Special Drawing Rights (SDRs), also known as the paper gold, are a form of international reserves created by the International Monetary Fund (IMF) in 1969 to solve the problem of international liquidity. They are not paper notes or currency. They are international units of account in which the official account of the IMF are kept.
Origin of Special Drawing Rights
Special Drawing Rights were created through the First Amendment of the Fund Articles of Agreement in 1969 following persistent US deficits in balance of payments to solve the problem of liquidity. Until December 1971, an SDR was linked to 0.88867 gram of gold and was equivalent to US $1. With the break down of fixed parity system after 1973 when the US dollar and other major currencies were allowed to float, it was decided to stabilize the exchange value of the SDR. Accordingly, the value of SDR was calculated each day on the basis of a basket of 16 most widely used currencies of the member countries of the Fund. Each country was given a weight in the basket in accordance with its importance in international trade and financial markets.
After the Second Amendment of the Fund Articles of Agreement in 1978, the SDR became an international unit of account. To facilitate its valuation, the numbers of currencies in the “basket” were reduced to five in January 1981. They include the US dollars, the German Deutsche Mark, the British Pound, the French Franc and the Japanese Yen. The present currency composition and weighting pattern of the SDR is revised every five years beginning January 1, 1986. The revision of weights is based on both the values of the exports of goods and services and the balances of their currencies held by other members. In 1977, they were US dollar (39%), German DM (21%), UK Pound and French Franc (11% each) and Japanese Yen (18%). The value of one SDR was equal to US $1.35610 on October 1, 1997.
Uses of SDRs
Special Drawing Right is an international unit of account which is held in the Fund’s Special Drawing Account. The quotas of all currencies in the Fund General Account are also valued in terms of the SDR.
Special Drawing Rights are used as a means of payment by Fund members to meet balance of payments deficits and their total reserve position with the Fund. They cannot be used for any other purpose. Thus SDRs act both as an international unit of account and a means of payment.
There are three principal uses of Special Drawing Rights:
- Transactions with Designation: Under it, Fund designates a participant in the SDR scheme who has a strong balance of balance of payments and reserve position to provide currency in exchange for SDRs to another participant needing its currency.
- Transactions with General Account: SDRs are used in all transactions with the General Account of the Fund. Participants pay charges in SDRs to the General Account for the use of the Fund resources and also to repurchase their own currency from it.
- Transactions by Agreement: The Fund allows sales of SDRs for currency by agreement with another participant.
In order to further widen the uses of Special Drawing Rights, the Second Amendment empowered the Fund to lay down uses of SDRs not otherwise specified. Accordingly, the following additional uses of SDRs are:
- in swap arrangements,
- in forward operations,
- in loans,
- in the settlement of financial objections,
- as security for the performance of financial obligations,
- in dominations or grants.
The Fund pays interest on all holdings of Special Drawing Rights kept in the Special Drawing Account and charges internet at the same rate on allocations to participants.
Merits of SDRs
The Special Drawing Rights scheme possesses the following merits:
- SDRs are a new form of international monetary reserves which have been created to free the international monetary system from its exclusive dependence on the US dollar.
- They have rid the world of its dependence on the supply of gold and fluctuations in gold prices.
- They cannot be demonetized like gold or become scare when the demand for dollar increases in the world.
- Unlike gold, SDRs are costless to produce because production of gold requires resources to mine, refine, transport and guard it.
- SDRs have been created to improve international liquidity so as to correct fundamental disequilibrium in balance of payments of Fund members. Under this scheme, the participants receive SDRs under transactions with designation and transaction by agreement unconditionally.
- Fund members are not required to change their domestic economic policies as they are expected under the Fund aid programmes.
- The payment and repayment of SDRs out of the Special Drawing Account is easier and more flexible than under the Fund schemes.
- Last but not the least, SDRs act both as a unit of account and a means of payment of international monetary system.
Criticisms
Despite these merits, the SDR scheme has been criticized in the following grounds:
- Inequitable Distribution: It is an inequitable scheme which has tended to make unfair distribution of international liquidity. The allocation of SDRs to participating countries is proportional to their quotes.
- Not Linked with Development Finance: SDR scheme does not link the creation of international reserves in the form of SDRs with the need for development finance on the part of developing countries.
- High Interest Rate: The interest rate originally payable on net use of SDRs is 1.5 percent.
- Failure to Distribute Social Saving: Williamson and others have criticized the SDR scheme for its failure to distribute social saving of SDRs to the developing countries. The present rules for allocation distribute the social saving to a participant country in proportion to his contribution or its demand for SRDs.
- Failure to Meet International Liquidity Requirement: The Fund has failed in its objective of increasing international liquidity through SDRs.