Special Drawing Rights was created by the International Monetary Fund in the year 1969. SDRs are a kind of reserves of foreign exchange assets which consist of leading countries globally.
Before the concept of SDR, many problems have been faced by the international community in increasing world trade and the gold and US dollars which were the only means of trade were being given in limited quantities. Therefore, to overcome this issue, the concept of SDR was created by the International Monetary Fund.
SDR is also known as a basket of national currencies which consists of five major currencies such as U.S. Dollar, Euro, Chinese Yuan (which was added recently in the year 2016), Japanese Yen, and Pound Sterling.
The value of SDR is calculated on a daily basis while the interest on SDR is determined on a weekly basis.
Advantages of SDR
- The allocation of SDR can be implemented quickly. For instance, if a decision is taken by the IMF executive board on 1st July 2020 then such a decision may be implemented by early October when the economic effects of the pandemic will still be raging.
Moreover, the SDR should be allocated quickly to maximize their positive impact on global economic confidence and how are they useful to recipient countries.
- The allocation of $500 billion of SDR would in turn lead to boost total international reserves except for gold, of the 189 members by 4.5 percent from $11.2 trillion at the end of 2020. The allocation of SDR is made on quota shares, with the result that the countries who have been allotted the largest quotas are given the largest allocations.
- Currently, there are 76 low-income and other countries that are potentially eligible for loans from the World Bank International Development Association and would receive $22 billion in SDR. The $22 billion in SDR would amount to a 9.4 percent to boost their combined international reserve.
- The countries that do not need their SDR can lend or give them to other countries or lend or give them to the International Monetary Fund.
Disadvantages of SDR
- The increase in international liquidity is not a general need. But the international scramble in the Covid-19 situation shows that there is a general need for US dollars. These reserves facilities are generally given to advanced countries and emerging market central banks and not much importance is given to developing countries.
- The allocation of SDRs will lead to an increase in inflation as the country start to spend their SDRs. This fact has been observed from the global financial crisis of 2007-2009.
- The SDR would be allocated to countries without any restrictions on the recipient’s countries economic policies. In this COVID-19 pandemic situation, providing financial assistance without any restrictions is the number one approach used by the countries.
- The allocation of SDR would be made to those countries that do not need to boost their international reserves. Such countries do not have the need to use their SDR and they are entitled to any benefit and cost.[1]
Issues and Challenges of SDR
- Estimation Of Need For Total Reserve Growth
Firstly, there is a problem of how to estimate and supplement the need of global reserves and this problem can be addressed in two parts:
- How much is the requirement of total reserve expansion? and;
- How much of this requirement can be met by expansion in other types of reserves?
We tried to estimate the need for a total reserve increase in the world by looking at the effects of different rates of reserve growth have on national policies. But the only with this is that the international economic policymakers are faced with the issue of multiplicity of targets. In this case on is interested in the effects of national policies for demand management, trade and capital flows, exchange rates and the financing of payment surpluses and deficits, and even on the willingness of the donor countries to provide aid to developing countries. But it is impossible to optimize all these policies simply by manipulating the rate of reserve expansion.
Another type of problem in the determination of international reserve needs arises from ignorance about the relevant empirical relationships.
This question of the relative importance to be attributed to reserve stocks and to reserve growth is still unsolved.
- Estimation Of Supply Of Other Reserves
The need for reserve creation in the form of SDRs depends not only on the prospective need for reserve growth in general but also on the supply of other reserves such as gold, foreign exchange holdings, and reserve positions in the Fund.
The supply of these reserves arises out of international credit operations.
- Rate Of Interest On SDRs
The relatively high level of the world interest rates, including rates paid on the foreign exchange reserves, that has prevailed, and the rather rapid changes that have occurred, over the last few years, raise the question whether the rate of interest presently paid on SDRs viz. 1 ½ percent is not too low, and whether the provisions governing rate changes are not too rigid. Under the present articles, any increase in the rate beyond 2 percent take place only if the remuneration payable to net creditors of the fund is likewise raised above 2 percent, a decision that Executive directors can make only by a 75 percent majority of the total voting power.
To pen down, the challenges and issues of SDRs are as follows:
- The rate of interest to pay and collect on SDRs vary from time to time.
- The link between the issuance of SDRs and the financing of economic development has to be created.
- The SDRs transfers are to be liberalized.
- The possible conversion of national currencies into SDRs.
- The other reserve instruments are replaced by the SDRs.[2]
[1]https://www.piie.com/blogs/realtime-economic-issues-watch/imfs-special-drawing-rights-rescue.
[2]https://link.springer.com/article/10.2307%2F3866374#citeas.
This Article is Authored by Shreya Garg, 4th Year BA.LLB Student at Gitarattan International Business School.
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