Special Drawing Rights

Special Drawing Right, established and created by the IMF in 1969, is a supplement reserve of foreign exchange assets comprising leading currencies across the globe for settling international transactions. The primary motive is to provide additional liquidity.

It is also useful in removing several restrictions the international community faces in growing world trade. The value of SDR is calculated based on a basket of 5 international currencies – U.S. Dollar, Chinese Renminbi, Euro, British Pound Sterling, and Japanese Yen. The currency code for SDR is XDR, and the numeric code is 960.

Table of contents

• What Is Special Drawing Rights?
  • Features
  • How To Calculate?
  • Example
  • Benefits
  • Limitations
  • Recommended Articles

• Special Drawing Right (SDR) is an international reserve asset created by the International Monetary Fund (IMF) to supplement its member countries' official reserves and facilitate international trade and transactions.
• The main objective of the Special Drawing Rights is to provide additional liquidity and discard several restrictions the international community faces in flourishing world trade.
• The benefits of the Special Drawing Rights are reduced dependence on the U.S., issues of balance of payment, and a stable system.
• The limitations of Special Drawing Rights are no gold backing, becoming a money supply, an administrative decision, and its abstract nature.

SDRs work voluntarily. One prescribed SDR holder and various fund members agree to buy and sell SDRs freely. This fund facilitates the transactions between the member countries that seek to sell or purchase SDRs and makes a voluntary agreement in the market of SDRs. If there are no voluntary buyers of SDRs, the IMF can designate members with a robust balance of payment position that helps them freely use currency and exchange for SDRs. In the case of special drawing rights of IMF, this is called the designation mechanism, where one can use SDRs to obtain a fair amount of money. Generally, SDR allocation is based on the existing IMF quota of each country.

Countries like China and Russia had urged the IMF to move away from the U.S. dollar-based system, thus providing the path for the SDRs to become the de facto reserve currency of the world. These countries have been aware of the fragile economic conditions of the U.S. Also, countries like China were forced to buy more U.S. treasury debts to keep their economy afloat. Hence, the particular drawing rights system was implemented where countries like China and others could exchange the excess dollars with a basket of currencies. They would still end up with around 44% dollars. That becomes a better scenario than being entirely dependent on the U.S. economy. From the above explanation, we understand the special drawing rights value.

The following are the salient features of special drawing rights of IMF.

• The SDRs are allocated based on the quota system held by the individual member country of the IMF.
• SDRs are created under a special drawing account. The resources of the special drawing account are made under an agreement among the member countries as a percentage of quotas with the IMF.
• Member countries use SDRs to meet liquidity requirements through bank credit creation. It helps the countries supplement the banking system's resources to meet the liquidity needs of the country.
• The balance of payment deficit of a participant country is removed using SDR.
• The special drawing rights value is such that it serves as a store value rather than a medium of exchange.
• Central banks of a member country of the IMF hold SDRs as their reserves, key currencies, and gold.
• SDRs are created as reserves and used to settle international payments.
• It helps build confidence among members as it has been statutorily laid down.
• Member countries are obliged to accept drawing rights from members providing funds in exchange for an equal amount of convertible currency.

The specific amount of each basket currency valued in U.S. dollars is added up. Then, the currency amount is calculated per the exchange rates quoted in the London market at everyday noontime. Hence, the value of SDR is determined daily and is based on the weight of each currency that is included in the SDR basket, such as USD – 41.73%, EURO – 30.93%, CHINESE RENMINBI – 10.92%, JAPANESE YEN – 8.33%, POUND STERLING – 8.09%. These weights determine the amount of each of the currencies included in the new SDR valuation basket since October 16.

In Moldova, the higher authorities of the nation used their SDR allocation after the budget crisis in late 2009, which helped them clear the accumulated arrears of expenditures, deteriorating fiscal position, and reduce reliance on short-term domestic financing, which was turning out to be expensive for the country.

Let us look at the special drawing rights benefits and uses.

• It serves as an IMF unit and various other international organizations.
• SDR allocation plays an important role in providing liquidity and supplementing member countries with official reserves during crises.
• It was created to serve as a supplementary international reserve in the context of the Bretton Woods fixed exchange rate system.
• They can exchange it for freely usable currencies of IMF members.

Some of the special drawing rights benefits are as follows:

• Reduced Dependence on the U.S. – Entire world will no longer be dependent on the currency of the U.S. to trade with each other.
• Issues of Balance of Payment – Most of the balance of payment will be resolved as the U.S. will lose its privilege and the world goes off the Dollar standards. The budget deficit problems of countries with the U.S. get resolved.
• Stable System – Since commodities like gold, oil, and food grains will not be exclusively traded in dollars. The U.S. government will not exert undue pressure on their prices by increasing and decreasing the supply of dollars. The Weighted Average of basket currencies makes the system more stable.

Thus, the above are the main advantages of special drawing rights.

Apart from the advantages of special drawing rights, the limitations are as follows.

• No Gold Backing – Tangible commodity like gold makes the currency more stable, but replacing dollars with SDR would replace one unstable system with another slightly less hazardous system.
• Money Supply Becomes an Administrative Decision – Since SDR does not have an open market, the money supply becomes an administrative decision that the IMF will take, whether expanded or contracted.
• Abstract Nature – SDRs are an abstract weighted average of multiple currencies. These are not currencies on their own. Hence, it becomes difficult to implement and manage at a microeconomic level.

This article is a guide to what is Special Drawing Rights. We explain its benefits, along with uses, example, limitations, features & how to calculate. You may learn more about financing from the following articles: –

• Currency Crisis
• Functional Currency
• Currency Market
• Currency Peg