SPECIAL DRAWING RIGHTS (SDR)

CHAPTER NO.1
INTRODUCTION
As the topic creation of SDR and its role in solving liquidity problem suggests,
we are going to look in the past that what was the purpose behind creation of SDR,
the various stages which it went through what is its present position and how far is
it serving the purpose for which it was created i.e to look after the liquidity crunch.
From the inception of International Monetary System (I.M.S.) the system has
been facing liquidity problem. Starting with the gold standard, the limited stock of
gold could not cope with the increasing world trade. The introduction of the goldexchange standard which included some key currencies as the American dollar, the
British pound sterling, German mark, French franc and Swiss franc. This
experiment did not meet the increasing world trade and with economic and
political dominance of America, the I.M.S. shifted to what in many circles became
the "pure dollar system". As more developing countries joined the system and with
the increasing dependency of the system on U.S. balance of payments deficit, the
I.M.F. decided to introduce the Special Drawing Right (S.D.R.) as are
serve currency.
Ever since its introduction, the S.D.R. has met stiff resistance particularly by the
U.S.A. This study has examined the potential of the SDR serving as a reserve asset
which can serve the interest of all countries and free it from particular countries'
political influence. The paper concludes that despite the resistance of the U.S.
and its allies, as the economies of developing countries match those of the
developed countries, the S.D.R. stands a good chance of becoming an acceptable
reserve currency of the Fund.

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CHAPTER NO.2
WHAT IS SDR
SDR is an international type of monetary reserve currency, created by the
International Monetary Fund (IMF) in 1969, which operates as a supplement to the
existing reserves of member countries. Created in response to concerns about the
limitations of gold and dollars as the sole means of settling international accounts,
SDRs are designed to augment international liquidity by supplementing the
standard reserve currencies.
SDRs could be regarded as an artificial currency used by the IMF and defined as a
"basket of national currencies". The IMF uses SDRs for internal accounting
purposes. SDRs are allocated by the IMF to its member countries and are backed
by the full faith and credit of the member countries' governments.

Special drawing rights (SDRs) are supplementary foreign exchange reserve assets
defined and maintained by the International Monetary Fund (IMF). Not a currency,
SDRs instead represent a claim to currency held by IMF member countries for
which they may be exchanged. As they can only be exchanged for euros, Japanese
yen, pounds sterling, or US dollars, SDRs may actually represent a potential claim
on IMF member countries' non gold foreign exchange reserve assets, which are
usually held in those currencies. While they may appear to have a far more
important part to play or, perhaps, an important future role, being the unit of
account for the IMF has long been the main function of the SDR.

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Created in 1969 to supplement a shortfall of preferred foreign exchange reserve

assets, namely gold and the US dollar, the value of a SDR is defined by a
weighted currency basket of four major currencies: the US dollar, the euro, the
British pound, and the Japanese yen. SDRs are denoted with the ISO 4217
currency code XDR.
SDRs are allocated to countries by the IMF. Private parties do not hold or use
them. As of March 2011, the amount of SDRs in existence is around XDR 238.3
billion, but this figure is expected to rise to XDR 476.8 billion by 2013.
Public SDRs
SDRs are an arcane and complex topic. According to the IMFs website, the SDR
is an international reserve asset, created by the IMF in 1969 to supplement the
existing official reserves of member countries (IMF 2009c: p. 1). With the
agreement of the Executive Board, the Fund periodically allocates official SDRs to
member countries in proportion to their IMF quotas. A basket of currencies
comprise the SDR. The Fund and the Board review the currencies included in the
SDR every five years. Presently, the currencies included in the SDR are those
currencies issued by Fund members whose exports of goods and services during
the five-year period ending 12 months before the effective review date had the
largest value and that are freely useable (IMF 2005: p. 6). SDR weights are
currently based on the value of exports and the amount of reserves denominated in
the respective currencies.

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Private SDRs
The IMF created SDRs in 1969 as an international reserve asset meant to support
the Britton Woods fixed exchange rate system by supplementing the existing
reserves of member countries. Since 1972 the Fund has also used the SDR as its
basic unit of account. Over time, the SDR has found a number of applications
outside the IMF official framework.
Current accounting uses of the SDR include:
Transit fees in the Suez Canal are denominated in SDRs.
Some airlines now designate charges for overweight baggage in SDRs.
A number of international organizations maintain their accounts in SDRs or
accounting units linked to the SDR. The Arab Monetary Fund, for instance,
maintains its accounts in Arab Accounting Dinars (AAD), which are linked
to the SDR.
In the past, some countries, such as Latvia, have pegged their currency to the
SDR. Coats (1990) suggest that the SDRs attractiveness as a unit of account
for private sector use derives from the stability of its value relative to values
of alternative units. By virtue of their currency composition, SDRdenominated securities can serve as a diversification vehicle and as a partial
hedge against currency risk. For example, at the time the first SDR was
created in 1969, 1 SDR was equivalent to 0.888 grams of fine gold and/or
$1.00.

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CHAPTER NO.3
HISTORY OF SDR

The Origins of the SDR Department:

The SDR Department was established in 1969 when the international financial
system was still based upon the gold standard and fixed exchange rates to address
short-term imbalances. It was feared that the slow rate of gold production would
limit the growth of international reserves and lead to either a devaluation of the
US dollar or constraints on international trade. As a solution, the IMF would print
SDRs or paper gold and allocate them among its members. Governments would
agree to accept SDRs at a fixed rate of SDR 35 per ounce of gold. The IMF would
create SDRs whenever there was deemed to exist a long-term global need to
supplement existing reserve assets. The SDR was to become the primary reserve
medium in the international monetary system.
When the Bretton Woods system collapsed in 1971-73 and the world moved to a
system of floating exchange rates, the rationale for SDR creation disappeared. The
SDR Department found a new function: it morphed into a foreign aid mechanism
to transfer money from rich to poor countries.
Quotas provide the vast majority of IMF resources and are familiar to Congress
which authorizes periodic additional funding, most recently in 1998.
finance the General Department where IMF lending takes place.

These

The SDR

Department is completely separate and has been provisioned by General

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Allocations of SDRs distributed in proportion to IMF quotas. To date, there have

been two General Allocations totaling SDR 21.4 billion (US$ 31 billion at current
exchange rates): SDR 9.3 billion in 1970-72 and SDR 12.1 billion in 1978-81.
The SDR was introduced by the IMF in 1970 to boost world liquidity after the
ratio of world reserves to imports had fallen by half since the 1950s. Through
book-keeping entries, the Fund allocated SDRs to member countries in proportion
to their quotas. Countries in need of foreign currency may obtain them from other
central banks in exchange for SDRs.
SDRs were first allocated in 1970 equal to 1/35 of an ounce of gold, or exactly $1
($1.0857 after the dollar was devalued in 1971). When the dollar came off the gold
standard the SDR was fixed from 1974 in terms of a basket of 16 currencies. This
proved too unwieldy and in 1981 the basket was slimmed to five major currencies
with weights broadly reflecting their importance in international trade (see Table).
Since 1981 the IMF has paid the full market rate of interest on the SDR, based on a
weighted average of rates paid by the individual constituents.

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CHAPTER NO.4
ROLE & CHARACTERISTICS OF SDR

The SDR is an international monetary reserve asset, created by the International

Monetary Fund (IMF) in 1969 to supplement the existing official reserves of IMF
member countries. In addition to its role as a supplementary reserve asset, the SDR
serves as a means of payment within the IMF, as well as the unit of account for the
IMF and several other international organizations. SDRs may be held only by the
official sector IMF member countries and certain institutions designated by the
IMF as prescribed holders.

The SDR is neither a currency, nor a claim on the IMF. Rather, it is a potential
claim on the freely usable currencies of IMF members. The concept of a freely
usable currency dates from the Second Amendment of the IMF Articles in 1977,
and is defined as a member's currency that the Fund determines is widely used to
make payments for international transactions and is widely traded in the principal
exchange markets.

The SDRs value is based on a basket of key international reserve currencies issued
by IMF members (or monetary unions that include IMF members) whose exports
of goods and services had the largest value over the previous five-year period, and
which have been determined by the IMF to be freely usable currencies. The
composition of currencies (and their weights) in the SDR basket is currently: U.S.

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dollar (44 percent), euro (34 percent), Japanese yen (11 percent), and pound
sterling (11 percent). The IMF Executive Board reviews the SDR basket every five
years; the next review is expected by the end of 2010. The IMF publishes the SDR
exchange rate daily.

The SDR carries a variable interest rate, calculated weekly and published on the
IMFs external website as a weighted average of short-term interest rates of the
SDR basket of currencies. The SDR interest rate is used to determine the interest
charged on the IMFs non-concessional loans, interest earned on IMF members
reserve positions in the IMF, interest paid to members on SDR holdings, and
interest charged on members SDR allocations.

The IMFs decision to create the SDR should be viewed against the background of
the Triffin dilemma.5,6 In the 1960s, the supply of reserve assets mainly gold
and U.S. dollars was constrained by the Bretton Woods system of fixed exchange
rates. Demand for international liquidity had to be met through U.S. balance of
payments deficits, which risked undermining confidence in the value of the dollar
in relation to the value of gold. However, elimination of U.S. deficits risked
causing a shortage of reserves, a slowdown in global economic activity, and
deflation. Hence, the dilemma facing economic policy makers was a choice
between an international liquidity shortage and a loss of confidence in the dollar.
The First Amendment to the IMF Articles of Agreement, which established the
SDR as a supplemental reserve asset to the existing supply of gold, was intended to
enable reserve growth to continue even if U.S. balance of payments deficits did
not.
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The international monetary system has changed substantially since the creation of
the SDR and the subsequent breakdown of the Bretton Woods system of fixed
exchange rates in the early 1970s. Private capital markets have grown, capital is
increasingly mobile, and the use of flexible exchange rates is widespread. Rather
than relying solely on current account surpluses to increase reserves, for example,
countries can borrow on international capital markets.

With these major changes in the international monetary system, the importance of
the SDR relative to other reserve currencies has diminished, prompting periodic
debate and controversy about the appropriate role of the SDR. Unlike IMF credit
provided in freely usable currencies as part of an IMF macroeconomic adjustment
program, the SDR is an unconditional reserve asset. IMF members that use their
SDRs are under no obligation to reconstitute their SDR holdings.

The IMF membership has taken decisions to allocate SDRs only four times over
the past forty years. The first two general SDR allocations were implemented over
three year periods -- the first allocation from 1970 through 1972, and the second
from 1979 through 1981. The third general SDR allocation was implemented on
August 28, 2009 and a onetime special SDR allocation was implemented on
September 9, 2009. SDRs are allocated to IMF members participating in the IMFs
SDR Department (which currently includes all IMF members) and can only be
allocated in proportion to their IMF quotas.

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CHAPTER NO.5
WHY WAS SDR CREATED

To support the Britton woods fixed exchange rate.

The Dominant constituents of International reserves are:
Government or Central bank holdings of gold.
Widely accepted foreign currencies (USD).
Inadequacy of these two key reserve assets, led to creation of a new
international reserve asset under the auspices of the IMF.
Triffen Dillemma
US dollar was the worlds principal foreign exchange reserve
asset.
A deficit is necessary for the United states to supply world
demands for its dollars.
A deficit will, in time, lessen the value of the Dollar and endanger
the entire system.

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CHAPTER NO.6
USES OF SDR
SDRs are used as a unit of account by the IMF and several other
international organizations.
A few countries peg their currencies against SDRs, and it is also used to
denominate some private international financial instruments.
SDRs acts as credits that nation with balance of trade surpluses can 'draw'
upon nations with balance of trade deficits.
Eliminates the logistical and security problems of shipping gold back and
forth across borders to settle national accounts.
SDRs are the basis for the international fees of the Universal Postal Union,
responsible for the world-wide postal system.
SDRs are also used to transfer roaming charge files between international
mobile telecoms operators and charges for some radio communications.
SDRs limit carrier liability on international flights as well as ship owner
liability for cargo damages and oil pollution.
In Europe, the Euro is displacing the SDR as a basis to set values of various
currencies.

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CHAPTER 7
BUYING AND SELLING SDR`S

IMF members often need to buy SDRs to discharge obligations to the IMF, or they
may wish to sell SDRs in order to adjust the composition of their reserves. The
IMF may act as an intermediary between members and prescribed holders
to ensure that SDRs can be exchanged for freely usable currencies. For more
than two

decades, the SDR market

has

functioned through

voluntary

trading arrangements. Under these arrangements a number of members and

one prescribed holder have volunteered to buy or sell SDRs within limits defined
by their respective arrangements. Following the 2009 SDR allocations, the
number and size of the voluntary arrangements has been expanded to ensure
continued liquidity of the voluntary SDR market. The number of voluntary SDR
trading arrangements now stands at 32, including 19 new arrangements since
the 2009 SDR allocations.

In the event that there is insufficient capacity under the voluntary trading
arrangements, the IMF can activate the designation mechanism. Under this
mechanism, members with sufficiently strong external positions are designated by
the IMF to buy SDRs with freely usable currencies up to certain amounts from
members with weak external positions. This arrangement serves as a backstop to
guarantee the liquidity and the reserve asset character of the SDR

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CHAPTER NO.8

SDR VALUATION

The value of the SDR was initially defined as equivalent to 0.888671 grams of fine
gold. At the time, this was also equivalent to one U.S. dollar. However, after the
collapse of the Bretton Woods system in 1973, the SDR was redefined as a basket
of currencies. Today, this basket consists of the Euro (EUR), Japanese Yen
(JPY), British Pound (GBP)and U.S. Dollar (USD). The U.S. dollar value of the
SDR is posted daily on the IMF's website. It is calculated as the sum of the specific
amounts of each component currency valued in U.S. dollars at noon in the London
market. If the London market is closed, New York market rates are used and, if
both markets are closed, European Central Bank reference rates are used. The
basket composition is reviewed every five years to ensure that it reflects the
relative importance of currencies in the world's trading and financial systems.

The basket composition is reviewed every five years to ensure that it reflects the
relative importance of currencies in the world's trading and financial systems. In
the most recent regular review that took place in October 2000, the method of
selecting the currencies and their weights was revised in light of the introduction of
the euro as the common currency for a number of European countries, and the
growing role of international financial markets. These changes became effective on
January 1, 2001. The next review by the Executive Board will take place in late
2005.

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CHAPTER NO.9
SDR INTEREST RATE

The SDR interest rate provides the basis for calculating the interest charged to
members on regular (non-concessional) IMF loans, the interest paid to members on
their SDR holdings and charged on their SDR allocation, and the interest paid to
members on a portion of their quota subscriptions. The SDR interest rate is
determined weekly and is based on a weighted average of representative interest
rates on short-term debt in the money markets of the SDR basket currencies.
The interest rate on the SDR is defined as the sum of multiplicative products in
SDR terms of the currency in the SDR amount valuation basket, the level of the
interest rate on the financial instrument of each component currency in the basket,
and the exchange rate of each currency against the SDR.

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CHPATER 10
MECHANICS OF SDR ALLOCATION

General allocations of SDRs are made as a percentage of a members quota with

all participants receiving the same percentagea members quota is based
broadly on its relative size in the world economy and determines both its
subscription to the capital of the IMF and voting rights in the organization; a
members quota has a bearing on its access to IMF financing.

Allocations under the special amendment to the Articles of Agreement would not
be made in proportion to quotas but rather pursuant to a methodology that would
bring participants net cumulative allocations-to-quota ratio to a specific
common benchmark.
SDR allocations provide each member with a costless asset. If a members SDR
holdings rise above its allocation (for example, if it purchases SDRs from
another member), it earns interest on the excess; on the other hand, if it holds
fewer SDRs than allocated, it pays interest on the shortfall at the official SDR
interest rate.

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CHAPTER NO.11
SDR ALLOCATION TO IMF MEMBERS

Under its Articles of Agreement (Article XV, Section 1, and Article XVIII), the
IMF may allocate SDRs to member countries in proportion to their IMF quotas.
Such an allocation provides each member with a costless, unconditional
international reserve asset on which interest is neither earned nor paid. However, if
a member's SDR holdings rise above its allocation, it earns interest on the excess.
Conversely, if it holds fewer SDRs than allocated, it pays interest on the shortfall.
The Articles of Agreement also allow for cancellations of SDRs, but this provision
has never been used. The IMF cannot allocate SDRs to itself or to other prescribed
holders.
General allocations of SDRs have to be based on a long-term global need to
supplement existing reserve assets. Decisions on general allocations are made for
successive basic periods of up to five years, although general SDR allocations have
been made only three times. The first allocation was for a total amount of
SDR 9.3 billion, distributed in 1970-72, and the second allocated SDR 12.1 billion,
distributed in 1979-81. These two allocations resulted in cumulative SDR
allocations of SDR 21.4 billion. To help mitigate the effects of the financial crisis,
a third general SDR allocation of SDR 161.2 billion was made on August 28, 2009.

Separately, the Fourth Amendment to the Articles of Agreement became effective

August 10, 2009 and provided for a special one-time allocation of SDR 21.5
billion. The purpose of the Fourth Amendment was to enable all members of the
IMF to participate in the SDR system on an equitable basis and correct for the fact
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that countries that joined the IMF after 1981more than one fifth of the current
IMF membershipnever received an SDR allocation until 2009. The 2009 general
and special SDR allocations together raised total cumulative SDR allocations to
about SDR 204 billion.

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CHAPTER NO.12
ADVANTAGES & DISADVANTAGES OF SDR

1.The major advantage of the scheme is its simplicity and flexibility. The SDRs are
a form of reserve assets which are suitable for incorporation into the countries'
reserves. These are also a form of international credit creation on the analogy of
domestic credit creation by the monetary authority. Moreover, the scheme
envisages pure fiduciary reserve creation, and therefore, is quite flexible.
2. The scheme would permit the Fund to increase unconditionally the amount of
world liquidity as per requirements, i.e., without depending upon the tenuous
supply of monetary gold or increasing the obligations of the reserve currency
countries. The scheme thus, seeks to create unconditional liquidity in international
reserves.
The drawing against SDRs would be unconditional in the sense that, no change
would be required to be made in the domestic economic policies (to restore balance
of payments equilibrium) by the country using SDRs.
3. An important merit of the SDRs scheme is that it is a sort of grafting on the
prevailing international monetary system without causing any disturbance. It
avoids any sort of internationalization of the existing reserves of the members. It
will not cause any change or transfer of even a fraction of the quotas to the new
Special Drawing Account (SDA) under the IMF scheme, because the resources of
the new account SDA are to be created by an agreement amongst the Fund
members as to the percentage of their existing quotas formed into SDRs.

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The SDRs scheme thus marks a major step in managing international monetary
system on a rational basis, while remaining within the conceptual framework of the
international gold exchange standard as adopted by the IMF.
4. The significance of the scheme, however, lies in the fact that it represents the
first serious effort in the set-up of international monetary system to move away
from gold as the pivot by providing for creation of a fiduciary reserve. No doubt,
though, the SDRs - 'paper gold' - may not completely replace the 'yellow metal', it
will be a useful and flexible supplement to existing reserve instrument and credit
facilities. Further, it (paper gold) relieves the world monetary authorities from
maintaining the open market value of gold. As such the SDRs scheme implies a
partial demonetization of gold.
5. Another merit of the SDRs is that unlike the present Ordinary Drawing Right in
the IMF which gives rise to only a temporary increase in international liquidity,
they are intended to make a permanent addition to it.
Further, the use of the SDRs does not require repayment according to a fixed
schedule as is the case with the Fund's ordinary resources. As such, a systematic
and regular addition to international liquidity would be provided by the SDRs.
6. Brahmananda observes that, the designation and reconstitution provisions are an
integral part of the SDR scheme. The designation provision is essential for the
sanction and operation of SDRs as international reserve and the reconstitution
provision will enforce the 'circularity' of the SDRs. In the absence of designation,
the SDRs have obviously no sanction behind them. The reconstitution requirement,
on the other hand, seeks to place SDRs in a vantage position as compared to the
other assets (gold and key currencies).
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However, the SDRs scheme in the form proposed and accepted by the world's apex
monetary authority, is subjected to many justifiable criticisms. We shall list some
of the important ones below.
1. The scheme is purely fiduciary in nature. Thus, there is all probability of distrust
in the new reserve assets (SDRs).
No doubt, the moneyness of SDRs does not require any backing once its general
acceptability is assured. However, assurance of general acceptability of SDRs in
international payment calls forth a very clever and efficient management of the
world's apex monetary authority, the IMF. Many critics have felt that, in the
prevailing international monetary situation this is a very difficult task for the IMF.
So if once people's confidence in the SDR is shaken, there are no other alternatives
to switch over to some other currency or gold and the scheme will be a flop.
2. Thus, the scheme does not seek to cure the basic problems of international
monetary relations such as the inter-central movements of short-term funds arising
out of the disturbance in international monetary equilibrium and the currency-gold
switches. The scheme also lacks the prevention of SDR-gold switches.
3. It has been observed that, though, SDR 'Paper Gold' is a useful and flexible
reserve instrument of international liquidity, it cannot be used to finance persistent
payment deficits without leading to a pervasive and massive international inflation.
4. To some critics, the entire scheme of SDRs seems to be a rescue operation for
the dollar. The scheme contains a disguised attempt to rehabilitate the dollar by
means of a collective international action, because the value of the SDR is
prescribed to be equal to the present official gold value of the dollar. It still seeks
to maintain the pre-war dollar parity in international monetary transactions which
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has assisted the United States in exporting inflation in the international money
market through the artificially over-valued dollar. The scheme smacks of saving
today's over-valued dollar from the logical consequence of devaluation.
5. Thus, the scheme is much in favour of U.S.A. but greatly disadvantages to the
rest of the world and especially to the poor nations. Critics feel that the scheme
should have been ratified only if the revised peg, i.e., value of SDRs, is kept in
parity with the prevailing value of the U.S. dollar in the international money
market, and not in parity with the artificially over-valued dollar (in terms of prewar gold-dollar parity).
6. There is no established formula to estimate a country's need for the reserves.
Further, the scheme also contains seeds of inequality and injustice. The distribution
of SDRs on the basis of IMF quotas fails to satisfy the canons of equity and
efficiency, because according to this scheme, a major part of SDRs has been
allocated to rich nations already having enough liquidity. The poor countries
lacking enough international exchange reserves will have to suffer further.
Brahmananda thus, observes that "the SDRs instead of being a panacea may
aggravate the financial disequilibrium in the world" because they do not satisfy the
canon of equality.
. In short, the allocation scheme of the SDRs on the basis of IMF quotas is not very
sound. The distribution of SDRs should have been made with due regard to the
needs of the developing countries. It has been suggested that a well defined portion
of SDRs should not be allotted to the developing countries, exclusively to meet
chronic deficits in their balance of payments.

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7. It has also been complained that the rate of interest on SDRs is very low, just 1.5
per cent. This would induce deficit countries to use their SDRs in preference to
other reserve assets to finance their deficits. On the other hand, the surplus
countries will be less eager to accumulate the SDRs. So there will be a lack of
mutual cooperation in implementing the scheme successfully in the long run.
It may be concluded that with certain fundamental changes and improvement in the
existing SDRs scheme, it is hoped that it will be effectively and efficiently
managed and implemented t solve the basic problems connected with the financial
disequilibrium in the world, otherwise the ape monetary authority of the world,
IMF, would have to be re-organized and the international monetary system
reconstituted.

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CHAPTER NO.13
THE SDR DEPARTMENT WORKS

SDR allocations initially create credit balances in each members account in the
SDR Department. Each country pays interest on its allocation and receives interest
on its credit balance at the same SDR floating interest rate. The SDR interest rate
is a weighted average of the yields on specified risk-free short-term instruments in
the US, UK, European and Japanese money markets whose currencies compose the
SDR. The US dollar component is the three-month US Treasury bill.

When a country exchanges its allocated SDRs for freely usable currencies, the
governments credit balance falls below its allocation. The country has borrowed
the difference between its allocation and its credit balance at the SDR interest rate.
When a country accepts additional SDRs in exchange for freely usable currencies,
its credit balance rises above its allocation. The country has lent the excess of its
credit balance over its allocation at the SDR interest rate. If a country does not use
its SDRs and does not accept SDRs in exchange for freely usable currencies, its
credit balance equals its allocation and it has no cost or benefit because the interest
payments received and paid exactly offset each other.

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CHAPTER NO.14
SDR AND WORLD LIQUIDITY:

We have already covered the basics about SDRs. Now we will analyze how far
SDRs have been successful in solving the world liquidity problem? SDRs were
mainly created so that the emerging economies didnt face any liquidity crunch.
The emerging economies were in main need of capital, so we will see whether the
SDRs were able to meet their needs or not?

The SDR Department is an arcane system of financing that was designed to

address a potential global shortage of international reserves. Now, it has been
transformed into a redistribution mechanism that compels rich countries to lend on
demand to poor nations at a highly subsidized floating interest rate--the weighted
average of the lowest short-term interest rates in the world. The United States is
the chief source of these perpetual and unconditional loans.

IMFs focus on Expansion of International Liquidity by Allocating SDRs

In keeping with its purpose, the IMF could and perhaps should contribute to
financial stability and the promotion of international trade by allocating SDRs to
stimulate economic recovery during an international recession. Expansion of
international liquidity through the issue of SDRs requires an 85 percent majority
vote.

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In the past, some industrial countries have opposed even modest allocations of
SDRs on the grounds that they would be inflationary. Today, in the face of a
widespread recession, a decline in the rate of growth of international liquidity, and
the need to expand liquidity to support the expansion of international trade, it
would be very difficult to make that argument. There would thus appear to be a
strong case for supplementing the creation of liquidity and meeting the needs of the
international economy by allocating SDRs.
Under the Articles of the IMF, SDRs are allocated to member countries in
proportion to their quotas. Thus the G-7 would receive more than 47 percent of any
allocation, and industrial countries as a group would receive 61 percent. However,
recipient countries may donate their SDRs to developing and emerging economy
countries or to a trust fund to benefit eligible countries (that is, countries that are
prepared to invest the funds in capacity-building projects and to adopt appropriate
policies).
Recipients of SDRs would, of course, cover the interest on the funds received at
the SDR rate of interest, the weighted average of the short-term Treasury bill rates
of France, Germany, Japan, the United Kingdom, and the United States (currently
2.25 percent a year). Recipient countries, which in most cases have little access to
financial markets and then only at much higher rates, would find these terms very
attractive.
As recipient countries experienced an improvement in their reserve position, they
would be able to sustain higher levels of investment and imports, with the
consequent increase in economic activity and international trade. Allocating SDRs
would thus also help avert new financial crises.

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CHAPTER 15
RECENT EVENTS

On 2 April 2009, the G-20 authorized the IMF to issue $250 billion in new SDRs
to augment the foreign reserves of IMF members. While the G-20 portrayed this
new issuance as a quick way to channel resources into emerging economies, SDRs
are allocated, as mentioned above, in proportion to members' existing IMF
quotas. As a result, $170 billion of the $250 billion new SDRs will go into the
reserves of rich countries, like the United States, Britain, France and Japan, that
have the lion's share of existing IMF quotas. In addition, countries like the United
States require approval from Congress to part with its share of SDRs. Nonetheless,
increases in the reserves of some emerging will be substantial i.e. South Koreas
will grow by $3.4 billion, Indias by $4.8 billion, Brazils by $3.5 billion, Russias
by $6.9 billion and China's by $7.3 billion.

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CONCLUSIONS

As currently conceived, SDRs constitute a system for giving countries limited

unconditional access to other countries currency reserves. The SDR itself is not a
currency; it is not used in private markets. The basket valuation of the SDR is
motivated by denominational convenience, and can be argued to be quite incidental
(and inessential) to the main purposes of the SDR. Large-scale substitution of
currency reserves for SDRs would have advantages for example, there would be
no danger of official portfolio shifts between reserve currencies but those
advantages would come at a fiscal cost, and disagreement about the sharing of that
cost among countries has defeated the substitution account idea in the past. The
SDR would be more effective if, as some have suggested, it could be traded
directly for reserve currencies with the issuing central banks, thereby resulting in
the rapid creation of outside liquidity. Such a system could be effected, without
being based on SDRs, simply though a system of central bank swap lines centered
on the IMF. Were such a system instituted, however, the IMFs surveillance
capabilities would need to be extended and its governance structure reformed.

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REFERENCE

BIBLIOGRAPHY

Foreign Exchange International Finance Risk Management,

- Rajwade. A.V.
International Financial Management, PHI publication, 2010.
-Sharan

WEBSITES

www.google.com
www.wikipedia.com

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