2. 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.
3. 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.
4. 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.
5. 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.
6. This basket is re-evaluated every five years, and the
currencies included as well as the weights given to
them can then change. A currency's 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.
7. Allocations:
Special drawing rights are allocated to member countries
by the IMF.
A country's 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 country's IMF
quota. For example, the US has 16.7% of the vote as of
March 2, 2011.
8. 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.
9. 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.
10. 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.
11. 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 participant's 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 member's SDR holdings are below its
allocation, it incurs a net interest obligation. Interest on SDR
holdings and allocations are received and paid quarterly.
12. 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.
13. 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.
14. 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.
15. 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.
16. 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 People's Bank of
China, Zhou Xiaochuan, drew media attention, and the
IMF showed some support for China's 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.
17. 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".
18. 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".