Special Drawing Rights (SDRs) are an international reserve asset, created by the IMF in 1969 to supplement its member countries’ official reserves. It serves as the unit of account of the IMF.
SDRs were first introduced in the context of the Bretton Woods’ fixed exchange rate system which came into operation in 1944 and saw many countries fix their exchange rates relative to the US dollar (and, by extension, to gold). The idea was that SDRs, which were initially created with a fixed value of 1 SDR to 1 US dollar, would boost international liquidity at a time when the future of the fixed exchange rate system was uncertain. However, with the collapse of the Bretton Woods system in the early 1970s, SDRs would go on to play only a minimal role as an international reserve asset, making up a small proportion of global reserve assets, which continue to be dominated by the US dollar.
SDRs are neither a currency, nor a claim on the IMF, and cannot be used directly in market transactions. However, they are a way for countries to gain access to hard currency and can also be used for repaying loans to the IMF. Holders of SDRs can obtain hard currencies in exchange for their SDRs either by voluntarily exchanging them with other members or by the IMF designating members with large holdings of reserves to purchase SDRs from members who need reserves. Such transactions do not involve the IMF staff negotiating with country authorities – meaning there is no conditionality involved and no required policy changes.
The value of SDRs is based on a basket of five currencies—the US dollar, the euro, the Japanese yen, the British pound sterling and, from 2016, the Chinese renminbi. This value is set daily by the IMF on the basis of these five currencies and their daily market exchange rates.
Within the IMF, there is an SDR Department that handles all transactions in SDRs. This department is strictly separate from the IMF’s General Department, which handles normal lending operations.
How are SDRs allocated?
The IMF has the authority under its Articles of Agreement to issue general allocations of SDRs to participants in its SDR Department (currently, all members of the IMF) in proportion to their quotas within the Fund. As the quota is based largely on a country’s relative position in the global economy, rich countries receive the majority of SDRs. However, the current quota system has been criticised by many (see Inside the Institutions IMF and World Bank decision-making and governance), including the G24, which in its 2021 IMF and World Bank Annual Meetings communique called for a ”shift in quota shares from advanced economies to EMDEs [Emerging Markets and Developing Economies], while protecting the shares of the poorest countries” (see Dispatch Annuals 2021).
A new issuance of SDRs represents an increase in the global money supply, as the IMF essentially creates the SDR allocations out of nothing but the commitment of IMF member states. Any SDR allocation must be approved by an 85 per cent majority of the total voting power, which gives the US a veto over issuance of SDRs, as the US currently holds 16.50 per cent of the total IMF voting shares (see Observer Winter 2019, Summer 2019).
SDRs allocations occur very rarely – the IMF has done so only four times in its history: in 1970-72, at the time of establishment of SDRs as the unit of account; in 1979-81; in 2009, to help in the recovery of the 2008 financial crisis; and the latest one, in 2021, as a response to the Covid-19 crisis. In 2009 a special allocation was issued to countries that had joined the IMF after 1981, to correct the fact that they had never received an SDR allocation.
SDRs allocations are highly political as their potential evolution as the “principal reserve asset in the international monetary system”, as intended according to the 1978 amendment to the IMF’s Articles of Agreement, would negatively impact the US dollar’s current “exorbitant privilege”.
Paying and receiving interest on SDRs
Importantly, when the IMF issues SDRs, they serve as both an asset and a liability for countries. Countries whose SDR holdings exceed their allocations receive interest based on the SDR interest rate, while those that exchange their SDRs for hard currencies must pay interest at the same rate. Within the SDR department thus the interest paid and received accounts net to zero.
To understand how this works in practice, consider the following example. If Indonesia were credited with SDR 50 billion as part of a general IMF allocation, it would in that moment have an allocation (i.e. what the IMF said Indonesia should have) of SDR 50 billion and also a holding (i.e. the actual amount Indonesia currently holds subsequent to the IMF allocation) of SDR 50 billion. On its allocation it would be required to pay interest to the IMF’s SDR Department, and on its holding it would receive interest from the SDR Department. The “SDR interest rate”, which Indonesia both pays and receives, is set weekly (based on the SDR basket of currencies).
Because Indonesia’s allocation and holdings of SDRs are currently equal (SDR 50 billion), the interest that Indonesia receives and pays exactly cancel each other out. However, if Indonesia decides to convert some of its SDRs into another currency (as described earlier in this article), then its holdings of SDRs will decrease. If Indonesia converts SDR 10 billion into US dollars, then its holdings will have fallen to SDR 40 billion, whilst its allocation (the amount officially credited to Indonesia by the IMF) will remain at SDR 50 billion. In this case, Indonesia will now be receiving less interest than it pays, and as such it will end up paying out annually to the IMF.
The 2021 SDR allocation
On 2 August 2021, following calls from civil society organisations (CSOs) (see Observer Spring 2021) and after the US reversed its opposition to the disbursal of additional SDRs to help low- and middle-income economies recover from the Covid-19 pandemic (see Dispatch Springs 2020), the IMF board of governors approved a general allocation of $650 billion worth of SDRs. While falling significantly short of the $3 trillion called for by civil society, the allocation was nevertheless significant, accounting for 69 per cent of all the SDRs ever disbursed (see Observer Autumn 2021).
As part of the 2021 allocation, high-income countries (HICs) received nearly $400 billion worth of SDRs, middle-income (MICs) received $230 billion, and low-income countries (LICs) just $21 billion. Given the IMF itself has stated the motivation for this unprecedented issuance of SDRs is to “help our most vulnerable countries struggling to cope with the impact of the COVID-19 crisis” and that high-income countries are unlikely to use their huge share of SDR, several groups, including the G7 in its June communique, have called the IMF for the first time to explore options for the channeling of SDRs from HICs to MICs and LICs. Additionally, CSOs such as Oxfam have called for solutions that provide debt-free financing and do not include economic conditionality that could force countries to impose austerity (see Observer Autumn 2021).
Discussions on how SDRs will be re-channelled are ongoing, but there are three likely courses of action:
- Using SDRs to boost the resources of the IMF’s Poverty Reduction and Growth Trust (PRGT) – the IMF’s concessional lending facility for LICs, with $17.9 billion worth of SDRs (see Observer Autumn 2021).
- Using SDRs to provide initial funding to a soon-to-be-created IMF fund, the Resilience and Sustainability Trust (RST) (see Observer Winter 2021), for which the G7 has given green light. According to the early suggestions this would be operational from the end of 2022, at the earliest, and would require economic conditionality for countries to access finance.
- On-lending SDRs to multilateral development banks (MDBs), including the World Bank. High-income economies appear interested in this option, but it remains unclear how countries can on-lend to MDBs while maintaining the option to recall their SDRs in the event of balance of payment emergencies.
The latest SDR allocation could serve as a boost for MICs and LICs to recover from the health and financial crisis brought by the Covid-19 pandemic and for the IMF to provide a large-scale debt-free financing scheme that would help those countries that have been hit the hardest by the pandemic. The debate about the use of SDR to support recovery, as demanded by civil society, versus maintaining it as a buffer, as suggested by the Fund, is already out there.