What are Special Drawing Rights - SDR
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.
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 on the SDR is represented by the following table:
|Currency||Weights determined in the 2015 Review||Fixed Number of Units of Currency for a 5-year period Starting Oct 1, 2016|
BREAKING DOWN Special Drawing Rights - SDR
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. To participate in this system, a country was required to have official 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.
A few years after the SDR was created, the Bretton Woods system imploded, moving major currencies to the floating exchange rate system. With 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.
How the Concept of SDR Is Used to Settle Claims
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 for 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 its reserves at favorable interest rates, mostly to adjust their balance of payments to favorable positions.
Besides acting as an auxiliary reserve asset, the SDR is the unit of account of 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 pound sterling and the euro.
The SDR Interest Rate
The interest rate on SDRs, or the 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. 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 5 basis points. It is posted on the IMF website.