By: Vikram.G.BLecturer, P.G. Dept. of Commerce V.D.C Bangalore-55
SDR or Paper Gold???? It is an unconditional reserve assets to influence the level of world reserves in order to solve the problem of international liquidity. Special drawing rights (SDRs) are supplementary foreign exchange reserve assets defined and maintained by the International Monetary Fund (IMF). SDR is not a currency, SDRs instead represent a claim to currency held by IMF member countries for which they may be exchanged. As they can only be exchanged for Euros, Japanese yen, pounds sterling, or US dollars, SDRs may actually represent a potential claim on IMF member countries non gold foreign exchange reserve assets, which are usually held in those currencies.
Created in 1969 to supplement a shortfall of preferred foreign exchange reserve assets, namely gold and the US dollar. They were allocated to participating members in portion to their Fund quotas. For this purpose Special Drawing Account has been established. The value of a SDR is defined by a weighted currency basket of four major currencies: the US dollar, the euro, the British pound, and the Japanese yen. SDRs are denoted with the ISO 4217 currency code XDR. The name may actually derive from an early proposal for IMF "reserve drawing rights. The word "reserve" was later replaced with "special" because the idea that the IMF was creating a foreign exchange reserve asset was contentious. As of March 2011, the amount of SDRs in existence is around XDR 238.3 billion, but this figure is expected to rise to XDR 476.8 billion by 2013.
History of SDRs Special drawing rights were created by the IMF in 1969 and were intended to be an asset held in foreign exchange reserves under the Bretton Woods system of fixed exchange rates. After the collapse of Bretton Woods system in the early 1970s the SDR has taken on a far less important role. Acting as the unit of account for the IMF has been its primary purpose since 1972. SDRs were created to the Fund Articles of Agreement in 1969.
Valuation of SDRs The value of the SDR is determined by the value of several currencies important to the world’s trading and financial systems. Initially its value was fixed, so that 1 SDR = 1 US dollar, but this was abandoned in favor of a currency basket after the 1973 collapse of the Bretton Woods system of fixed exchange rates. Composed of the US dollar, the euro, the British pound and the Japanese yen, the basket of currencies used to value the SDR is "weighted" meaning that the more important currencies have a larger impact on its value. Currently, the value of one SDR is equal to the sum of 0.423 Euros, 12.1 yen, 0.111 pounds, and 0.66 US Dollars.
This basket is re-evaluated every five years, and the currencies included as well as the weights given to them can then change. A currencys importance is currently measured by the degree to which it is used as a foreign exchange reserve asset and the amount of exports sold in that currency. Current valuation Due to fluctuating exchange rates, the relative value of each currency varies continuously and so does the value of the SDR. The IMF fixes the value of one SDR in terms of US dollars daily.
Allocations: Special drawing rights are allocated to member countries by the IMF. A countrys IMF quota, the maximum amount of financial resources that it is obligated to contribute to the fund, determines its allotment of SDRs. Any new allocations must be voted on in the SDR Department of the IMF and pass with an 85% majority. All IMF member countries are represented in the SDR Department, but this is not a one country, one vote system. Voting power is determined by a member countrys IMF quota. For example, the US has 16.7% of the vote as of March 2, 2011.
Allocations are not made on a regular basis and have only occurred on several occasions. The first round took place due to a situation that was soon reversed, the possibility of an insufficient amount of US dollars because of US reluctance to run the deficit necessary to supply future demand. Extraordinary circumstances have, likewise, led to the other SDR allocation events.
How to use SDRs In order to use its SDRs, a country must find a willing party to buy them. The IMF acts as an intermediary in this voluntary exchange; it also has the authority under the designation mechanism to ask member countries with strong foreign exchange reserves to purchase SDRs from those with weak reserves. The maximum obligation any country has under this mechanism is currency equal to twice the amount of its SDR allocation. As of 2011, SDRs may only be exchanged for Euros, Japanese yen, UK pounds, or US dollars. It is not, however, the IMF that pays out foreign currency in exchange for SDRs: the claim to currency that SDRs represent is not a claim on the IMF.
Other Uses of SDRs Unit of account:- Some international organizations use the SDR as a unit of account. The IMF says using the SDR in this way "help[s] cope with exchange rate volatility". As of 2001, organizations that use the SDR as a unit of account, besides the IMF itself, include: African Development Bank, Arab Monetary Fund, Asian Development Bank, Bank for International Settlements, Common Fund for Commodities, East African Development Bank, Economic Community of West African States, International Center for Settlement of Investment Disputes, International Fund for Agricultural Development, and Islamic Development Bank. It is not only international organizations that use the SDR in this way. JETRO uses SDRs to price foreign aid. In addition, charges, liabilities, and fees prescribed by some international treaties are denominated in SDRs. Use in international law:- In some international treaties and agreements, SDRs are used to value penalties, charges or prices. For example, the Convention on Limitation of Liability for Maritime Claims caps personal liability for damages to ships at XDR 330,000. The Montreal Convention and other treaties also use SDRs in this way.
Currency peg:- The IMF says, "the SDR may not be any country’s optimal basket“, but a few countries do peg their currencies to the SDR. One possible benefit to nations with SDR pegs is that they may be perceived to be more transparent. As of 2000, the number of countries that did so was four. This is a substantial decrease from 1983, when 14 countries had SDR pegs. As of 2007 and 2010, Syria pegs its pound to the SDR. The Fund pays interest to each holder of SDRs, and it makes charges at the same rate on each participants net cumulative SDR allocations (i.e., the SDRs that were allocated to a member by the Fund in the past, net of any cancellations, which in practice have not taken place to date). Therefore, in net terms, members receive interest at the SDR interest rate on the amount that their holdings exceed their cumulative allocations. Conversely, if a members SDR holdings are below its allocation, it incurs a net interest obligation. Interest on SDR holdings and allocations are received and paid quarterly.
The SDR interest rate is determined weekly on each Friday and is based on a weighted average of representative interest rates on 3-month debt in the money markets of the four SDR basket currencies (i.e., the U.S. dollar, Japanese yen, euro, and pound sterling). The only other cost borne by members is a very small levy to cover the operational costs of the SDR Department. This levy has recently amounted only to about one-hundredth of one percent of the cumulative allocation of each participant.
Use by developing countries In 2001, the UN suggested allocating SDRs to developing countries for use by them as cost-free alternatives to building foreign exchange reserves though borrowing or running current account surpluses. In 2009, a SDR allocation was made to countries that had joined the IMF after the 1979–1981 round of allocations was complete (and so had never been allocated any). First proposed in 1997, many of the beneficiaries of this 2009 allocation were developing countries.
Alternative to US dollar The SDR comes to prominence when the US dollar is weak or otherwise unsuitable to be a foreign exchange reserve asset. This usually manifests itself as an allocation of SDRs to IMF member countries. Distrust of the US dollar is not the only stated reason allocations have been made, however. One of its first roles was to alleviate an expected shortfall of US dollars 1970. At this time, the US had a conservative monetary policy and did not want to increase the total amount of US dollars in existence. If the US had continued down this path, the dollar would have become a less attractive foreign exchange reserve asset: it would not have had the necessary liquidity to serve this function. Soon after SDR allocations began, the US reversed its former policy and provided sufficient liquidity. In the process a potential role for the SDR was removed. During this first round of allocations, 9.3 billion SDRs were distributed to IMF member countries.
The SDR resurfaced in 1978 when many countries were wary of taking on more foreign exchange reserve assets denominated in US dollars. This suspicion of the dollar precipitated an allocation of 12 billion SDRs over a period of four years. Concomitant with the financial crisis of 2007–2010, the third round of SDR allocations occurred in the years 2009 and 2011. The IMF recognized the financial crisis as the cause for distributing the large majority of these third-round allotments, but some allocations were couched as distributing SDRs to countries that had never received any and others as a re-balancing of IMF quotas, which determine how many SDRs a country is allotted, to better represent the economic strength of emerging markets. In total, 203.4 billion SDRs were allocated in this round.
During this time China, a country with large holdings of US dollar foreign exchange reserves, voiced its displeasure at the current international monetary system promoting measures that would allow the SDR to "fully satisfy the member countries demand for a reserve currency“. These comments, made by a chairman of the Peoples Bank of China, Zhou Xiaochuan, drew media attention, and the IMF showed some support for Chinas stance. It produced a paper exploring ways the substance and function of the SDR could be increased. China has also suggested the creation of a substitution account to allow exchange of US dollars into SDRs. When substitution was proposed before, in 1978, the US appeared reluctant to allow such a mechanism to become operational. It is likely just as reluctant today.
SDRs??? The IMF itself calls the current role of the SDR "insignificant“. Developed countries, who hold the greatest number of SDRs, are unlikely to use them for any purpose. The only actual users of SDRs may be those developing countries that see them as "a rather cheap line of credit". One reason SDRs may not see much use as foreign exchange reserve assets is that they must be exchanged into a currency before use. This is due in part to the fact private parties do not hold SDRs: they are only used and held by IMF member countries, the IMF itself, and a select few organizations licensed to do so by the IMF. Basic functions of foreign exchange reserves, such as market intervention and liquidity provision, as well as some less prosaic ones, such as maintaining export competitiveness via favorable exchange rates, cannot be accomplished directly using SDRs. This fact has led the IMF to label the SDR as an "imperfect reserve asset".
Another reason they may see little use is that the number of SDRs in existence is relatively few. As of January 2011, SDRs represented less than 4% of global foreign exchange reserve assets. To function well a foreign exchange reserve asset must have sufficient liquidity, but SDRs, due to their small number, may be perceived to be an illiquid asset. The IMF says, "expanding the volume of official SDRs is a prerequisite for them to play a more meaningful role as a substitute reserve asset".