Structural Adjustment Programs (SAPs)

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 serve as a potential claim on the freely usable currencies of IMF members and are designed to provide liquidity in times of global financial imbalance. SDRs are not a currency in themselves but represent a form of international monetary resource that can be exchanged among governments and central banks to maintain stability in the global financial system.

Background and Introduction

The concept of Special Drawing Rights was introduced in 1969, following the recognition that the global economy required additional reserve assets beyond gold and the US dollar. During the post-war Bretton Woods era, international liquidity depended heavily on the US dollar, which created imbalances as world trade expanded faster than US gold reserves. The SDR was created to act as a supplementary international reserve asset to support the existing system of fixed exchange rates.
Initially, SDRs were meant to serve as a replacement or complement to gold in international settlements. Although the collapse of the Bretton Woods system in the early 1970s shifted the world to a system of floating exchange rates, SDRs retained their role as a key component of the IMF’s financial framework.

Nature and Characteristics of SDRs

SDRs are neither a currency nor a direct claim on the IMF. Instead, they are an artificial international reserve asset, the value of which is based on a basket of major global currencies. SDRs are allocated by the IMF to its member countries in proportion to their IMF quotas, reflecting their relative position in the global economy.
The essential features of SDRs include:

• Accounting Unit: SDRs serve as a unit of account for the IMF and several other international organisations.
• Interest Rate Mechanism: The IMF determines an SDR interest rate weekly, based on the weighted average of representative short-term government debt instruments in the currencies making up the SDR basket.
• Liquidity and Transferability: SDRs can be exchanged for freely usable currencies through voluntary trading arrangements among member countries or through IMF-facilitated transactions.
• Reserve Asset Function: They add to a country’s official reserves, improving external stability and enhancing confidence in its capacity to meet balance-of-payments obligations.

Composition of the SDR Basket

The value of the SDR is determined by a basket of five major international currencies, representing the world’s leading economies and trading systems. The current composition (revised in August 2022) includes:

1. US Dollar (USD)
2. Euro (EUR)
3. Chinese Renminbi (CNY)
4. Japanese Yen (JPY)
5. British Pound Sterling (GBP)

The weights assigned to these currencies are reviewed every five years by the IMF to reflect their relative importance in global trade and financial markets. The valuation formula ensures stability and representation of major global currencies, while the inclusion of the Chinese yuan in 2016 marked a historic recognition of China’s growing role in the global economy.
The daily value of one SDR is published by the IMF and fluctuates according to movements in the exchange rates of the underlying currencies.

Allocation and Use of SDRs

SDRs are allocated to IMF member countries in proportion to their quotas, which represent their financial commitment to the IMF. Allocations do not require repayment but carry a cost or benefit depending on a country’s net SDR position:

• Positive SDR balance: The country earns interest on its holdings.
• Negative SDR balance: The country pays interest on the shortfall relative to its allocation.

Countries can use SDRs in several ways:

• Exchange for hard currency: Members can voluntarily trade SDRs for freely usable currencies through bilateral arrangements.
• Settlement of IMF obligations: SDRs can be used to pay IMF charges or repurchase obligations.
• Loans or transfers: Countries can lend or donate SDRs to other members, particularly through IMF-administered trust funds for low-income nations.

The IMF acts as the intermediary ensuring that SDRs remain a reliable and liquid asset within the international monetary system.

Historical Allocations

Since their inception, there have been several major general allocations of SDRs:

• 1970–1972: The first allocation of SDR 9.3 billion to address global reserve shortages under the Bretton Woods system.
• 1979–1981: A second allocation of SDR 12.1 billion during a period of oil price shocks and inflation.
• 2009: Allocation of SDR 161.2 billion in response to the global financial crisis to strengthen international liquidity.
• 2021: The largest-ever allocation of SDR 456 billion (approx. US$650 billion) to help countries combat the economic effects of the COVID-19 pandemic.

These allocations significantly increased global reserves, particularly benefiting low- and middle-income countries struggling with external financing pressures.

Role in the Global Financial System

SDRs play several important roles in the international monetary framework:

• Supplementing Reserves: They enhance countries’ official reserves without creating external debt.
• Stabilising Liquidity: SDRs provide a collective mechanism to inject liquidity during global crises.
• Reducing Dependence on Key Currencies: They offer a multilateral alternative to reliance on any single national currency like the US dollar.
• Promoting International Cooperation: Through SDR allocations, the IMF can provide equitable support to its member nations, enhancing global financial stability.

SDRs have also been used to capitalise international financial facilities, such as the Poverty Reduction and Growth Trust (PRGT) and the Resilience and Sustainability Trust (RST), which provide concessional financing to developing nations.

Valuation and Interest Rate

The SDR valuation is calculated daily based on the weighted exchange rates of the basket currencies. The SDR interest rate, adjusted weekly, is based on short-term government securities of the same currencies, including the US Treasury bills, Euro area three-month rates, UK Treasury bills, Japanese discount bills, and Chinese interbank rates.
This mechanism ensures that SDRs reflect current financial market conditions and maintain their real value as a reserve asset.

Advantages of SDRs

The SDR mechanism provides several economic and financial benefits:

• Enhances international liquidity without creating new external debt.
• Provides flexibility in crisis management by allowing countries to access foreign exchange indirectly.
• Acts as a collective insurance mechanism for member countries against balance-of-payments shocks.
• Strengthens the IMF’s role as a global stabilisation institution.
• Encourages multilateralism in international monetary relations.

Limitations and Criticisms

Despite their utility, SDRs have certain limitations:

• Limited acceptance: SDRs are not used by private entities or in ordinary international trade. Their use is confined to IMF members and prescribed holders.
• Unequal benefit distribution: Since allocations are based on IMF quotas, advanced economies receive a larger share even though developing countries may have greater need.
• Dependence on voluntary exchanges: The effectiveness of SDRs relies on countries’ willingness to exchange them for hard currency.
• Not a full substitute for reserve currencies: SDRs cannot replace the dollar or euro as transactional currencies in global markets.
• Governance and reform issues: Proposals for broader SDR use require consensus among IMF members, which is often difficult to achieve.

Contemporary Relevance and Future Outlook

In recent years, SDRs have gained renewed importance due to recurring global financial crises. The 2021 allocation during the COVID-19 pandemic demonstrated their potential as a rapid, non-debt-based mechanism to inject liquidity into the world economy. Several economists and policymakers have proposed expanding SDR allocations to finance climate resilience, pandemic recovery, and sustainable development goals.