SPECIAL DRAWING RIGHTS (SDR)

The SDR is an international reserve asset, created by the IMF in 1969 to supplement the existing official reserves of member countries. SDRs are allocated to member countries in proportion to their IMF quotas. The SDR also serves as the unit of account of the IMF and some other international organizations. Its value is based on a basket of key international currencies.

The Special Drawing Right (SDR) was created by the IMF in 1969 to support the Bretton Woods fixed exchange rate system. A country participating in this system needed official reserves—government or central bank holdings of gold and widely accepted foreign currencies—that could be used to purchase the domestic currency in world foreign exchange markets, as required to maintain its exchange rate. But the international supply of two key reserve assets— gold and the U.S. dollar—proved inadequate for supporting the expansion of world trade and financial development that was taking place. Therefore, the international community decided to create a new international reserve asset under the auspices of the IMF.

Under the amended rules, the activities of the Fund were conducted under two separate accounts. The general transactions of the Fund including the sales of foreign currencies, to member countries, were conducted through the General Account. In other words, the Genral Account dealt with the general drawing rights of the member countries. But with the new scheme, a new account had been opened known as Special Drawing Account. All operations and transactions involving special drawing rights were conducted through the special drawing account. In other words, this account dealt with the special drawing rights of the member countries.

However, only a few years later, the Bretton Woods system collapsed and the major currencies shifted to a floating exchange rate regime. In addition, the growth in international capital markets facilitated borrowing by creditworthy governments. Both of these developments lessened the need for SDRs.

Today, the SDR has only limited use as a reserve asset, and its main function is to serve as the unit of account of the IMF and some other international organizations. The SDR is neither a currency, nor a claim on the IMF. Rather, it is a potential claim on the freely usable currencies of IMF members. Holders of SDRs can obtain these currencies in exchange for their SDRs in two ways: first, through the arrangement of voluntary exchanges between members; and second, by the IMF designating members with strong external positions to purchase SDRs from members with weak external positions.

SDR valuation

The value of the SDR was initially defined as equivalent to 0.888671 grams of fine gold—which, at the time, was also equivalent to one U.S. dollar. After the collapse of the Bretton Woods system in 1973, however, the SDR was redefined as a basket of currencies, today consisting of the euro, Japanese yen, pound sterling, and U.S. dollar. The U.S. dollar-value of the SDR is posted daily on the IMF's website. It is calculated as the sum of specific amounts of the four currencies valued in U.S. dollars, on the basis of exchange rates quoted at noon each day in the London market.

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. In the most recent review that took place in November 2005, the weights of the currencies in the SDR basket were revised based on the value of the exports of goods and services and the amount of reserves denominated in the respective currencies which were held by other members of the IMF. These changes became effective on January 1, 2006. The next review by the Executive Board will take place in late 2010.

The SDR interest rate

The SDR interest rate provides the basis for calculating the interest charged to members on regular (non-concessional) IMF loans, the interest paid and charged to members on their SDR holdings, and the interest paid to members on a portion of their quota subscriptions. The SDR interest rate is determined weekly and is based on a weighted average of representative interest rates on short-term debt in the money markets of the SDR basket currencies.

SDR allocations

Under its Articles of Agreement, the IMF may allocate SDRs to members in proportion to their IMF quotas. Such an allocation provides each member with a costless asset on which interest is neither earned nor paid. However, if a member's SDR holdings rise above its allocation, it earns interest on the excess; conversely, if it holds fewer SDRs than allocated, it pays interest on the shortfall. The Articles of Agreement also allow for cancellations of SDRs, but this provision has never been used. The IMF cannot allocate SDRs to itself.

There are two kinds of allocations:

General allocations of SDRs have to be based on a long-term global need to supplement existing reserve assets. General allocations are considered every five years, although decisions to allocate SDRs have been made only twice. The first allocation was for a total amount of SDR 9.3 billion, distributed in 1970-72. The second allocation was distributed in 1979-81 and brought the cumulative total of SDR allocations to SDR 21.4 billion.

A proposal for a special one-time allocation of SDRs was approved by the IMF's Board of Governors in September 1997 through the proposed Fourth Amendment of the Articles of Agreement. This allocation would double cumulative SDR allocations to SDR 42.8 billion. Its intent is to enable all members of the IMF to participate in the SDR system on an equitable basis and correct for the fact that countries that joined the Fund subsequent to 1981—more than one fifth of the current IMF membership—have never received an SDR allocation. The Fourth Amendment will become effective when three fifths of the IMF membership (111 members) with 85 percent of the total voting power accept it. As of end-March, 2008, 131 members with 77.68 percent of total voting power had accepted the proposed amendment. Approval by the United States, with 16.75 percent of total votes, would put the amendment into effect.

(From internet.)

Merits and demerits of SDRs must be studied as well.