Special Drawing Rights

SPECIAL DRAWING RIGHTS
CHAPTER -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 ie; 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 gold-exchange 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 a reserve 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
The International Monetary Fund (IMF) was founded in 1945 as part of the Bretton
Woods system agreement a year earlier. The goal of the IMF is to foster macroeconomic
stability and global growth and to reduce poverty around the world.
Interestingly, economist John Maynard Keynes first proposed a supranational currency
known as "Bancor" at the Bretton Woods conference, but his proposal was rejected. Instead,
the IMF adopted a system of pegged exchange rates tied to the value of gold bullion. At the
time, the world reserve assets were the US Dollar and gold. However, there was not enough
supply of these internationally to keep sufficient reserves for the IMF to function properly. In
order to fulfill its mandate, in 1969 the IMF created Special Drawing Rights, or SDRs as a
supplement to help fund its stabilization efforts.
By 1973, the original Bretton Woods system had been almost completely abandoned.
President Nixon restricted gold outflows from the United States, and major currencies shifted
from a pegged system to a floating exchange rate regime. Still, the SDR system has been
largely successful, with the IMF allocating approximately SDR 183 Billion, providing needed
liquidity and credit to the global financial system
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.
1.1HISTORY OF SDRs:
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.3 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. These finance the General
Department where IMF lending takes place. The SDR Department is completely separate
and has been provisioned by General 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 197881.
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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
How 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
CHAPTER-2
FEATURE,NEEDS ,ADVANTAGES AND DISADVANTAGES OF SDRs
2.1 FEATURES OF SPECIAL DRAWING RIGHT SCHEMES
1. The creation of Special Drawing Rights (SDRs) is essentially similar to the concept of
credit creation which central banks undertake in their countries to supplement the resources
of the banking system to meet the monetary requirements the liquidity need of the country.
The SDRs scheme is an extension of the same principle. In fact, basically, the idea of SDRs is
drawn from the popular Keynesian plan of creation of ICU and Bancor currency.
2. The scheme proposes that the allocation of SDRs is to be made on the basis of the quotas
held by the individual member countries.
3. SDRs have been created under a Special Drawing Account (SDA) with the IMF. The
resources of the new account, SDA, are created by an agreement amongst members as to the
percentage of the existing resources (quotas) with the IMF to be formed into SDRs. At the
Paris Conference on July 24, 1969, the Group of Ten, however, recommended that some $
3,500 million worth of SDRs be created in the beginning year and $ 3,000 million in each of
the two succeeding years.
4. With the introduction of the SDR scheme, thus, the accounts of the IMF are divided into:
(i) the General Account, and (ii) the Special Drawing Account. The General Account deals
with the ordinary transactions of the IMF relating to subscriptions, towards quotas, drawings,
purchases, payment of charges, etc. the SDA conducts the SDR transactions.
5. The scheme proposes that the Special Drawing Rights would be a sort of gold paper. Thus,
the value of the SDRs is fixed in gold. As per the existing scheme, the unit value of SDRs is
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expressed in terms of gold equal to 0.888671 gram of fine gold for one U.S. dollar prior to
August, 1971. With effect from February 13, 1973, an SDR is equivalent to $ 1.2. The value
of SDR being fixed, it has to be maintained by the member participants.
6. The scheme, thus, envisages a pure fiduciary reserve creation. It provides for regularly
creating SDRs in the IMF which the member countries would accept as reserves and use for
the settlement of international payments. The SDRs have been, thus, aptly described as
Paper Gold. These paper gold reserves are expected to fill the gap of deficiency in
international liquidity resulting from a mere rise of 2.5 per cent in world monetary reserves
against the expansion in international trade at 8 per cent per annum.
7. The SDRs themselves are not international money. SDRs are just like coupons which can
be exchanged for currencies required by the holder of SDRs for making international
payments. Further, SDR transactions are carried out through entries in the SDA books of the
IMF.
8. Under the new scheme, the central banks of the member countries of the IMF will hold
SDRs as their reserves along with gold and key currencies. However, the participants are
required to provide their currency in exchange for SDRs when called upon to do so, the
purpose being that countries would provide the requisite backing of real resources to the
SDRs.
9. It has been statutorily laid down that due restraint would be exercised in the creation of
SDRs in order to maintain peoples confidence in it.
10. The SDRs allocated to the Fund members are transferable assets under the designation
issued by the IMF, subject to certain limits of holding. Thus, it is obligatory on the part of the
participating countries to accept drawing rights from Fund members in exchange for the
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equal amount of convertible currency. This obligation, however, cannot exceed twice a
countrys allocation.
11. Under the scheme, the use of SDRs would obviously imply a reduction in the reserves of
the using country, while the other participating countries which are receiving drawing rights
in international settlements would accumulate their SDR holdings.
It is proposed that a modest rate of interest will be paid in SDR on holdings of such Drawing
Rights.
12. The scheme provides that the decumulation and accumulation of SDRs would be taking
place within the Special Drawing Account itself. Over a five-year period, a country shall not
use more than 70 per cent of its average net cumulative allocation.
13. Further, members using SDRs would incur an obligation to reconstitute their position in
accordance with the principle which is to take into account the amount and duration of its
use. The provision of reconstitution is assumed to be very essential to enforce the
circularity of the SDRs.
Though the scheme seeks to reconstitute the IMF and its international liquidity structure, it
aims at increasing international liquidity without causing any basic change in the present IMF
system and its functioning
2.2HOW IS SDRs STRUCTERED

How is a SDR structured?
IMF is responsible for all transactions, i.e. the IMF acts as a broker
Types of SDR transaction

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(a)Voluntary: Transactions take place with a voluntary counterparty

(b) Designation: In case no voluntary counterparty can be found, the IMF designates a
counterparty, however this has not been necessary since September 1987
2 types of allocations
(a) General: based on long-term need to increase existing reserve assets
(b) Special: ensure all members of IMF the relative same amount of SDRs, since countries
join the IMF at different times
(ix) With the introduction of SDR scheme, there will be two accounts in the IMF:
(a) The general account,
(b) The special drawing rights account.
The general account deals with ordinary drawing rights already existing and ordinary
transactions of the IMF relating to quotas, drawings, subscription, interest charges, etc. The
SDR account will deal with SDRs. The best way to understand the scheme is to think of the
rights as pieces of papers which other countries will accept in payment of debtthat is, paper
gold.
In other words, these rights are just like coupons which can be exchanged for currencies
required by the holder of SDRs for making international payments. However, they are not
pieces of paper like bank notes or treasury bills, they are simply entries in the SDR account of
IMF. Initially, at least the Fund will not itself possess any of the new assets.
2.3ORIDINARY RIGHT RESERE VERSUS SPECIAL DRAWING

RIGHTS
IMF Ordinary Drawing Rights versus Special Drawing Rights (ODRs

versus SDRs):
However, SDRs are quite different from the ordinary drawing rights already in existence for
the last over 45 years or so. The main difference is that SDRs are available automatically,
whereas IMF had to be satisfied as to the fulfillment of certain conditions in case of the use of
ordinary drawing rights.
The latter used to arise as a by-product of gold subscriptions to the Fund but SDRs are
deliberately created in amounts considered necessary to meet the need as and when it arises
for a supplement to the growth of world reserves.
The SDRs add permanently towards reserves in a way that the conventional or ordinary
drawing rights do not. For example, when Britain makes a conventional 25 million drawing
on the IMF, it pays in that amount sterling in exchange for foreign currency and at the end of
three to five years has to reverse the transaction. This was the position before SDRs came into
operation.
Under the SDR scheme, Britain will transfer 25 million of its SDRs to say, Germany, for
marks. Britains holdings of SDRs will fall and Germanys holdings of SDRs would rise
accordingly. Germany having been designated by Fund will provide marks to that extent.
Thus, the great merit of SDRs lies in its automatic character. Unlike the existing IMF drawing
rights, SDRs are not created by countries contributions of gold and currency to the Fund and
once drawn they do not have to be paid back to the Fund. The novelty of SDRs lies in that
they would not be treated as borrowings as is the case with the ordinary drawing rights and
existing claims on the IMF.
The SDRs could be used as gold in as much as they would be the ultimate source for
purchasing other currencies. The international money created in the form of SDRs by the
Fund constitutes official reserve assets for those who hold it. With the creation of the SDRs,
the Fund has clearly served in a direct manner as a central banker to the monetary authorities
of member-countries.
Its great merit lies in that reserve creation in the Fund has become a deliberate process under
international controlthe decisions to create new reserves of SDRs are made on the basis of
careful calculation and judgment as to the need for reserves by the world community and on
the basis of a recognition that world payments equilibrium requires. Hence, SDRs are, as
such, quite different from ordinary drawing rights.
2.4USES AND NEED OF SDRs

NEED OF SDRs
According to the IMF, SDRs (or XDR) are an international reserve asset to supplement its
member countries' official money reserves. Technically, the SDR is neither a currency, nor a
claim on the IMF itself. Instead, it is a potential claim against the currencies of IMF
members.
An SDR allocation is a low-cost method of adding to member nations' international reserves,
allowing members to reduce their reliance on more expensive domestic or external debt.
Developing nations can use SDRs as a cost-free alternative to accumulating foreign currency
reserves through more expensive means, such as borrowing or running current account
surpluses.
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The SDR is also used by some international organizations as a unit of account where
exchange rate volatility would be too extreme. Such organizations include the African
Development Bank, Arab Monetary Fund, Bank for International Settlements, and the Islamic
Development Bank. By using SDRs, local currency fluctuations do not have as large of an
impact. SDRs can only be held by IMF member countries and not by individuals, investment
companies, or corporations.
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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2.5ADVANTAGES AND DISADVANTAGES OF SDRs

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.
Advantages. The SDR is stable. It is used for accounting purposes by the IMF and even
some multinational corporations. Commercial banks accept deposits and make loans in
SDRs, and it is used to price some international transactions.
Disadvantages. Since the SDR is an average of five currencies it is less valuable than the
strongest and is among the first to go when reserves are sold off. Developing countries argue
that it would help their liquidity if they had more SDRs, but the quota system ensures that the
rich industrial countries have most of them
SDR PROS &CONS

PRO SDRs
Stable (due to basket of currencies, i.e. diversified reserves)
No exorbitant privilege for the USA

A way for developing countries (with weak currencies) to get access to the FX market
Less country risk for industrial countries lending currency to (in exchange for SDRs)
developing nations
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CONS SDRs
Liquidity
No private market
Market credibility
Shifting the problem from the USD to the SDRs
Advantage of SDR over a diversified reserves basket SDR basket only consists of 4
currencies
Geopolitical risks
IMF voting power Limited
No. of currencies
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CHAPTER-3
ROLE ,VALUE,INTEREST RATES ,ALLOCATION OF SDRs
3.1 ROLE OF SDRs
The SDR was created by the IMF in 1969 to support the Bretton Woods fixed exchange
rate system. A country participating in this system needed official reserves
government or central bank holdings of gold and widely accepted foreign currencies
that could be used to purchase the domestic currency in foreign exchange markets, as
required to maintain its exchange rate. But the international supply of two key reserve
assetsgold and the U.S. dollarproved inadequate for supporting the expansion of
world trade and financial development that was taking place. Therefore, the
international community decided to create a new international reserve asset under the
auspices of the IMF.
Only a few years after the creation of SDRs, the Bretton Woods system collapsed and
the major currencies shifted to a floating exchange rate regime. In addition, the growth
in international capital markets facilitated borrowing by creditworthy governments.
Both of these developments lessened the need for SDRs. However, more recently, the
2009 SDR allocations totaling SDR 182.6 billion have played a critical role in
providing liquidity to the global economic system and supplementing member
countries official reserves amid the global financial crisis.
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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. Holders of SDRs can obtain these
currencies in exchange for their SDRs in two ways: first, through the arrangement of
voluntary exchanges between members; and second, by the IMF designating members
with strong external positions to purchase SDRs from members with weak external
positions. In addition to its role as a supplementary reserve asset, the SDR serves as the
unit of account of the IMF and some other international organizations
3.2 VALUE OF SDRs

Basket of currencies determines the value of the SDR
The value of the SDR was initially defined as equivalent to 0.888671 grams of fine gold
which, at the time, was also equivalent to one U.S. dollar. After the collapse of the Bretton
Woods system in 1973, the SDR was redefined as a basket of currencies. Today the SDR
basket consists of the euro, Japanese yen, pound sterling, and U.S. dollar. The value of the
SDR in terms of the U.S. dollar is determined daily and posted on the IMFs website. It is
calculated as the sum of specific amounts of the four basket currencies valued in U.S.
dollars, on the basis of exchange rates quoted at noon each day in the London market.
The basket composition is reviewed every five years by the Executive Board, or earlier if
the IMF finds changed circumstances warrant an earlier review, to ensure that it reflects
the relative importance of currencies in the worlds trading and financial systems. In the
most recent review (in November 2010), the weights of the currencies in the SDR basket
were revised based on the value of the exports of goods and services, and the amount of
reserves denominated in the respective currencies that were held by other members of the
IMF. These changes became effective on January 1, 2011. In October 2011, the IMF
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Executive Board discussed possible options for broadening the SDR currency basket.
Most directors held the view that the current criteria for SDR basket selection remained
appropriate. The next review is currently scheduled to take place by the end of 2015.
Value
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.
Valuation of SDRs:
According to the SDR scheme, it will be a sort of gold paper. The value of SDR was fixed in
gold. The value of the SDR being fixed had to be maintained by the member countries one
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SDR = one US dollars worth of gold at the then official rate of 35 an ounce or 0.888671
grams fine gold. But its link with gold has been given up.
The SDR is now defined in terms of a basket, or collection, of the five major currencies of the
world: the US dollar, the Deutsche mark, the Japanese yen, the French franc and the pound
sterling. The value of the SDR at any given time in terms of a given currency may be
calculated by using the exchange rates of the constituent currencies against the dollar and the
rate of the given currency against the dollar.
A new system of valuation, thus, replaced the previous system under which the SDR was
valued in terms of gold or US dollar. As such, the SDR began to assert as a unit of account.
The Fund decided from January 1981 to have a standard basket of 5 currencies only instead
of 16 currencies as was the case earlier.
The new unified standard basket will compose of the currencies of any 5 member countries
having the largest export of goods and services during the last five years and widely used in
world trade and payments period. At present these are the US dollar Deutsche mark, Japanese
yen, French franc and pound sterling.
The value of the SDR will be equal to the sum of the values of these currencies weighted as
US dollar 42 per cent, Deutsche mark 19 per cent, Japanese yen 15 per cent, French franc 12
per cent and Pound Sterling 12 per cent. Because SDRs now comprise the dollar, mark, yen,
franc and pound sterling, any fluctuation in one currency would be outweighed by gains in
another thus making the new instrument (of SDR) a stable investment thereby enhancing its
role as an international asset. At present one unit of SDR = $ 1.30 approximately and
increased to 1.38 in May 1988.
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According to Fund sources one great use of the change over to the five currency standard
basket will be that all exchange rates used for calculating the value of SDRs will be obtained
by the IMF from the London market [for example, the US dollar rate for the Japanese yen
used in daily calculation will be obtained from now on (1981 onwards) from London
Exchange Market rather than the Tokyo Exchange Market].
As such, it will be easier for banks or other holders of SDR denominated deposits to replicate
the SDR in the private market when they need to do so. Such a stability in value is a desirable
characteristic of a reserve asset and a unit of account.
3.3 SDRs INTEREST RATE

The SDR interest rate provides the basis for calculating the interest charged to borrowing
members, and the interest paid to members for the use of their resources for regular (nonconcessional) IMF loans. It is also the interest paid to members on their SDR holdings and
charged on their SDR allocation. The SDR interest rate is determined weekly and is based
on a weighted average of representative interest rates on short-term debt instruments in the
money markets of the SDR basket currencies.
3.4 SDRs 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. The SDR
mechanism is self-financing and levies charges on allocations which are then used to pay
interest on SDR holdings. If a member does not use any of its allocated SDR holdings, the
charges are equal to the interest received. However, if a member's SDR holdings rise
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above its allocation, it effectively 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 197072, the secondfor SDR 12.1 billiondistributed in 1979-81, and the thirdfor SDR
161.2 billionwas 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 rectify the fact 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 SDR 204 billion.
LOW
INCOME
COUNTIES
TO
BENEFIT
FROM
IMF
ALLOCATION OF SDRs
The IMF took action to bolster its members reserves through an allocation of Special
Drawing Rights (SDRs) of about $250 billion. The allocation was made on August 28
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and responds directly to the G-20s call for swift policy action to meet the needs of
the developing world.
With the majority of countries struggling to combat the deep global economic downturn,
the IMF took action to bolster its members reserves through an allocation of SDR
equivalent to about $250 billion that will be followed by a smaller allocation of $33 billion
on September 9. This means an allocation of more than $20 billion of SDRs to lowincome countries (LICs) to bolster their foreign exchange reserves and help alleviate
financing constraints due to the global financial crisis and the sharp rise of food and fuel
prices in 2007.
The allocation of SDRs boosts member countries reserves because SDRs can be turned
into usable currencies. Once the SDRs have been added to a member countrys official
reserves, the country can voluntarily exchange its SDRs for hard currencies, such as the
U.S. dollar, euro, yen, or pound sterling, through voluntary trading arrangements with
other IMF member countries. Some countries have already volunteered to set up trading
arrangements that will facilitate the buying and selling of SDRs. The allocation is
distributed to all member countries according to their quotas in the IMF.
ADDRESSING LICs HIGHER FINANCING NEEDS

About $110 billion of the combined allocations will go to emerging market and
developing countries, including over $20 billion to low-income countries. Many of these
countries currently face difficult spending decisions as they decide how to address the
fallout from the global crisis. For them, the SDR allocation means potential access to
unconditional financial resources that could limit the need for adjustment through
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contractionary policies and allow greater scope for countercyclical policies in the face of
recession and rising unemployment.
The general SDR allocation is a key part of our response to the global crisis,
demonstrating the value of a cooperative multilateral approach, IMF External Relations
Director Caroline Atkinson said. The Funds low-income members will benefit
significantly, she added. Despite a smaller number of SDRs going to the IMFs lowincome members, the allocation will resultin most casesin a proportionately bigger
increase in reserves for them than it will for the advanced economies, which already have
a substantial cushion of reserve
SDRS ALLOCATION RESPOND TO G-20 CALL

It was at its April summit in London that the Group of Twenty (G-20) industrial and
emerging market countries called for an SDR allocation of $250 billion. The proposed
general allocation was approved by the IMFs Board of Governors on August 7, 2009, and
came into effect on August 28. The allocation is based on a long-term global need to
supplement IMF members existing reserve assets and it provides liquidity to the global
economic system.
The G-20 had also called for urgent ratification of a long-pending amendment to the
IMFs Articles of Agreement. This so-called Fourth Amendment was proposed to enable
all Fund members to participate in the SDR system on an equitable basis and correct for
the fact that countries that joined the Fund after 1981now more than one-fifth of the
current IMF membershiphave never received an SDR allocation.
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The amendment to the Articles had originally been set in motion over ten years ago, but it
needed to then pass successfully through the legislatures of three-fifths of the Funds
members, having 85 percent of the total voting power. Recently amended U.S. legislation
paved the way for making the amendment effective in August. The amendment provides
for a special one-time allocation that will be separate and additional to any SDRs allocated
to members under the general allocation of SDRs.
MECHANICS OF SDRs 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.
3.5 SDRs AND DEVELOPING ECONOMIES

SDRs and Developing Economies:
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The greatest criticism, however, of the SDR scheme has come from developing economies
because SDRs do not provide for a specific link between reserve creation and development
assistance in underdeveloped countries. Besides, their creation and distribution are arbitrary
and unjust from the viewpoint of developing economies.
They also complain of small share in any allocation of SDRs as against developed countries.
The share of developing countries is not likely to be more than 28 per cent of the aggregate
issue. Prof. Triffin, the US Economist, also denounced the scheme of paper gold on this
ground. He said, It is morally repugnant to assign the lions share of the SDRs (about 72 per
cent) to the 25 richest and most developed countries of the world.
Apart from the share in the Fund quotas, the share of the developing countries in the direct
distribution of the SDRs, or the paper gold, as it is called, which is intended to replace gold in
the international monetary system, is quite negligible, the major share in each fresh
distribution going to the big industrialized countries; thus defeating in no small measure the
main objective of transferring real resources to the poorer countries.
Of nearly 9.0 billion SDRs held by member-countries in 1976 and early 1977, the USA alone
held nearly 2 billion SDRs or more than a fifth. Thus, the distribution of IMF facilities, to
increase international liquidity amongst its members, either in the way of normal entitlements
under the quota system or in the form of direct allocation of SDRs, has not been designed to
bridge the gap between the rich and the poor countries, who remain far apart from each other
as before, if not worse off.
It is true that the scheme of SDRs in its present form and as applicable to developing
economies has a good number of limitations, which go to make this scheme, as such for
them, of limited value. Even then, these poor economies are not justified in denouncing the
23
scheme on the grounds that the facilities available under it are inadequate or unjust or that
advantages are uncertain or that they face the possibility of additional inflation or that there is
no link between development finance and international liquidity.
Special drawing rights are also of great use to developing economies firstly, by enabling them
to maintain somewhat more adequate reserves; secondly, by enabling them to maintain their
economies on an even keel thereby saving them from abrupt shocks. Thirdly, by providing
them potential benefits from the maintenance of adequate reserves, especially in industrial
countries which take the bulk of their exports and provide them with capital.
Fourthly, if the less developed countries so desire, they can together as participants veto
proposals for SDRs allocations over some basic periods. Developing countries also gain
indirectly inasmuch as their currencies get strengthened, thereby promoting international
trade. The developing countries are likely to gain more in the form of aid as well as trade
from this scheme. There is a definite implied link (though not direct link) between the
creation of international liquidity through SDRs and the pursuit of more liberal aid and trade
practices on the part of rich nations.
CHAPTER-4
PROBLEMS&LIMITATION OF SPECIAL DRAWING RIGHTs
Mr. P.P. Schweitzer, the Managing Director of the IMF, strongly defended and praised the
Funds SDRs as an effective supplement to traditional reserve assets. He described the
creation of SDRs as a major advance in the evolution of international monetary system.
24
President of the USA welcomed the scheme as a great step forward and appealed to world
monetary authorities to look beyond gold with the help of SDRs. Richard Cooper, Professor
of Economics at the Yale University, called the scheme of SDRs a progressive and potentially
important step which will ultimately replace gold in the world monetary system. By agreeing
to the scheme of creating SDRs in September 1967, the Finance
Ministers of the free world took the first and momentous step to solve the problem of
international liquidity. The significance of the scheme lies in the fact that for the first time as
a result of deliberate international decisions, the total stock of reserves and its rate of growth
are determined, rather than allowed to be determined solely by the availability of gold and the
accumulation of balances in reserve currencies. SDRsthe paper goldwill be international
money which will keep the world trade and economy moving.
It will be backed by nothing more than a fact that nations will accept it in payments for world
trade and it will exist only on the Funds books (like bank credit deposits) and will change
hands only on ledger-sheets. These SDRs, created as these were, by a stroke of the pen will
essentially be entries in the book of the Fund. Simplicity, flexibility, unconditional character
of liquidity designation and reconstitution provisions are an integral part of the SDR Scheme
and constitute its main merits.
The decision to create SDR has given the IMF the authority to create monetary reserves
systematically so as to assure an adequate volume and growth of international reserves
without having to rely on gold or the balance of payments deficits of the reserve currency
countries. It also enabled the participating member-countries of the IMF to add to their
reserves without any net export of real resources or repayment.
25
In the light of these characteristics the SDR was envisaged to pay a prominent role as an
international reserve asset and the future creation of monetary reserves would be largely
through SDR allocations. Moreover, the replacement of the internationally held key-currency
balances by SDR would not only reduce the reserve currency role of the dollar but also bring
to an end the privilege of the United States to run huge balance of payments deficits with its
own currency (seigniorage benefits).
But SDR scheme has not been welcomed as an unmixed blessing and, therefore, has
been subjected to the following critical comments:
1. It is said by Paul Einzig that it is no safeguard against a major emergency. The fact that the
SDRs would be released in five equal annual installments shows that it is not an emergency
measure which wills immediately place or release large resources during emergency to meet
the problem. The facilities are meant for financing routine expansion of world trade. SDRs
can be used so far, largely to meet the balance of payments difficulties.
2. The plan is denounced on the ground that it has an inflationary bias. The system of SDRs is
likely to operate as a built-in-inflator. It is bound to over stimulate expansion leading to
higher prices. The developed countries have argued that one of the causes of the global
inflation in the 1970s has been an unwarranted increase in the present size of global reserves.
But this limitation is not peculiar to SDRs, any scheme of increasing international liquidity
will have an inflationary potential, which has to be avoided by judicious application of the
scheme.
3. It is argued that though the SDRs are automatic yet they are not the same as owned
reserves. Many countries are still not prepared to regard second line reserves in an
26
international institution as equivalent to till money. But, after all, the various types of
facilities that go to add to international liquidity cannot be in the nature of owned reserves.
4. Doubts have also been expressed about the designation provision, on which the scheme of
SDRs depends. The Fund has the directing role in designation so that participating countries
can get currencies in exchange for their SDRs from member-countries which are in surplus.
The Fund expects members generally not to swap SDRs with currencies and/or gold and viceversa without designation.
It is said that in the absence of designation by the Fund the scheme may not work at all. SDRs
become effective media if each participant accepts the obligation that it will part with its
currency to a maximum of thrice its quota of SDRs. The Fund, as such, has to be assured of
designation, without which members may have to borrow amongst themselves informally.
5. Distribution of SDRs will be based on quotas, which is, something quite irrational. Quotas
are themselves out of alignment with the economic position of different countries. The
distribution of SDRs on the basis of quotas is, therefore, inequitable and arbitrary because
they ignore the needs of the countries on which distribution of SDRs should be based.
6. Again, the freedom of opting in and opting out during the basic period makes the
possibility of empty periods more real and as such SDRs cannot be accumulated continuously
like gold. This brings in an element of uncertainty and makes the whole scheme of limited
value. Moreover, it is said that it provides no solution to the real problem. It does not get to
the root of the problem and provides only marginal help to cover the problem of deficits.
7. Mr. Schweitzer, Managing Director of IMF, did admit that the problem of veto presented a
snag in the scheme. The resistance of any country or a group of countries holding fractionally
27
more than 17 per cent of the voting rights in the IMF would be fatal to such a proposal. This
was the chief reason why the scheme got a mixed reception in USA.
8. It is said that deliberate creation of reserves in the form of SDRs by the conscious
decisions of member-countries is one of the great merits of the schemebut it is also a great
demerit because there is the problem of correct interpretation of global needs. How global
needs are to be defined, understood and what factors are to be taken into accountall present
practical difficulties. Deciding the right quantity of reserves to be created at a time is not an
easy job.
9. Experts like Milton Friedman, Bernstein, Triffin felt that activation of SDRs without
greater flexibility in the exchange rates would be a great mistake. According to these experts
what the international monetary system needs is not a greater capacity to postpone adjustment
which the most that SDRs or any other reserves can providebut a better adjustment
mechanism.
10. To some critics, the entire scheme of SDRs appears to be a rescue operation for the ailing
dollar. The entire scheme is a clever attempt to rehabilitate the dollar by means of collective
international action because the value of the SDR is prescribed to be equal to the present
official gold value of the dollar. (This position had changed in 1976). The whole scheme is in
favour of USA and is disadvantageous to the poor economies.
11. It has also been remarked that the rate of interest on SDRs is very low, being around 1.5
per cent. It will encourage deficit countries to use their SDRs in preference to other reserves
to finance their deficits. On the other hand, the surplus countries will be less eager to
accumulate the SDRs on account of the low rate of interest on them.
28
CHAPTER-5
FUTURE OF SDRs
SDRAs a Private AssetIts Wider Use Likely?
Parallel to the development of the Funds or official SDR, international organizations,
borrowers, and investors looking for a hedge against the current combination of uncertainty
29
interest and exchange rate developments have started using the same unit of account, creating
the commercial or private use of SDR. The value of private SDR is by and large
determined on the basis of the same basket of currencies as the official one.
However, private value and use of SDRs do take into consideration the conventions of market
place and are not constrained by the rules governing the uses of official SDRs. The main
impetus of commercial or private use of SDR came from the simplification of official SDR
basket in 1981 which made it more attractive asset to international financial markets.
As a result, it is now used to denominate a wide range of private financial instruments and
obligations, such as commercial bank current accounts and deposits, syndicated loans, fixed
and floating rate certificates of deposit, floating rate notes and Eurobonds. But the use of
SDR in private markets has developed rather slowly. In 1981, no doubt there was burst of
activity in the use of private SDR instruments but it was not prolonged or widespread enough
so as to create a self-sustained vibrant market for private SDR.
The reasons being the lack of familiarity with the use of SDR due to investors natural
aversion for complexity and weights attributed to its constituent currencies in the basket as
they did not reduce exchange rate risk adequately; the Fund did not actively contribute to the
establishment of private market for SDR denominated instruments, etc.
Usually, the private interest in the SDR is strongest when the US, dollar is weak. A few
transactions are then arranged, but as soon as the US dollar improves the volume tends to
ebb. This was experienced in 1987 and early 1988 when the value of dollar fell. Preferably,
however, the SDR should be viewed as an all-weather instrument and not as a short-run
speculative alternative to currencies.
30
The viability to the SDR rests on the proposition that it is more stable than individual
currencies and that it helps give a means of exchange stability to those whose business is
either in SDRs or who are exposed to exchange risks in several currencies in proportions
approximately matching the composition of the SDR. For the time being, the private market
for SDRs is still small but more than a dozen commercial banks are presently 1987-88
actively accepting short-term currency deposits indexed in SDRs and many pore are
interested in developing this business.
The banks accepting SDR deposits usually will try to cover themselves, for example, in the
forward markets or make loans in the individual currencies; which comprise the SDR. Less
frequently, they extend SDR-denominated loans. The private financial market in SDRdenominated paper is a somewhat specialized marketthis is reflected in the relatively low
volume of notes traded, in the predominance of short maturities, and in the fact that little if
any re-depositing seems to take place.
There are, however, three potential sources of future growth:

(1) The rising number of official institutions based on the SDR and engaged in the private
markets ;
31
(2) The trend toward diversification of central bank reserves, including a possible desire of
central banks to cover open SDR-denominated positions resulting from their indebtedness to
the Fund ; and
(3) The deficit countries, which are familiar with the SDR and may be willing to take up
medium-term banking credit indexed in SDRs to spread their currency risk.
As regards the Fund, no plans exist it the moment to issue SDR-denominated notes to the
market, although the legal possibility exists for the Fund to do so with the consent of the
members whose currencies it would use as a vehicle.
As a trustee of the Trust Fund, the Fund could also, if it so wishes, place SDR deposits with
commercial banks. So far, however, all deposits have been placed with the BIS. The private
SDR could be revived if international market operators anticipate that the considerable
fluctuations and uncertainties in interest and exchange rates of recent years are (1987- 88)
likely to continue and are to be and should be hedged.
Both the Fund and its member central banks could play an important role in making an infant
currency an adult by broadening the scope of private sector use of SDR. Specifically Fund
could enhance its role by being fully committed to support the private use of SDRs, by
augmenting its resources through borrowing from private market, by encouraging more
member-countries that peg their currencies to do so to the SDR and by creating or
encouraging a settlement system for international payments in SDRs.
SDRsFuture Safety Net:

The main purpose of creating the SDR was to make the supply of reserves less dependent on
the official settlement balances of US and to provide an alternative to counteract reserve
32
shortages. It was decided under the First Amendment of the Articles of IMF to allocate SDRs
to meet the need as and when it arises for a supplement to existing reserve assets.
The second Amendment of the Articles of Agreement of IMF in 1976 at Jamaica and
implemented in 1978 exhorted the members to make SDRs the principal reserve asset in the
international monetary system. But despite these efforts SDR could not assume a major role
(as anticipated) in the system.
In fact, its share in the total foreign exchange reserves had actually declined during the last
decade. The use of SDR as a unit of account in private transactions remained limited and the
market for SDR denominated assets and liabilities did not expand much. The limited success
concerning SDR as an international asset may be due to its, features and restricted usability.
Developments in the internationalespecially the expansion of international financial
markets provided a flexible and efficient source of reserves to many countries and accounted
for declining interest in SDRs. Moreover, the emerging trends in multi-currency reserve
system have reduced dependence on single currency in international settlements and reserve
holdings. All this affected the objective of placing the SDR at the centre of the system as the
main reserve asset.
Nevertheless, it is believed that the instrument of SDR still have a useful role to play in
meeting the long-term global needs for supplementing reserves in a system largely based on
borrowed reserves. As such, the availability of SDR as a safety net for future contingencies
must be considered.
33
SDRsNew Allocations:
There is no agreement on the question whether the present situation calls for new allocations
of SDRs. The developed countries led by USA argue that there is at present no clear evidence
of a long- term global need to supplement international reserved, given the present state of
total reserves and lending from international markets. They think that international financial
markets and official channels provide adequate means of meeting the global demand for
reserves and regular SDR allocations would lead to excessive liquidity creation apart from
inflation.
The developing and underdeveloped countries, on the other hand, stress for new and regular
allocations of SDRs. They argue that the severe strains that have been built up in the system
over the last decade or so are reflected in the decline of reserves in relation to imports and
foreign debt, the lopsided distribution of reserves and the rise of barter trade. Apart from
short-term considerations relating to the state of liquidity, a resumption of SDR allocations is
justified by long-term systematic considerations also.
Long-term growth of trade must be supported by an expansion of international reserves
SDRs, therefore, should be rejected into the system in accordance with a steady quantitative
rule so designed that their relative role in official reserves would expand gradually over time.
It is rather sad that developed countries should take such a technical and narrow view that
there is no global need and, therefore, no need to create SDRs. Affluent countries argue that
the gravity of debt problems calls more for adjustment policies and conditional financing than
the general creation of SDRs.
The arguments advanced by developed countries led by USA miss basic facts: First, reserve
assets in the shape of SDRs are owned reserves and as such are qualitatively different from
34
reserves acquired through international commercial borrowings; Second, the terms and
conditions at which commercially borrowed reserves are supplied, reflect more than the
borrowers own policies and performance on which hinges their credit-worthinessapart
from the fact that such borrowings entail heavy costs.
An allocation of SDRs on regular basis will enable these (developing) countries to have at
their command additional liquidity at no cost. Since interest is payable on the net use of
SDRs. The fact cannot be ignored that the rich countries continue to approach the issue of a
fresh and regular allocation of SDRs in terms of minimum role it can playto tide over the
problem of debt burden and not in terms of resources to those who need them most for
development.
During the period since the first allocation of SDRs, the international monetary system has
undergone a number of structural changes. The first of these was the suspension of the
convertibility of official US dollar balances into gold in August 1971. Second was the
breakdown of the system of fixed exchange rates and the advent of greater exchange rate
flexibility.
Third was the expansion and integration of international credit markets, particularly those
involving bank assets and liabilities. And fourth was the growth in the importance of
currencies other than the US dollar in official reserves. According to the authors of the IMF
Occasional Paper, these structural changes significantly altered the mechanisms through
which reserves are provided and have had far-reaching consequences for the international
monetary system as a whole.
They point out that since the first allocation of SDRs, increasing attention has been paid to
the potential contribution of the SDR to the stability of the international monetary system.
35
The argument has been made that excessive borrowing could be avoided or reduced if
reserves were regularly supplied through different channels, particularly by allocating SDRs.
In addition, they observe, it has been suggested that the SDR might play a role in controlling
the amount of international liquidity. It is a pity that in spite of the stated objective of making
SDR the principal reserves asset of the international monetary system, the IMF could not so
far achieve consensus on the contribution of SDR to the creation and distribution of
international reserves.
Consequently, SDRs role in the system has been minimal and the reserve currencies,
particularly the US dollar, continue to dominate the supply of international reserves.
Nevertheless, SDR remains the only reserve asset through which the IMF can effectively
regulate the amount and distribution of international reserves. Every effort should, therefore,
be made to strengthen the role of SDR as a component of international reserves as well as a
unit of account.
36
CHAPTER-6
CONCLUSION
In recent years there have been major differences about the future role of the SDR in the
international financial system. The major industrialised countries have repeatedly blocked
moves for a new allocation of SDRs. For the reserve currency issuing countries, other
industrialised countries and even some of the middle-income countries - during some or most
of the time - , international capital markets can meet their liquidity requirements.
However, for the vast majority of developing and transition economies, the cost of acquiring
and holding reserves is very high, whether it be through borrowing - where this is possible or through adjustment. This has a negative impact on the capacity of many countries to
finance growth and poverty reduction. Large deficits in reserve issuing currencies can also
bring their own problems, and may threaten global financial stability. Indeed, the very large
and growing size of the US current account deficit could become very problematic and
destabilising.
The time has come, therefore, to revisit the case for using SDRs to increase world reserves in
a way that would not oblige countries to run either large surpluses or large deficits, as these
are costly and potentially destabilising. Periodic SDR allocations could play a useful role in
improving the distribution and quality of total global reserves.
A more specific role for SDRs in the international financial system could be the provision of
sufficient resources to the IMF for financing large-scale official emergency lending in times
of crisis. The current level of IMF resources, despite recent increases, cannot be relied upon
to provide the scale of lending necessary to restore market confidence during periods of
intense financial panic. In this sense, it is welcome that the G-24, at their September 2000
37
meeting in Prague, reiterated their call for a study on a systemic emergency facility financed
through the temporary creation of SDRs.
The SDR could therefore usefully play a stronger role in the international financial system,
encouraging greater stability and bringing net benefits for both developing countries and the
global system as a whole
The short and chequered history of SDRs may be viewed as disappointing only when
measured against the grand hopes that were expressed about them at their birth. Although
they arrived too little, and too late to save the Bretton Woods system, they have been
adapted to postBretton Woods arrangements and were an important part of the liquidity
package put together to respond to the international financial crisis. Technical work has
continued on enhancing their role. The SDR's prospective contribution to international
monetary stability and the world economy remains considerable.
Thus, in order to enhance SDRs role in the international monetary system three
conditions are essential:
First, allocations should be made at regular intervals so that SDR constitutes a large
proportion of the total international reserves.
Second, the use of SDR in transactions outside the official circles should be enhanced.
Third, the future allocations of SDR should be determined by countries need for additional
reserves rather than their IMF quotas. This would give less developed countries a larger share
of SDR allocations to help replenish their international reserve assets.
38
CHAPTER-7
BIBLIOGRAPHY
ARTICLES & REFERENCES
1. "Kazakhstan, Republic of: Financial Position in the Fund as of May 31, 2011".
International Monetary Fund. Retrieved June 25, 2011.
2.
"Resident Representative Office in the Pacific Islands". International Monetary
Fund. Retrieved June 24, 2011.

3. "Resident Representative Office in Kosovo". International Monetary Fund.
RetrievedJune 25, 2011.
4. . International Monetary Fund. March 20, 2009. Retrieved June 25, 2011.
5. "Macedonia, former Yugoslav Republic of: Financial Position in the Fund as of May
31, 2011". International Monetary Fund. Retrieved June 25, 2011.
6. "Moldova, Republic of: Financial Position in the Fund as of May 31, 2011".
International Monetary Fund. Retrieved June 25, 2011.
39

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