Special Drawing Rights (SDRS): Meaning, Origin and Uses

In this article we will discuss about:- 1. Meaning of Special Drawing Rights (SDRS) 2. Origin of SDRs 3. Uses 4. Allocation 5. Merits 6. Criticisms.

Meaning of Special Drawing Rights (SDRS):

Special Drawing Rights (SDRs), also known as the paper gold, are a form of international reserves created by the IMF in 1969 to solve the problem of international liquidity. They are not paper notes or currency. They are international units of account in which the official accounts of the IMF are kept.

They are allocated to the IMF members in proportion to their Fund quotas and are used to settle balance of payments deficits between them.

Origin of SDRs:

SDRs were created through the First Amendment to the Fund Articles of Agreement in 1969 following persistent US deficits in balance of payments to solve the problem of international liquidity. Until December 1971, an SDR was linked to 0.88867 gram of gold and was equivalent to US $1. With the breakdown of the fixed parity system after 1973 when the US dollar and other major currencies were allowed to float, it was decided to stabilise the exchange value of the SDR.

Accordingly, the value of the SDR was calculated each day on the basis of a basket of 16 most widely used currencies of the member countries of the Fund. Each country was given a weight in the basket in accordance with its importance in international trade and financial markets.

After the Second Amendment to the Fund Articles of Agreement in 1978, the SDR became an international unit of account. To facilitate its valuation, the numbers of currencies in the “basket” were reduced to five in January 1981.

They include the US dollars, the German Deutsche Mark, the British Pound, the French Franc and the Japanese Yen. The present currency composition and weighting pattern of the SDR is revised every five years beginning January 1, 1986.

The revision of weights is based on both the values of the exports of goods and services and the balances of their currencies held by other members. In 1977, they were US dollar (39%), German DM (21%), UK pound and French franc (11% each) and Japanese yen (18%). The value of one SDR was equal to US $ 1.35610 on October 1,1997.

Uses of SDRs:

SDR is an international unit of account which is held in the Fund’s Special Drawing Account. The quotas of all currencies in the Fund General Account are also valued in terms of the SDR. As the international monetary asset, the SDR is held in the international reserves of central banks and governments to finance their deficits or surpluses of balance of payments. All transactions by the Fund in the form of loans and their repayments, its liquid reserves, its capital, etc., are expressed in the SDR.

SDRs are used as a means of payment by Fund members to meet balance of payments deficits and their total reserve position with the Fund. They cannot be used for any other purpose. Thus SDKs act both as an international unit of account and a means of payment.

There are three principal uses of SDRs:

1. Transactions with Designation:

Under it, Fund designates a participant in the SDR scheme who has a strong balance of payments and reserve position to provide currency in exchange for SDRs to another participant needing its currency. The currency to be exchanged for SDRs may belong to the designated participated or/ and to other participants. Participants are allowed to accept SDRs in this way as long as their holdings are less than three times their total allocations.

2. Transactions with General Account:

SDRs are used in all transactions with the General Account of the Fund. Participants pay charges in SDRs to the General Account for the use of the Fund resources and also to repurchase their own currency from it.

3. Transactions by Agreement:

The Fund allows sales of SDRs for currency by agreement with another participant. In order to further widen the uses of SDRs, the Second Amendment empowered the Fund to lay down uses of SDRs not otherwise specified.

Accordingly, the following additional uses of SDRs are:

(i) In swap arrangements,

(ii) In forward operations,

(iii) In loans,

(iv) In the settlement of financial objections,

(v) As security for the performance of financial obligations, and

(vi) In donations or grants.

The Fund also empowers certain institutions as “other holder” of SDRs. Besides the World Bank and its associates, some of the other holders of SDRs are the Bank for International Settlements, the African Development Bank.

These ‘other holders’ acquire and use SDRs in transactions and operations by agreement under the same terms and conditions as applicable to the participants. Efforts are being made by the Fund to have a greater use of the SDR as a unit of account in private transactions and in financial markets of the world. The Fund pays interest on all holdings of SDRs kept in the Special Drawing Account and charges interest at the same rate on allocations to participants.

Allocation of SDRs:

The Fund allocates SDRs to participants in proportion to their quotas for various uses mentioned above. Initially, the Fund created SDR $ 9.3 billion over the three years 1970-72. The total holdings of SDR $ 9.3 billion continued till 1978.

In 1978, the Fund decided to raise them by SDR $ 4 billion in each of the years 1979,1980 and 1981. As a result, the total holdings of SDRs were SDR $ 13.1 billion in 1979, SDR 17.3 $ billion in 1980 and SDR $ 21.4 billion in 1981. Since 1981 no further allocation of SDRs has been made by the Fund.

The quantity of SDRs is determined by members of the Fund. It can only be increased if 85% votes of its members favour their increase. The basis of allocation of SDRs among the members of IMF is their quota subscriptions. At present, about 70% of SDRs are distributed to 26 rich countries and the remaining 30% to developing countries.

Merits of SDRs:

Despite these weaknesses, the SDRs scheme possesses the following merits:

1. SDRs are a new form of international monetary reserves which have been created to free the international monetary system from its exclusive dependence on the US dollar.

2. They have rid the world of its dependence on the supply of gold and fluctuations in gold prices.

3. They cannot be demonetized like gold or become scarce when the demand for dollar increases in the world.

4. Unlike gold, SDRs are costless to produce because production of gold requires resources to mine, refine, transport and guard it.

5. SDRs have been created to improve international liquidity so as to correct fundamental disequilibria in balance of payments of Fund members. Under this scheme, the participants receive SDRs under transactions with designation and transaction by agreement unconditionally.

6. Fund members are not required to change their domestic economic policies as they are expected under the Fund aid programmes.

7. The payment and repayment of SDRs out of the Special Drawing Account is easier and more flexible than under the Fund schemes.

8. Last but not the least, SDRs act both as a unit of account and a means of payment of international monetary system.

Criticisms of SDRs:

Despite these merits, the SDR scheme has been criticised on the following grounds:

1. Inequitable Distribution:

It is an inequitable scheme which has tended to make unfair distribution of international liquidity. The allocation of SDRs to participating countries is proportional to their quotas. In this sense, the allocation of SDRs to developing countries is too low as compared to their needs. Low allocation of SDRs reduces the borrowing capacity of such countries.

2. Not Linked with Development Finance:

SDR scheme does not link the creation of international reserves in the form of SDRs with the need for development finance on the part of developing countries. The need for liquidity on the part of developing countries is great “because of their higher costs of adjustment, limited access to private banking and higher capital markets, greater variability of exchange earnings, and opportunity cost of holding foreign exchange reserves”. Under these circumstances, there is need to create more SDRs with fair distribution so that more unconditional liquidity is made available for the greater needs of developing countries.

3. High Interest Rate:

The interest rate originally payable on net use of SDRs is 1.5 per cent. This has been gradually raised through time in order to make a more acceptable asset to hold. Now both users of SDRs pay and holders of SDRs receive, a market rate of interest based on interest rates prevailing in US, Britain, France, Germany and Japan which are quite high for developing countries.

4. Failure to Distribute Social Saving:

Williamson and others have criticised the SDR scheme for its failure to distribute social saving of SDRs to the developing countries. The present rules for allocation distribute the social saving to a participant country in proportion to his contribution or its demand for SDRs.

If the supply of SDRs equals the demand for it, there will no redistribution of resources between countries. But this is not so in the case of developing countries whose holdings of SDRs are very low as compared to the 26 developed countries. Thus the present scheme of SDRs fails to transfer social savings to the developing countries.

5. Failure to meet International Liquidity Requirements:

Unfortunately, due to the rigid attitude of the United States and some other developed countries, the Fund has not been able to resume allocation of SDRs from January 1982, despite the repeated pleas of the developing countries over these years.

So the Fund has failed in its objective of increasing international liquidity through SDRs. Consequently, faced with a recession, an inadequate flow of concessional aid and falling prices of commodities and raw materials, developing countries have been facing severe balance of payments and debt problems. Thus SDRs have failed to solve the problem of international liquidity.