this move by the PBOC may open the door for the IMF to include the Chinese currency in future.

It does seem that the IMF already recognizes the importance of the Chinese currency and will perhaps include the Yuan in its calculations when it is allowed to float more freely against the other major currencies.

A future move to include the Yuan would most likely be a major step in increasing the value of the Chinese currency.