Exploring the Power of SDR in Boosting Global Financial Resources for Post-COVID-19 Recovery
Bukhari Sillah
02 Mar, 2022
Introduction
The global economy is slowly recovering from the COVID-19 crisis, but the path to broad-based recovery is uncertain, with growth prospects diverging widely between advanced and developing countries. Many developing economies have been hit harder by the pandemic than advanced economies. Millions have been pushed into poverty, and food insecurity has sharply risen significantly in poor fragile, and conflict-affected countries. Urgent priorities are to contain the pandemic and build economic resilience and green economies to avoid a major decline in people’s well-being and reduce economic scarring from the Covid-19-induced crisis. This calls for increased international cooperation and innovative resource mobilization.
Large stimulus packages of advanced countries cushioned the global impact of the pandemic. But international support has fallen short of the necessary liquidity and fiscal support for developing countries. Concessional resources should be an essential part of the global financial response to avoid prolonged damage to the development prospects of low-income countries. In this respect, Special Drawing Rights (SDRs) could provide tremendous liquidity and concessional resources for developing countries that now face acute twin deficits.
What is SDR?
Introduced in 1969 as a reserve asset, the SDR consists of the US dollar, Euro, British Pound, Japanese Yen, and Chinese renminbi.[1] Countries can borrow from the SDR against their official reserves to meet their balance of payments. Borrowing or lending SDR entails an interest rate, which is determined weekly based on a “weighted average of representative interest rates on short-term government debt instruments in the money markets of the SDR basket currencies, with a floor of 5 basis points”.[2] The SDR is a product of the Bretton Woods Agreement, and its importance within the international finance system has diminished after the Bretton Woods agreement collapsed and the world moved to a floating exchange rate mechanism. For an SDR to be allocated, the decision must receive an 85 percent majority of the total voting power of the members in the SDR Department. The allocation is distributed to member countries in proportion to their quota shares at the Fund. The important merit of SDRs is that it has freed the international monetary system from its exclusive dependence on the U.S. dollar and fluctuations in gold prices. With SDRs, the payment and repayment of money have become easier and more flexible. In addition, the IMF has adopted a series of decisions allowing the additional uses of SDRs in swap arrangements, forward operations, loans, the settlement of financial objections, and as a security for performance of financial obligations and donations.
| Table 1: SDR allocations since inception | ||
|---|---|---|
| Date | Amount | Remarks |
| 1970 – 1972, General allocation | SDR 9.3 billion | Yearly installments |
| 1979 – 1981, General allocation | SDR 12.1 billion | Yearly installments |
| August 2009, Special allocation | SDR 21.5 billion | To enable countries that joined the IMF after 1981 (after previous allocations) to participate in the SDR system on an equitable basis |
| September 2009, General allocation | SDR 161.2 billion | To boost global liquidity in the face of the 2008 – 2009 Global Financial Crisis |
| August 2021, General allocation | SDR 456.5 billion | To support liquidity-constrained countries in addressing the impact of the COVID-19 pandemic |
| Total | SDR 660.6 billion (US $(943 billion) | |
On August 2, 2021, the Board of Governors of the IMF approved a general allocation of SDRs equivalent to US$650 billion (about SDR 456 billion, Table 1)) to boost global liquidity at a time of unprecedented crisis. It is the largest SDR allocation in the history of the IMF, and it is credited to IMF member countries in proportion to their existing quotas in the Fund. The quota share of Emerging Market and Developing Economies is 42.2 percent, while that of low-income countries is at 3.2 percent.[3]It is estimated that around US$275 billion (about SDR 193 billion) of this allocation would go to emerging markets and developing countries, including low-income countries. Given the mismatch between SDR allocation and external balance positions, the IMF looks to members with strong external positions to voluntarily channel part of their SDRs to scale up lending for low-income countries through the IMF’s Poverty Reduction and Growth Trust (PRGT). Other options could include channeling SDRs through multilateral development banks (MDBs) to help poorer and more vulnerable countries in their recovery efforts.
How could MDBs Use SDRs to Enhance Their Operations and Capital?
The SDRs scheme has been criticized for favoring rich nations. Further, it has been said that it is an inequitable scheme that has tended to result in unfair distribution of international liquidity. Oftentimes, its allocation rights do not match the balance of payment challenges of the countries. Those countries in high need, especially low-income countries, have small allocations of SDRs, while rich advanced countries get most SDR allocations. It is worth noting that the IMF has undertaken significant efforts to remedy this mismatch to support poor countries. For example, the Poverty Reduction and Growth Trust (PRGT) and the Resilience and Sustainability Trust (RST) are channels that have been approved to deal in SDRs. Also, non-members and official entities could be designated as prescribed holders of SDRs. At present, there are 15 prescribed holders comprising union or regional central banks, intergovernmental monetary institutions, and development institutions, including the Islamic Development Bank.[4]
Participation of MDBs in SDRs could allow for multilateral coordination on the ‘use of financing instruments that have their own characteristics, and it can at the same time guarantee the maintenance of the status of SDRs as reserve assets.’[5] SDR operations could be considered as subsidized financing instruments whose interest rates would be lower than or equal to the concessional loans of MDBs.
MDBs could participate in SDRs in many ways, specifically:[6]
- Through the direct allocation by the IMF to MDBs using the arrangement and technicalities deployed for PRGT and RST. This will expand the use of SDRs and, at the same time, result in fast and efficient resource delivery to low-income countries.
- Most allocation rights of SDRs often do not match the balance of payment needs of participating members. In other words, those with the most rights to receive SDRs do not face balance of payment constraints. But members with excess SDRs could channel their SDRS to MDBs for on-lending to other members in need. Channeling through MDBs rather than directly to a member in need guarantees credit quality and maintenance of SDRs and a reserve unit.
- Besides on-lending of SDRs, MDBs could also accept SDRs as capital subscriptions from their member countries. This will, in turn, enhance liquidity and financing resources, as it helps MDBs leverage their lending capacity.
Furthermore, using blockchain-based crypto-asset technology, crypto-SDR could be a game-changer in development financing. Former IMF Managing Director Christine Lagarde raised the possibility of launching a digital version of the SDR, dubbed “IMFCoin”.[7] This could reinvigorate the SDR’s standing in the international financial system because a digital currency might replace the dollar as a reserve currency in international trade transactions. Furthermore, linking the crypto-SDR to development objectives through MDBs could create uniform currency for development financing. Crypto-SDR could be easily tracked and monitored, and thus, its impact can be easily evaluated. Blockchain technology and smart contracts allow for transparency and verifiability of the use of the crypto-SDR funds, which significantly enhances the proper governance of development financing. SDR crypto could also become a social cryptocurrency proposed by Sami Al-Suwailem[8] if its interest-bearing feature could be dropped. The proposal identified three key stakeholders of the social cryptocurrency, and they are a managing authority, target beneficiary (socially disadvantaged groups/individuals and micro and small enterprises), and service providers (business proving goods and services). MDBs could function as credible managing authority for a social SDR-crypto that enjoys global acceptance. Given their longstanding experience in social development projects, MDBs could efficiently and effectively channel social SDR-crypto towards social development interventions that hardly attract commercial interest.
More broadly, major MDBs could put together a global “build-back-better” compact program—or a set of regional compacts—and use the SDRs to finance what the MDBs jointly agree to be the most critical components of a global post-COVID19 recovery in the poorest developing countries for long-term investments for economic resilience and sustainable future.
Another option is to allocate the SDRs through the major MDBs but in the form of partial risk and/or partial credit guarantees to incentivize the international private sector to invest heavily in quality green infrastructure in poor countries as a way of addressing both the post-COVID19 economic recovery and COP21/26 objectives.
SDRs could also be used to support a large expansion of trade finance for SMEs in eligible MCs to sustain the tradable segment of the economy as a source of inclusive and productive/competitive employment growth. Well-planned and managed trade finance programs have a comparatively fast turnaround of the funds so that they can leverage a lot of growth and employment for the participating countries.
However, MDBs’ use of SDRs for capital and financing operations requires the coordinated efforts of the IMF, member countries, and rating agencies. Rating agencies should recognize and treat this new instrument with special consideration so that dealing in SDRs should increase the rating quality of MDBs and not otherwise.
Concluding remarks
SDRs could be a powerful international currency providing necessary liquidity and financial resources for the global recovery, and more importantly, for low-income countries that are witnessing acute twin deficits after the pandemic-induced recessions. MDBs could complement IMF and its related channels of PRGT and RST to harness the power of SDRs for the global good.
[1] The Chinese renminbi was added as the fifth currency in the SDR basket on October 1, 2016.
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