What Are Special Drawing Rights (SDRs)?
Special drawing rights (SDR) refer to an international type of monetary reserve currency created by the International Monetary Fund (IMF) in 1969 that operates as a supplement to the existing money reserves of member countries. Created in response to concerns about the limitations of gold and dollars as the sole means of settling international accounts, SDRs augment international liquidity by supplementing the standard reserve currencies.
- Special drawing rights (SDRs) are an artificial currency instrument created by the International Monetary Fund, which uses them for internal accounting purposes.
- The value of the SDR is calculated from a weighted basket of major currencies, including the U.S. dollar, the euro, Japanese yen, Chinese yuan, and the British pound.
- The SDR interest rate (SDRi) provides the basis for calculating the interest rate charged to member countries when they borrow from the IMF and paid to members for their remunerated creditor positions in the IMF.
- SDRs are allocated based on the quota amounts of each member country. The higher the quota amount, the larger the SDR allocation a country will receive. In general, stronger economies have higher quotas.
- SDRs can be used to exchange for other currencies, the repayment of loans, the payments of obligations, pledges, the payment of interest on loans, or paying for increases in quota amounts.
Understanding Special Drawing Rights (SDRs)
An SDR is essentially an artificial currency instrument used by the IMF and is built from a basket of important national currencies. The IMF uses SDRs for internal accounting purposes. SDRs are allocated by the IMF to its member countries and are backed by the full faith and credit of the member countries' governments. The makeup of the SDR is re-evaluated every five years. The current makeup of the SDR is represented by the following table and will be updated in July 2022:
|Currency||Weights Determined in the 2015 Review||Fixed Number of Units of Currency for a 5-Year Period Starting Oct. 1, 2016|
The SDR was formed with a vision of becoming a major element of international reserves, with gold and reserve currencies forming a minor incremental component of such reserves. This consisted of central bank or government reserves of gold and globally accepted foreign currencies that could be used to buy the local currency in foreign exchange markets to maintain a stable exchange rate.
However, the international supply of the U.S. dollar and gold—the two main reserve assets—wasn’t sufficient to support growth in global trade and the related financial transactions that were taking place. This prompted member countries to form an international reserve asset under the guidance of the IMF.
In 1973, a few years after the SDR was created, the Bretton Woods system imploded, moving major currencies to the floating exchange rate system. In time, international capital markets expanded considerably, enabling creditworthy governments to borrow funds. This saw many governments register exponential growth in their international reserves. These developments diminished the stature of the SDR as a global reserve currency.
Besides acting as an auxiliary reserve asset, and though its stature has diminished, the SDR is the unit of account for the IMF. Its value, which is summed up in U.S. dollars, is calculated from a weighted basket of major currencies: the Japanese yen, the U.S. dollar, the Chinese yuan, the pound sterling, and the euro.
Allocation of Special Drawing Rights (SDRs)
The allocation of SDRs to each member country is based on the member's IMF quota shares. The stronger a country's economy, the higher quota shares it has. For example, the United States has 82,994 shares, while Afghanistan has 323 shares.
The more quota shares that a country has, the more it pays into the IMF, which comes with greater voting power. The SDR share of emerging market and developing economies is approximately 42.2%. Of this amount, 3.2% is for low-income countries.
Under the Articles of Agreement of the International Monetary Fund, the IMF may allocate SDRs to members under certain conditions. For a general allocation of SDRs to occur, the allocation must meet the IMF's goal of "meeting the long-term global need to supplement existing reserve assets." The allocation must also receive an 85% majority approval of the total voting power of members in the SDR Department.
To date, SDR 660.7 billion has been allocated, which is equal to approximately $943 billion.
On Aug. 2, 2021, the IMF allocated $650 billion of SDRs; the largest in its history. The reason was to boost global liquidity during the Coronavirus pandemic.
After SDRs have been allocated to each country, they have a few options on how they can manage them. They can hold the allocated SDRs as part of their foreign exchange reserves, sell their reserves, or use their reserves. For example, a member country can exchange an SDR for a freely usable currency.
Members can also use SDRs for other reasons, such as the repayment of loans, payments of obligations, pledges, the payment of interest on loans, or paying for increases in quota amounts.
Requirements of Special Drawing Rights (SDRs)
The current requirements to be included in the SDR were established in 2000.
The Board states that the SDR basket is to comprise of the currencies of members or monetary unions "whose exports had the largest value over a five-year period, and have been determined by the IMF to be freely usable."
"Freely usable," according to the IMF, is a currency that "(i) is, in fact, widely used to make payments for international transactions, and (ii) is widely traded in the principal exchange markets."
Determining what is "freely usable" is gauged on metrics such as the number of shares of the currency in reserve holdings, the currency denomination of international debt securities, the volume of transactions in foreign exchange markets, cross-border payments, and trade finance.
Settling Claims With Special Drawing Rights (SDRs)
The SDR isn’t regarded as a currency or a claim against the IMF assets. Instead, it is a prospective claim against the freely usable currencies that belong to the IMF member states. The Articles of Agreement of the IMF define a freely usable currency as one that is widely used in international transactions and is frequently traded in foreign exchange markets.
The IMF member states that hold SDRs can exchange them for freely usable currencies by either agreeing among themselves to voluntary swaps or by the IMF instructing countries with stronger economies or larger foreign currency reserves to buy SDRs from the less-endowed members. IMF member countries can borrow SDRs from reserves at favorable interest rates, mostly to adjust their balance of payments to favorable positions.
Interest Rates on Special Drawing Rights (SDRs)
The interest rate on SDRs, or the SDRi, provides the basis for calculating the interest rate that is charged to member countries when they borrow from the IMF and paid to members for their remunerated creditor positions in the IMF. It is also the interest paid to member countries on their own SDR holdings and charged on their SDR allocation.
The SDRi is determined weekly based on a weighted average of representative interest rates on short-term government debt instruments in the money markets of the SDR basket currencies, with a floor of five basis points. It is posted on the IMF website.
How Many Currencies Make Up an SDR?
The value of an SDR is made up of five currencies, which are the U.S. dollar, euro, Chinese yuan, Japanese yen, and pound sterling.
How Much Is a Special Drawing Right Worth?
The value or worth of an SDR is calculated daily and is based on the weights of the currencies that make up the SDR basket: U.S. dollar (41.73%), euro (30.93%), Chinese yuan (10.92%), Japanese yen (8.33%), and pound sterling (8.09%). The value of the SDR is arrived at by summing up in U.S. dollars the value of these currencies.
Can SDRs Replace the Dollar?
SDRs are considered to be an international reserve currency, and as such, could technically replace the dollar in terms of global transactions; however, given the strength and wide use of the dollar internationally, this is not likely to happen any time soon.
Why Is an SDR Called Paper Gold?
An SDR is called paper gold because at the time of its creation it was viewed as an asset that could act as a reserve asset that would supplement gold reserves and other currencies, thus the name, paper gold.
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