The global financial landscape is complex, with various instruments and mechanisms designed to facilitate international trade and financial stability. Among these, the Special Drawing Right (SDR) stands out as a unique international reserve asset created by the International Monetary Fund (IMF). While not a currency itself, the SDR plays a crucial role in the international monetary system.
What Exactly is the SDR?
The SDR is defined as an international reserve asset, not a currency. Its value is derived from a basket of five major currencies: the US dollar, the euro, the Chinese renminbi, the Japanese yen, and the British pound sterling. This basket approach provides diversification and stability to the SDR’s value. Think of it as a weighted average of these key global currencies.
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The Purpose Behind the SDR
The IMF established the SDR in 1969 as a supplementary international reserve asset. This occurred during a time when exchange rates were pegged to gold and the US dollar was the dominant reserve currency. Initially, the SDR was defined as equivalent to a specific amount of gold, mirroring the value of one US dollar at that time.
When the fixed exchange rate system collapsed in 1973, the SDR’s definition evolved. It was redefined to represent the value of a basket of leading world currencies. While not a currency for direct transactions by individuals, the SDR functions as an asset that countries can exchange for actual currencies when needed. Furthermore, the SDR serves as the unit of account for the IMF itself and various other international organizations.
Who Are the Holders of SDRs?
SDRs are not accessible to individuals or private entities. Instead, SDRs are held by IMF member countries and the IMF itself. The IMF retains the authority to approve other entities, such as central banks and multilateral development banks, as official SDR holders. As of February 2023, a select group of 20 organizations had been designated as prescribed holders. These participating members and prescribed holders are authorized to trade SDRs amongst themselves. However, it’s important to note that prescribed holders do not receive SDR allocations, and they cannot request SDR exchanges through the “designation” process available to member countries.
Understanding SDR Value and its Fluctuations
The value of the SDR in relation to the US dollar is calculated daily. This calculation is based on the spot exchange rates observed around noon in London. This daily valuation is readily available on the IMF website, providing transparency and up-to-date information.
The composition of the SDR basket is reviewed by the IMF every five years, or sooner if deemed necessary. This review process ensures that the basket accurately reflects the relative importance of currencies in the global trading and financial systems. A significant update occurred in 2015 when the IMF’s Executive Board determined that the Chinese renminbi (RMB) met the criteria for inclusion in the SDR basket. In October 2016, the RMB was officially added, and the three-month yield for China Treasury bonds was incorporated into the methodology for setting interest rates on SDRs.
During these reviews, the IMF evaluates the criteria for selecting currencies for the SDR basket and the initial weights assigned to each currency. While the currency amounts within the SDR basket remain fixed for each five-year valuation period, the relative weights of these currencies fluctuate due to changes in exchange rates. Consequently, the overall value of the SDR is dynamic and adjusts daily based on market exchange rates, reflecting the interplay of currencies like the dollar to euro exchange rate and others within the basket.
To be included in the SDR basket, a currency must meet two key criteria, demonstrating its international prominence and usability.
The Quinquennial SDR Valuation Review Process
In response to the global COVID-19 pandemic and to prioritize its work, the IMF Executive Board extended the existing SDR valuation basket to July 31, 2022. This effectively reset the five-year cycle for SDR valuation reviews. The subsequent review, concluded in May 2022, reaffirmed the existing composition of currencies within the SDR basket while updating their respective weights. (Historical weights are available here). The revised basket came into effect on August 1, 2022.
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General Allocations of SDRs and Global Liquidity
The IMF’s Articles of Agreement empower the institution to allocate SDRs to its member countries (but not to prescribed holders) under specific circumstances. There have been four general allocations of SDRs to date. Most recently, in 2022, the IMF’s Board of Governors approved a substantial general allocation of approximately SDR 456 billion, equivalent to US$650 billion. This significant allocation aimed to bolster global liquidity and assist countries in their response to the COVID-19 pandemic. This distribution marked the largest SDR allocation in the IMF’s history. Prior to this, a general allocation of around SDR 161 billion (US$250 billion equivalent) in 2009 played a crucial role in enhancing liquidity during the global financial crisis.
General SDR allocations require broad consensus among IMF members. When a general allocation is approved, SDRs are distributed to member countries proportionally to their quota shares within the IMF.
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Special SDR Allocation for Equitable Distribution
In addition to general allocations, the IMF implemented a special one-time SDR allocation of SDR 21.5 billion (approximately US$33 billion) in 2009. The purpose of this special allocation was to address historical inequities in SDR distribution, particularly for countries that joined the IMF after 1981. At that time, these newer member countries, representing over one-fifth of the IMF’s membership, had never received an SDR allocation.
Interest Rates and SDR Holdings
Does the IMF charge interest related to SDRs? Yes, the SDR interest rate, or SDRi, is a fundamental component. It serves as the basis for calculating interest charged and paid to members, including interest on regular borrowing from the IMF and on SDR Holdings.
The SDR interest rate is determined weekly and is based on a weighted average of interest rates on three-month debt instruments in the money markets of the currencies included in the SDR basket. This ensures that the SDR interest rate reflects prevailing market conditions in the major economies represented in the basket, including those tied to the dollar to euro exchange dynamics.
SDR ALLOCATIONS AND HOLDINGS
In conclusion, the SDR is a vital instrument in the international monetary system, acting as a supplementary reserve asset and a unit of account. Its value, derived from a basket of प्रमुख currencies including the US dollar and the euro, reflects the global economic landscape and plays a critical role in supporting international liquidity and financial stability.
This page was last updated in January 2023
