Special Drawing Rights (SDR)

The Special Drawing Right (SDR) is a unit of financial reserve developed and put forth by the International Monetary Fund (IMF). Although not an official form of legal tender, SDRs facilitate sizable foreign currency transactions between banks, governments and IMF member nations.

SDRs play a key role as an accounting unit for the IMF. The issuance of IMF loans and credit, as well as subsequent repayment, are denominated in SDRs. Whether a member country is seeking financial aid following a natural disaster or wishes to expand existing infrastructure, IMF funding is extended via SDRs.

Historical Background

World War II and the post-war era brought widespread financial strife to the global economy. Currency instabilities and runaway government debts plagued the international monetary system as fallout from WWII spread.

In an attempt to formally address these challenges, delegates from 44 countries met in July 1944 at Bretton Woods, New Hampshire. Among the achievements of Bretton Woods was the creation of the World Bank, IMF and the United States dollar (USD) being designated the world's reserve currency.

Following the conclusion of WWII in September 1945, a robust economic expansion ensued. Countries from around the globe flourished in relative calm as the strain of WWII subsided. For the post war period of 1950 to 1973, the gross domestic product (GDP) growth of developed economies averaged 5% annually.^[1] Leaders in this regard were Japan, the United States and the United Kingdom.

While the spike in output and foreign trade fostered an atmosphere of geopolitical stability, the international monetary system put into action at Bretton Woods became strained. Supplies of the world's two primary reserve assets, the USD and gold, grew insufficient to support the exploding global economy.

To address this challenge, the IMF created a new reserve asset known as the SDR. Instituted in 1969, the SDR was to ensure exchange-rate stability and supplement IMF member nations' official financial reserve assets. It was initially pegged to gold at the rate of 1 SDR to 0.888671 grams of fine gold.^[2]

Upon the collapse of Bretton Woods in 1973, currency pegs to the USD, and indirectly gold, were abandoned by countries around the world. In the place of the fixed-rate system of currency valuation that had been in place since 1944, came a free-floating exchange rate structure. This evolution in the global monetary system reduced the dependence upon SDRs. Thus, a fundamental change to the SDR came to pass as a basket of currencies replaced a quantity of gold as means of valuation.^[2]

Valuation

Since dropping the gold peg in the early 1970s, the value of SDRs has been tied to a weighted-average basket of currencies. In a similar fashion as some of the leading equities indices, an SDR's value is relative to the performance of its components.

In order for a nation's currency to be included in the SDR basket, it must meet the following criteria:^[2]

• IMF Membership: The currency in question must be that of an IMF member or monetary union.
• Exports: The nation of the domestic currency must rank among the top five globally in exports.
• Freely Usable: A currency must be deemed "freely usable" by the IMF. This means it is liquid and widely accepted as the basis for international transactions.

As of 2018, the basket is comprised of the United States dollar, Chinese yuan renminbi, euro, Japanese yen and British pound sterling. The Chinese yuan renminbi is the most recent addition, added in October 2016.

The SDR basket is reviewed every five years for relevance and efficiency. It is updated according to the present standing of each IMF world reserve currency as well as its domestic economy. As of 2015, the SDR basket is made up of the following currencies and weights:^[2]

The currency value of the SDR is calculated and posted by the IMF on a daily basis. Rates fluctuate according to open market conditions. Official spot exchange rates used in the valuation are provided by the Bank of England, Federal Reserve Bank of New York and the European Central Bank.

IMF Loans And The SDR

SDRs serve as the premier mode of transfer for IMF loans to member nations in need of financial assistance. SDRs are allocated via endowment or credit at the discretion of IMF authority while adhering the governing Articles of Agreement. The cost of borrowing, or yield to depositing, from the IMF is determined via the SDR Interest Rate (SDRi).

The SDRi is derived and posted on a weekly basis. Values are calculated according to a weighted average of current interest rates pertaining to short-term government debt offerings. The SDRi represents the going rate of IMF funding, with an absolute bottom of 5 basis points. Prevailing rates are variable, depending upon the international market for various forms of government-issued debt.

In the wake of the 2008 global financial crisis, the IMF expanded lending operations dramatically. To promote financial stability and reinforce struggling capital markets, the IMF committed more than £532 billion in loans to member nations in the form of SDRs. In order to be prepared for future trials of the 2008 ilk, the IMF increased lending capacity to 690 billion SDR.

Summary

SDRs are an integral part of the world's financial system. They have acted as a conduit for monetary transfer during times of both trial and prosperity to nations around the world. Utilised at the IMF's discretion, SDRs serve either as accounting units or a means of transaction for governments and central banking authorities around the globe.