What Are Special Drawing Rights (SDRs)?

What Are Special Drawing Rights (SDRs)?

Let me explain what Special Drawing Rights, or SDRs, really are. They're an international reserve currency created by the International Monetary Fund back in 1969. Think of them as a supplement to the money reserves that member countries already hold. SDRs came about because there were worries about relying only on gold and dollars for settling international accounts, so they help boost global liquidity by adding to the standard reserve currencies.

Key Takeaways on SDRs

Here's what you need to know directly: SDRs are an artificial currency tool from the IMF used for their internal accounting. Their value comes from a weighted basket of major currencies like the US dollar and British pound. The SDR interest rate sets the basis for charges on IMF loans to members. Allocations depend on each country's quota, and you can use SDRs for things like currency exchanges, repaying loans, paying interest, pledges, or covering quota increases.

Understanding Special Drawing Rights (SDRs)

At its core, an SDR is an artificial instrument built from a basket of key national currencies, and the IMF uses it for accounting inside the organization. They allocate SDRs to member countries, and the basket gets reviewed every five years. Right now, starting from August 2022, the makeup includes the US dollar at 43.38% with 0.57813 units, euro at 29.31% with 0.37379 units, Chinese renminbi at 12.28% with 1.0993 units, Japanese yen at 7.59% with 13.452 units, and pound sterling at 7.44% with 0.080870 units.

The idea behind SDRs was to make them a big part of international reserves, with gold and other currencies playing smaller roles. These reserves are what central banks or governments hold in gold and accepted foreign currencies to buy local currency and keep exchange rates stable. But the supply of dollars and gold wasn't enough for growing global trade, so countries created this IMF-guided reserve asset.

SDRs also serve as the IMF's unit of account, though their role has shrunk over time. Their value is in US dollars, calculated from that basket: yen, dollar, renminbi, sterling, and euro. Remember, the Bretton Woods system collapsed in 1973, shifting to floating rates, and capital markets grew, letting governments borrow more and build reserves, which reduced SDRs' importance as a global reserve.

The Allocation of Special Drawing Rights (SDRs)

Allocations go out based on each member's IMF quota shares—the stronger the economy, the more shares, like the US with 82,994 versus Afghanistan's 323. More shares mean you pay more into the IMF and get more voting power. Emerging markets and developing economies hold about 42.3% of SDR shares, with 3.3% for low-income countries.

The IMF can allocate SDRs if it meets the goal of supplementing long-term global reserve needs, and it needs 85% approval from voting members. As of 2022, they've allocated SDR 660.7 billion, worth about $943 billion. The biggest allocation was $650 billion in August 2021 to help liquidity during COVID-19.

Once allocated, countries can hold them as reserves, sell them, or use them—say, exchanging for a usable currency. Other uses include repaying loans, settling obligations, pledges, interest payments, or quota increases.

Requirements of Special Drawing Rights (SDRs)

The rules for inclusion in the SDR basket were set in 2000: currencies from members or unions with the largest exports over five years, and they must be 'freely usable' as determined by the IMF. That means widely used for international payments and traded in major exchange markets.

They measure this with things like reserve holdings shares, international debt denominations, forex transaction volumes, cross-border payments, and trade finance.

Settling Claims With Special Drawing Rights (SDRs)

SDRs aren't a currency or a claim on IMF assets; they're a potential claim on usable currencies from member states. A freely usable currency is one widely used internationally and traded in forex markets. Members can swap SDRs voluntarily or the IMF can direct stronger economies to buy them from weaker ones. Countries borrow SDRs at good rates to fix balance of payments issues.

Interest Rates on Special Drawing Rights (SDRs)

The SDR interest rate, or SDRi, bases the charges for IMF loans and pays members for creditor positions. It's also the rate on holdings and allocations. They calculate it weekly from weighted averages of short-term debt rates in the basket currencies' markets, with a five basis point floor, and post it on the IMF site.

Common Questions About SDRs

You might wonder how many currencies make up an SDR—it's five: US dollar, euro, renminbi, yen, and sterling. The value is calculated daily based on their weights, summed in US dollars. Could SDRs replace the dollar? Technically yes as a reserve, but the dollar's dominance makes it unlikely soon. They're called 'paper gold' because they were meant to supplement gold and currencies as reserves.

The Bottom Line

In summary, SDRs give IMF members a way to boost reserves with this interest-bearing instrument based on major currencies. They're not currencies themselves but provide liquidity, especially in tough times.