Special Drawing Rights (SDRs)

Special Drawing Rights (SDRs) are an international reserve asset created by the International Monetary Fund (IMF) to supplement the official foreign exchange reserves of member countries. They are not a currency in themselves but represent a potential claim on the freely usable currencies of IMF members. The SDR system was established to provide global liquidity and promote international monetary stability, particularly during periods of balance-of-payments crises or shortages of foreign exchange reserves.

Background and Evolution

The concept of Special Drawing Rights was introduced in 1969 under the First Amendment to the IMF Articles of Agreement, in response to concerns about the adequacy and stability of global reserves. During the 1960s, the world’s reserve system relied heavily on gold and the U.S. dollar. However, the fixed exchange rate regime under the Bretton Woods system began to experience strain as global trade expanded and demand for liquidity increased.
To address the shortage of international reserves and reduce dependence on the U.S. dollar, the IMF created SDRs as a supplementary asset that could be allocated to member countries according to their IMF quotas. The first allocation took place between 1970 and 1972, amounting to about SDR 9.3 billion.
After the collapse of the Bretton Woods system in the early 1970s and the move to floating exchange rates, the role of SDRs evolved. They became an additional tool for maintaining financial stability, particularly during periods of global economic crisis.

Nature and Characteristics

SDRs are often referred to as “paper gold”, as they supplement rather than replace existing reserve assets. They are not physical currency but exist as electronic entries in the IMF’s books. Their value and usability depend on the collective agreement among IMF member states.
Key characteristics include:

• Reserve Asset: SDRs represent a claim on the freely usable currencies of IMF members, such as the U.S. dollar, euro, Chinese renminbi (yuan), Japanese yen, and British pound sterling.
• Allocation: SDRs are allocated to countries in proportion to their IMF quotas, which reflect their relative size in the global economy.
• Transferability: SDRs can be exchanged voluntarily between member countries or used in transactions with the IMF for currency or other obligations.
• Interest Rate: The IMF determines an SDR interest rate weekly, based on a weighted average of representative short-term government debt instruments of the basket currencies.

Valuation of SDRs

The value of the SDR is determined daily by the IMF, based on a basket of major international currencies. The current basket, revised every five years, comprises five currencies:

• U.S. Dollar (USD)
• Euro (EUR)
• Chinese Renminbi (CNY)
• Japanese Yen (JPY)
• British Pound Sterling (GBP)

Each currency’s weight reflects its importance in global trade and finance. As of the latest revision, the weights are approximately:

• U.S. Dollar – 43.38%
• Euro – 29.31%
• Chinese Renminbi – 12.28%
• Japanese Yen – 7.59%
• British Pound – 7.44%

The SDR’s value is expressed in U.S. dollars and fluctuates daily with changes in exchange rates of the constituent currencies.

Allocation and Distribution

The IMF allocates SDRs to member countries in proportion to their IMF quota shares. Each country’s allocation is recorded in its SDR holdings account at the IMF.

• Countries with balance-of-payments surpluses may voluntarily exchange SDRs with others that require foreign exchange to meet international obligations.
• The IMF may facilitate these exchanges through a network of voluntary trading arrangements (VTAs) between member states.

Significant allocations have been made at different points in history, particularly during global crises:

• 1970–1972: SDR 9.3 billion (first allocation).
• 1979–1981: SDR 12.1 billion (to address global economic instability).
• 2009: SDR 182.6 billion (during the global financial crisis).
• 2021: SDR 456 billion (approximately USD 650 billion) — the largest allocation ever, to support global recovery from the COVID-19 pandemic.

Uses of SDRs

SDRs serve multiple purposes in international finance:

1. Reserve Asset: Countries can use SDRs to bolster their foreign exchange reserves, thereby strengthening their ability to manage balance-of-payments needs.
2. Settlement of IMF Obligations: Member countries can use SDRs to pay charges, subscriptions, and repayments to the IMF.
3. Bilateral Transactions: Countries can voluntarily exchange SDRs for freely usable currencies among themselves through the IMF’s Voluntary Trading Arrangements.
4. Aid and Development Support: Some countries use part of their SDR allocations to support low-income nations by contributing to IMF trust funds or special financing mechanisms.
5. Balance-of-Payments Support: In times of external payment difficulties, nations can convert SDRs into hard currencies to stabilise their external accounts.

Benefits of SDRs

1. Supplementary Global Liquidity: SDRs provide an additional source of international liquidity, reducing the global economy’s reliance on any single national currency such as the U.S. dollar.
2. Reduced Dependence on Foreign Borrowing: Countries facing temporary balance-of-payments pressures can use SDRs instead of resorting to expensive external borrowing.
3. Crisis Management Tool: Large SDR allocations, such as during the 2008–09 financial crisis or the COVID-19 pandemic, provide countries with a buffer to manage global shocks.
4. Equitable Distribution: Since SDRs are distributed based on IMF quotas, all member countries benefit proportionately, improving the inclusiveness of global financial support.
5. Low-Cost Financing: The SDR interest rate is relatively low and stable, offering an inexpensive alternative to commercial borrowing.

Limitations of SDRs

Despite their advantages, SDRs face several constraints that limit their effectiveness:

1. Limited Use: SDRs can only be exchanged among IMF members or with the IMF, not used directly in private international markets.
2. Allocation Based on Quotas: Wealthier countries with higher IMF quotas receive the largest share of SDRs, whereas low-income nations get smaller allocations despite having greater financing needs.
3. Dependence on Voluntary Exchange: The mechanism for exchanging SDRs relies on voluntary cooperation among member countries, which can delay access to funds.
4. Not a Currency: SDRs are not a medium of exchange or store of value in the traditional sense, limiting their role as a true global reserve currency.
5. Inflationary Risk: Large SDR allocations may increase global liquidity, potentially fuelling inflationary pressures if not managed carefully.

SDRs and India

India is an active participant in the SDR system. It has received allocations in line with its IMF quota and uses SDRs as part of its official reserves. The Reserve Bank of India (RBI) includes SDRs in the composition of India’s total foreign exchange reserves, along with foreign currencies, gold, and IMF reserve positions.
India also utilises SDRs to contribute to international financial stability efforts and development financing through the IMF’s Poverty Reduction and Growth Trust (PRGT) and other facilities.

Future of SDRs

The global debate around SDRs continues to evolve, especially regarding their potential role in reforming the international monetary system. Some economists advocate for expanding the use of SDRs as a global reserve currency, reducing reliance on national currencies such as the U.S. dollar and improving resilience during global crises.
Proposals include:

• Establishing SDR-based international bonds or liquidity facilities.
• Using SDRs to fund climate adaptation and development projects in low-income countries.
• Creating mechanisms for the reallocation of unused SDRs from wealthier to poorer nations.

However, achieving such reforms requires broad political consensus among IMF members and significant institutional adjustments.