How is Special Drawing Right Calculated and Allocated
The rules regarding allocation and use of SDR
During the late sixties the growth in world resources did not keep pace with the growth in international trade. During 1963-68 the monetary reserves in the form of gold and US dollars increased by about 16% while for the same period the growth in the international trade was of the order of 70%. The slackness in the growth of resources was mainly due to the dependence on the accretion of gold to monetary reserves.
It was foreboding that the slow growth of monetary reserves would result in hampering the growth of international trade and in serious balance of payments difficulties to many countries. The need to increase the international liquidity, i.e., resources for settlement for international debts, was felt and after much thought on the subject, it resulted in the introduction of Special Drawing Rights (SDRs) in 1970.
SDRs are entitlements granted to member-countries enabling them to draw from the IMF apart from their quota. It is similar to a bank granting a credit limit to the customer. When SDRs are allocated the country’s Special Drawing Account with the IMF is credited with the amount of allotment. When the country experiences a balance of payments deficit and requires other currencies, it has to apply to the IMF. On receipt of such application, the IMF would designate another country with strong balance of payments and reserve position to accept SDRs from the deficit country and pay in exchange some currency.
As can be observed from the above, SDR is not a currency and has no backing of any security. Nor is the IMF liable on the SDRs allocated, It is merely an asset created out of book entries. It is an independent reserve asset, supplementing other reserve assets the volume of which could be increased or decreased according to the reserve needs of the international community. The ceal strength of the SDR lies in the undertaking by the member-countries to abide by the Articles of Agreement of the IMF and exchange SDRs for currencies.
Allocation of Special Drawing Right
Allocation of SDRs Is made to member-countries in proportion to their quotas. The decision to allocate SDRs is taken periodically by the Board of Governors taking into account the requirements of international liquidity. A majority of 85% of the voting power is required for decisions involving allocation or cancellation of SDRs. Starting from 1970, when SDRs were first allocated, the quantum of SDRs allocated has increased over the period and as at the end of April 1990, the total amount of SDRs allocated stood at SDRs 21.4 billion.
Valuation and Interest on Special Drawing Right
Initially the value of one SDR was equal to a specific quantity of gold (which equaled the value of 1 US dollar) and was provided with an absolute gold value guarantee. That is why, SDRs were popularly known as `Paper Gold’. Later, the value of SDR was linked to a basket of 6 principal currencies. Effective from January 1, 1981, the number of currencies in the basket has been reduced to five.
Currently the currencies and their weightage are: US Dollar (40%), Deutsche Mark (21%), French Franc (11%), Japanese Yen (17%), and Pound-sterling (11%). When a member-country utilizes SDRs, its holding would be less than the allocation. For this utilisation of SDRs, interest at 100% of the weighted-average of the short-term rates prevailing in the above five countries is charged. The interest rate is revised every quarter.
Similarly for those with additional holdings of SDRs, interest at the same rate is paid.
Utilization of Special Drawing Right
Originally SDRs were to be utilized only for meeting balance of payments deficits. But due to later developments and as a consequence of endeavors to make it an international unit of account, use of SDRs has been liberalized. Now SDRs can be used directly among the members without the approval of the IMF. A country may swap SDRs with another country to acquire A currency it desires. SDRs may be utilized to pay charges to IMF.
SDR has gained importance both as a reserve asset and as a unit of settlement of international transactions. Few international banks accept time deposits designated in SDR. Fifteen member-countries have pegged their currencies to SDR.