IFI governance

Background

The IMF’s special drawing rights (SDRs)

1 April 2009 | Inside the institutions

The special drawing right (SDR) is an international reserve asset, created by the IMF in 1969 to supplement the existing official reserves of member countries. Countries can exchange SDRs for hard currency at the IMF. The SDR also serves as the unit of account of the IMF and some other international organisations. Its value is based on a basket of key international currencies.

The SDR is in some ways like a currency, but is currently used only at the IMF. The value of the SDR is based on the exchange rates of the US dollar, the euro, the yen and the pound sterling. The basket composition is reviewed every five years to ensure that it reflects the relative importance of currencies in the world’s trading and financial systems.

The SDR is not a claim on the IMF but a potential claim on the freely usable currencies of IMF members. Holders of SDRs can obtain hard currencies in exchange for their SDRs in two ways: first, through voluntary exchanges between members; and second, by the IMF designating members with strong large holdings of reserves to purchase SDRs from members who need hard currencies. Such transactions do not involve the IMF staff negotiating with country authorities – meaning there is no conditionality involved and no required policy changes.

SDRs were originally proposed in the late 1950s but were not created until the late 1960s. The purpose was to supplement countries’ reserves in the context of the fixed exchange rate system which had been operating since 1944. The system had been based on the convertibility of the dollar to gold, but this was proving unsustainable as trade increased because of limits in the availability of gold, and the increasing unwillingness of the US to maintain the system.

However, since the collapse of the fixed exchange rate system in 1971, SDRs have become less important. SDRs can be issued by the IMF only when 85 per cent of the IMF membership agrees. This gives the US a veto over issuance of SDRs. SDRs have been allocated just two times in the history of the IMF, at their creation and in 1981 which brought the total allocations to 21.4 billion SDRs (almost $32 billion at today’s exchange rates). Only 144 countries have been allocated SDRs, because many of the IMF’s current 185 members joined the institution after 1981. Notably, countries in Central and Eastern Europe and Central Asia have not been allocated SDRs.

Generally SDRs must be issued to countries in proportion to a country’s quota share at the IMF. As the quota is based largely on GDP, rich countries hold the majority of SDRs. A special one-time allocation of SDRs to countries that joined the IMF after 1981 was proposed and approved by the IMF board of governors in 1997 but has not yet gone into effect. It requires the approval of capitals of IMF members, but the US Congress has yet to approve the measure.

Within the IMF, there is an SDR Department which handles all transactions in SDRs. This department is strictly separate from the IMF’s General Department, which handles the IMF’s normal operations of lending. Countries that have larger holdings of SDRs than their allocations receive interest based on the SDR interest rate. Those countries that exchanged their SDRs for hard currencies must pay interest at the same rate. Thus within the SDR department the interest paid and the interest received is also equal, and the accounts net to zero.

The IMF Articles of Agreement also allow for cancellations of SDRs, but this provision has never been used. The IMF cannot allocate SDRs to itself. Many commentators, including business figures such as George Soros and former US Treasury official Ted Truman, have proposed new SDR allocations as a method of combating the financial crisis. When the IMF issues SDRs, it is a straight forward increase in the global money supply, as the IMF essentially creates the SDR allocations out of nothing but the commitment of IMF member states. Some critics of this approach have said this would be inflationary, but others have countered that in a deflationary situation, SDR allocations could help maintain price stability.

The SDR also has the potential to supplant the dollar as a global reserve currency if the IMF membership agreed to move it in that direction. This would involve much larger allocations of SDRs, as global reserve holdings were worth over $6.7 trillion at the end of 2008. The governor of China’s central bank and the UN General Assembly president’s commission of experts on financial reforms both backed the idea of a global reserve currency.