15 May 2009
Ousmène Mandeng, Ashmore Investment Management
The IMF’s Special Drawing Right (SDR) is seeing an unexpected revival. Only in 2006, the Managing Director of the IMF concluded that there was not the necessary support from IMF member countries to seek issuance of SDRs, reflective of what had been a steady decline in the relevance of the SDR since the 1980s. In April 2009, the G20 surprisingly committed to an SDR allocation of US$250 billion. This is huge compared with the current outstanding amount of SDRs of US$32 billion yet small in terms of total international foreign currency reserves ofUS$7000 billion. Calls for reducing reliance of the international economy on the dollar coincide with a new role for the SDR. But what role can the SDR play today?
The SDR is a reserve asset created by the IMF in 1969. It is a mechanism by which IMF member countries can obtain freely usable currencies from other IMF member countries as an unconditional credit line. The SDR was originally valued equal to one dollar. In 1974, the SDR was redefined as a basket of 16 currencies constituted of countries that represented at least 1 percent of world exports including emerging markets currencies South African rand, Saudi Arabian riyals and Iranian rials. The basket was reduced over time to the dollar, euro, pound and yen of today. Countries receiving SDRs also incur a liability in SDRs in the same amount. The SDR pays and incurs a market interest rate being the weighted average of 3-month treasury bills or equivalent of the countries of the constituent currencies. Countries holding SDRs in proportion to their allocation pay zero interest.
Debates on the SDR have tried to address different concerns with varying emphasis from reserve needs, to reserve diversification, to cost of holding reserves, to SDR distribution. However, ultimately SDR allocation criteria have been based on “long-term global need”, that is a structural need for global reserve supplementation, a notion remaining somewhat controversial even within the IMF. Two SDR allocations were made in1970-72 and 1979-81. Since 1981, no further SDR allocation has been made.
The SDR was conceived in the 1960s amid a perceived shortage of reserve assets and concerns about the dollar largely in response to the so-called Triffin dilemma to complement dollars and gold in official reserve holdings. In 1978, the IMF established that the SDR should become the principal reserve asset. This was motivated increasingly by the continued depreciation of the dollar that gave rise to calls by central banks for greater diversification away from the dollar in the second half of the 1970s and has been associated with the IMF’s unsuccessful efforts to create the so-called substitution account to swap dollars for SDRs.
Efficiency and distributional criteria dominated the debate on SDRs during the 1990s. The cost of holding foreign exchange reserves in particular for emerging markets has been considered excessive and SDRs were seen as cost-effective alternatives to acquiring reserves. The fact that many IMF member countries had never received any SDR allocation, those joining after 1981 (e.g. Russia), had also repeatedly raised the need for an SDR allocation on equitable grounds.
In 1996, the IMF convened a seminar on the future of the SDR amid mounting difference of opinions on the role of the SDR in the international monetary system. Seminar participants concluded that the SDR is unlikely to become the principal reserve currency of the system, it should be preserved though as a safety net and a solution should be found to the equity problem. In 1997, the IMF decided on a special SDR allocation that has remained pending since and SDRs as a reserve asset declined greatly in importance.
SDRs have been allocated in proportion to countries’ quotas at the IMF (countries’ capital shares in the IMF). Current holdings vary as a function of net uses when countries reduce (exchange SDRs for currencies) or increase their SDR holdings (exchange currencies for SDRs) relative to their allocations. Emerging markets and developing countries hold on average about 22 percent of SDRs. The U.S. remains the largest SDR holder with 29 percent.
The pattern of SDR net uses has remained broadly stable but varied greatly between countries. Emerging markets on average have continuously been net users of SDRs also during key crisis years in 1995 and 1998 and in 2003, at the height of IMF outstanding credit, indicating some albeit limited utility of SDRs for acquiring foreign currencies.
Efforts to boost the SDR have in the past often been motivated by a sickly dollar. This time, this also seems the main motivation. Resource augmentation, while relevant for some countries, is likely to have only a marginal impact on average in light of the proposed allocation amount. Any allocation will also be constrained by the existing distribution of quotas at the IMF that will see any general allocation to go predominantly to the industrialised countries.
Meaningful diversification is the role the SDR can play today to be relevant, addressing a concern fundamental to the motivation of creating SDRs in the first place, namely to reduce the dependence of the international economy on a narrow set of national currencies. Diversification of the SDR basket would be within the spirit of its historical composition and may bring about greater balance in the use of currencies. Since the SDR is above all an official market between the IMF and its member countries and some other international institutions like the BIS, diversification could also include currencies that are presently not readily accessible especially some emerging markets currencies. This would make the SDR particularly attractive for the private market who still finds it difficult to obtain exposure to certain currencies. China’s and Russia’s recent SDR proposals point into that direction.
The SDR constituent currencies today represent about60 percent of world output but yet constitute nearly 100 percent of central bank international reserves. The diversification potential is therefore substantial. Currency diversification is expected to occur through different channels and a broadened SDR could complement such efforts. The SDR remains marred by prevailing institutional arrangements on allocation and distribution. In its short history many attempts to promote the role of the SDR have failed. It may therefore require substantial efforts by the IMF membership to make it work this time. Less patient central banks may therefore prefer to seek alternative routes.