INTERNATIONAL

FINANCE ASSIGNMENT
Special Drawing Rights

Group 9

Aman Agarwal:UM20132
Devanshi Shah:UM20142
Ramneek Singh:UM20160
Rasi Sarda:UM20161
Shivani Kalapatapu:UM20165
Shivani Sharma:UM20167
Table of Contents

INTRODUCTION TO SPECIAL DRAWING RIGHTS .............................................................................. 2

ROLE OF SDR......................................................................................................................................................... 2

REQUIREMENTS OF SDR-................................................................................................................................ 3

SETTLING CLAIMS WITH SPECIAL DRAWING RIGHTS- ................................................................. 3

SDR INTEREST RATE: ....................................................................................................................................... 6

SDR ALLOCATION .............................................................................................................................................. 7

SDR OPERATIONS ............................................................................................................................................... 8

A GIST: ........................................................................................................................................................................ 8
HOW DOES SDR WORK? ......................................................................................................................................... 9

CONCLUSION: .................................................................................................................................................... 10

REFERENCES: .................................................................................................................................................... 11

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Introduction to Special Drawing Rights
Special drawing rights refer to an interest bearing supplementary foreign exchange reserve assets
that were created by the IMF in 1969 to supplement the shortfall of gold and U.S. dollars. They
are not visible or tangible like a currency. Instead, they function as a bank balance. Like a bank
account, they represent those funds that a country owns and can use to settle its accounts with
other nations should its balance of payments position put it in a net debtor status. Since it can be
used to offset deficits in the balance of payments just like gold or reserve currencies, it is also
called paper gold. SDRs cannot be held by private parties and are allocated only to sovereign
nations by the IMF itself. As of October 2014, the number of SDRs stands at XDR 204.9 billion.

When it first came into existence, the value of SDR was pegged to the value of fine gold-
0.888671 grams of it, to be precise, which was also the value of the U.S dollar back then.
However, after the Bretton Woods fixed exchange rate system fell apart, and many large
developed countries started accepting floating exchange rates, it was decided that SDR would be
defined by a basket of key international currencies. Hence, the value of an SDR is calculated
based on a basket of five international currencies viz, U.S. dollar, British pound sterling, Chinese
Renminbi (added to the basket in 2016), euro, and Japanese yen. The basket is reviewed and
adjusted by the IMF once every five years. The currency value of SDR is calculated on a daily
basis and published on the IMF website. As on June 22,2021, one SDR was worth $1.426480.

Role of SDR
The International Monetary Fund (IMF) employs an SDR as a fictitious currency and relies on it
for internal accounting purposes. The SDR is made up of a basket of major currencies from
around the world. The IMF assigns SDRs to its members, demonstrating their governments'
complete trust and support. Every five years, the SDR is re-evaluated.
The SDR was created with the goal of being a standout feature of international reserves. Gold
and reserve currencies, on the other hand, would be a negligible component of such reserves.
As was the case during the global financial crisis, SDR allocations can help provide liquidity and
bolster member countries' government reserves.
The IMF and other international organizations use the SDR as their accounting unit.

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The SDR is neither a currency nor a claim on the International Monetary Fund. Rather, it is a
prospective claim on IMF members' freely useable currencies. These currencies can be
exchanged for SDRs.

Requirements of SDR-
In the year 2000, the current conditions for inclusion in the SDR were created.
According to the Board, the SDR basket will be made up of currencies from members or
monetary unions "whose exports had the largest value over a five-year period, and have been
determined by the IMF to be freely usable."
According to the IMF, a currency is "Freely usable" if it is "widely used to make international
payments and widely traded in the major exchange markets."
What is "freely usable" is determined by the number of shares of the currency in reserve
holdings, the currency denomination of international debt securities, the volume of transactions
in foreign exchange markets, cross-border payments, and trade finance.

Settling Claims with Special Drawing Rights-

The SDR isn't considered a currency or a claim on IMF assets. It is a potential claim against the
IMF member states' freely useable currencies. A freely usable currency, according to the IMF's
Articles of Agreement, is one that is extensively used in international transactions and often
exchanged in foreign exchange markets.
SDRs can be exchanged for freely useable currencies by IMF member states consenting to
voluntary swaps or by the IMF urging nations with stronger economies or greater foreign
currency reserves to purchase SDRs from the less-endowed members. Member nations of the
IMF can borrow SDRs from reserves at a low interest rate, mostly to improve their balance of
payments.

Basket of currencies:
The SDR was first defined as being equivalent to 0.888671 grams of pure gold, which was also
equivalent to one U.S. dollar at the time. The SDR was renamed a basket of currencies once the
Bretton Woods system collapsed.
The decision to replace the sixteen-currency basket with one made up of the currencies of the

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five greatest industrial countries (the freely useable currencies) is gaining traction within the
banking world. At a time when huge payments imbalances have emerged as a results of oil price
hikes, currency fluctuations and interest rate differentials are problems for both lenders and
borrowers. The Euromarkets are tasked with recycling capital from surplus to deficit countries,
and floating currency rates have turned most international financial transactions into speculative
activities. In this situation, a unit of account made out of the five freely accessible currencies
provides benefits to plug participants.

Criterion:
For currencies to be included within the SDR basket, both the export requirement and also the
freely usable condition must be met. The export criteria are met if the currency issuer is a
monetary union or an IMF member that should also be one of the amongst the top five global
exporters. The IMF considers a currency to be "freely useable" if it is extensively used to make
foreign payments and widely traded on major exchange markets.

Current Situation:
Every five years or earlier as requires, the SDR basket is revised to confirm that it accurately
reflects the relative importance of each currency within the world's trading and financial systems.

Currency Weights determined in the 2015 Fixed Number of Units of

Review Currency for a 5-year period
Starting Oct 1, 2016

U.S. Dollar 41.73 0.58252

Euro 30.93 0.38671

Chinese Yuan 10.92 1.0174

Japanese Yen 8.33 11.900

Pound Sterling 8.09 0.085946

Source-IMF

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After the World War-2, the Bretton Woods Agreement designated the U.S. dollar as the
international currency, and it is now the most widely used currency for international transactions.
Most people consider the U.S. Treasury to be risk-free, giving the country a low-risk premium.
As a result, countries keep U.S. dollars in reserve since the currency keeps its value reasonably
well over time.
Share of currencies held in global foreign exchange reserves from 1st quarter 1999 to 4th
quarter 2020:

U.S. dollar (USD) Euro (EUR) Japanese Yen (JPY)

Share of foreign exchange reserves

Pound sterling (GBP) Chinese renminbi (CNY) Canadian dollar (CAD)

Australian dollar (AUD) Swiss franc (CHF) Other currencies

120%
100%
80%
60%
40%
20%
0%
Q1 1999
Q1 2000
Q1 2001
Q1 2002
Q1 2003
Q1 2004
Q1 2005
Q1 2006
Q1 2007
Q1 2008
Q1 2009
Q1 2010
Q1 2011
Q1 2012
Q1 2013
Q1 2014
Q1 2015
Q1 2016
Q1 2017
Q1 2018
Q1 2019
Q1 2020
Currency

Source-Statista

The Chinese renminbi (yuan) has been included in the International Monetary Fund's Special
Drawing Rights (SDR) basket since 2016. This decision acknowledged the renminbi's role as a
reserve currency, particularly in Asian countries. China also has substantial foreign exchange
reserves, owing to its enormous positive trade balance.

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SDR Interest Rate:
The SDR is used to calculate the interest rate that members pay on non-concessional borrowing
from the IMF. It is also used to pay members for their remunerated creditor positions in the IMF.
It also refers to the interest paid on SDR holdings and the interest charged on SDR allocations.
The SDR's value is determined by a weighted basket of major currencies, which includes the US
dollar, euro, Japanese yen, Chinese yuan, and British pound.
The interest rate on each component currency in the SDR basket's financial instrument, given as
an equal yearly bond yield: three-month benchmark yield for China Treasury bonds published by
China Central Depository and Clearing Co; three-month spot rate for euro area central
government bonds with an AA+ rating issued by the European Central Bank; three-month
Japanese Treasury Discount bills; three-month UK Treasury bills; and three-month US Treasury
bills.
The SDR is calculated weekly using a weighted average of representative interest rates on short-
term government debt instruments in the SDR basket countries' money markets, with a five-
basis-point floor. It can be seen on the IMF's website. An example is shown below:

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SDR Allocation
SDR allocations can play a role in providing liquidity and supplementing member countries’
official reserves, as was the case amid the global financial crisis.
SDRs are issued by the International Monetary Fund (IMF) to countries and cannot be stored or
utilized by individuals.
In August 2009, there were approximately 21.4 billion SDRs in circulation and 182.6 billion was
provided to "supply liquidity to the global economic system and complement member countries'
official reserves" during the global financial crisis of 2009. By October 2014 SDRs were XDR
204 billion. Recently, economists and finance ministers from poorer nations have urged for a
new $4 trillion allocation to help member economies recover from the worldwide pandemic. The
G24 and others recommended a $500 billion budget investment for this aim in March 2021.

SDR allocations are extremely rare, with the IMF only doing so four times in its history: in 1970-
72, when SDRs were first introduced as a unit of account; in 1979-81; in 2009, to aid in the
recovery from the 2008 financial crisis; and most recently, in 2021, in response to the Covid-19
crisis. To compensate nations that joined the IMF after 1981 but had never received an SDR
allocation, a special allocation was granted in 2009.
On August 23, 2021, India received INR 1.3 lakh crores ($ 18 billion) in Special Drawing Rights
from the IMF (SDR).

The IMF Board of Governors agreed a global distribution of SDRs approximately to US$650
billion (roughly SDR 456 billion) on August 2, 2021, to address the long-term global
requirement for reserves and assist nations India receives 2.6 percent of the total allocation,
which is proportional to its voting rights.

The allocation aims to meet the world's long-term reserve needs, promote global economic
resilience and stability, and assist liquidity-strapped countries in dealing with the COVID-19
epidemic. SDRs can be used for a variety of reasons by countries. This could involve paying for
imports (increasing the balance of payments), paying off debts, or using the funds for domestic
public investments (such as social protection, health, and education), or any other purpose.

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SDR Operations
A gist:

A country's reserve at the IMF represents the amount that a country can draw automatically from
the IMF, that is unconditionally and without prior permission.

• Each member contributes 25% of its quota in the form of foreign currencies and
SDRs and the balance 75% in its own currency.
• The 25% that has been contributed in the form of SDRs and foreign currencies is
called the Reserve Tranche, which can be borrowed.
• However, it may so happen that some other country has purchased some of its
currency from the IMF. If so, then it can borrow more than its reserve tranche.
• However, if it has purchased some other country's currency from the IMF, then it
can only borrow less than its reserve tranche.

Clarification on the same can be provided with the help of an example:

Assume that Australia's quota is 1000 AUD, of which it has contributed 250 in the
form of SDRs and 750 in the form of AUD. Now suppose, that Singapore has
borrowed 300 AUD from the IMF. If so, Australia's reserve position at the IMF
= 250 + 300 = 550 AUD.

This 25% of the SDRs can be used by IMF members and the IMF complying with the AoA and
decisions of the Executive Board and Board of Governors. The International Monetory Fund has
the authority to prescribe other holders of SDRs, non-members, member countries that are not
SDR Department Participants, institutions that perform the functions of a central bank for more
than one member, and other official entities.

As of end-January 2021, there were 15 organizations approved as prescribed holders.

• Prescribed holders may not receive allocations of SDRs.

• SDRs cannot be held by private entities or individuals.

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 • Participating members and prescribed holders can buy and sell SDRs in the
voluntary market. If required, the IMF can also designate members to buy SDRs
from other participants.

How does SDR work?

(1) SDR's would be activated for five years at a time with an agreed amount of new SDR's
distributed each year. Initially a distribution of $ 1 billion to $ 2 billion each year over the first
five-year period is planned. This would make available $ 5billion to $ 10 billion of new reserves
in this period.

(2) The amount of SDR's distributed annually could be changed during as well as at the end of, a
five-year period on a fresh ballot of at least 85% of IMF votes.

(3) The SDR's would be distributed to IMF members in proportion to their IMF quotas. Out of a
total distribution of $ 1billion each year Britain would get about $100million, U.S* about $ 220
million, Germany $53 million and France $45 million SDR's.

(4) A crucial difference between SDRs and conventional drawing on the IMF is that the former
would add permanently to world reserves in a way that the latter does not. When Britain, makes
a conventional drawing of $ 50 million on the IMF it pays in that amount of Sterling in exchange
for foreign currencies and at the end of three to five years has to reverse the transaction. Under
the new scheme Britain would transfer$ 50million of its SDR's to say Germany in exchange for
Deutsch marks. Britain's holdings of SDR's would foil and Germany's would rise accordingly.
But Britain's total reserves would be run down only as Britain spends the Deutschmarks.

(5) Countries would be allowed to use a net average of 70% of the SDR's over a five-year period
without any obligation to reconstitute. They will be obliged to reconstitute any excess above that
by using their own currencies to purchase foreign exchange which they must make available to
creditors.

(6) Because of the net average rule, Britain could draw down the whole of its annual $ 100
million SDR's allocation for four years running and still stay virtually within its obligations by
not touching any of its allocation in the fifth year.

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(7) No country would be obliged to supply more of its currency than twice the equivalent of its
own allocation of SDR's.

(8) The system shall be having a built in stabilizing mechanism because the deficit countries
would be drawers and much of the demand would tend to be for the currencies of the countries
which are in Balance of Payment surplus.

(9) SDR's would be gold guaranteed in order to eliminate risks.

Conclusion:
SDRs were designed in the late 1960s to address potential sovereign liquidity shortfalls. But as
time passed, it was clear that they failed to serve this primary purpose. On top of this, the
distribution of SDRs according to IMF quotas was also condemned by critics for being
discriminatory. The officials of IMF were concerned more with the successful establishment of
the SDR facility than with the equitable distribution of the SDRs, which led to the inequity in the
SDR distribution arrangement. As a final blow, developments in the global economy in the
1970s diminished the stature of the SDR to an auxiliary reserve asset.

Today SDRs have renewed importance in the face of the COVID-19 pandemic. As the world
experiences financial fragility, SDRs can be an invaluable tool for addressing urgent liquidity
challenges. Although they are not a long-term remedy for the underlying problems, SDRs can be
used to service debts and finance critical expenditure. For emerging markets, foreign currency-
strapped economies, and lower-income economies in South Asia and Africa, SDRs can provide
the means to pay for vaccines and/or other necessary health care investments. Hence it is time
IMF and the wealthier nations act quickly and utilize SDRs to accelerate the post-Covid recovery
of these nations and usher in financial stability for the world economy.

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References:
• https://www.investopedia.com/terms/s/sdr.asp

• https://www.imf.org/en/Topics/special-drawing-right/2021-SDR-Allocation

• https://www.thenewsminute.com/article/let-s-talk-about-india-s-sdrs-using-imf-s-rs-13-
lakh-crore-allocation-boost-our-social?amp

• https://www.cgdev.org/publication/challenge-reallocating-sdrs-primer

• https://corporatefinanceinstitute.com/resources/knowledge/finance/special-drawing-
rights-sdr/

• https://www.imf.org/en/About/Factsheets/Sheets/2016/08/01/14/51/Special-Drawing-
Right-SDR

• http://www.statista.com.xavier-library.remotexs.in/statistics/233674/distribution-of-global-
currency-reserves/

• Cameron, Duncan. “Special Drawing Rights.” International Journal, vol. 36, no. 4, [Sage
Publications, Ltd., Canadian International Council], 1981, pp. 713–31,
https://doi.org/10.2307/40201998.

• Neumann, Manfred J. M. “Special Drawing Rights and Inflation.” Weltwirtschaftliches

Archiv, vol. 109, Springer, 1973, pp. 232–52, http://www.jstor.org/stable/40437685.

• KAZMI, S. AQDAS ALI. “Special Drawing Rights and International Liquidity.” The Punjab
University Economist, vol. 8, no. 2, Department of Economics, University of the Punjab,
1970, pp. 153–60, http://www.jstor.org/stable/25821332.

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