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

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CHAPTER NO.2.WHAT IS SDR

SDR is an international type of monetary reserve currency, created by the International Monetary Fund (IMF) in 1969, which operates as a supplement to the existing reserves of member countries. Created in response to concerns about the limitations of gold and dollars as the sole means of settling international accounts, SDRs are designed to augment international liquidity by supplementing the standard reserve currencies. SDRs could be regarded as an artificial currency used by the IMF and defined as a "basket of national currencies". The IMF uses SDRs for internal accounting purposes. SDRs are allocated by the IMF to its member countries and are backed by the full faith and credit of the member countries' governments.

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

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Created in 1969 to supplement a shortfall of preferred foreign exchange reserve assets, namely gold and the US dollar, the value of a SDR is defined by a weighted currency basket of four major currencies: the US dollar, the euro, the British pound, and the Japanese yen. SDRs are denoted with the ISO 4217 currency code XDR. SDRs are allocated to countries by the IMF. Private parties do not hold or use them. As of March 2011, the amount of SDRs in existence is around XDR 238.3 billion, but this figure is expected to rise to XDR 476.8 billion by 2013. Public SDRs SDRs are an arcane and complex topic.According to the IMFs website, the SDR is an international reserve asset, created by the IMF in 1969 to supplement the existing official reserves of member countries (IMF 2009c: p. 1). With the agreement of the Executive Board, the Fund periodically allocates official SDRs to member countries in proportion to their IMF quotas. A basket of currencies comprise the SDR. The Fund and the Board review the currencies included in the SDR every five years. Presently, the currencies included in the SDR are those currencies issued by Fund members whose exports of goods and services during the five-year period ending 12 months before the effective review date had the largest value and that are freely useable (IMF 2005: p. 6). SDR weights are currently based on the value of exports and the amount of reserves denominated in the respective currencies. Private SDRs The IMF created SDRs in 1969 as an international reserve asset meant to support the Britton Woods fixed exchange rate system by supplementing the existing
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reserves of member countries. Since 1972 the Fund has also used the SDR as its basic unit of account. Over time, the SDR has found a number of applications outside the IMF official framework. Current accounting uses of the SDR include: Transit fees in the Suez Canal are denominated in SDRs. Some airlines now designate charges for overweight baggage in SDRs. A number of international organizations maintain their accounts in SDRs or accounting units linked to the SDR. The Arab Monetary Fund, for instance, maintains its accounts in Arab Accounting Dinars (AAD), which are linked to the SDR. In the past, some countries, such as Latvia, have pegged their currency to the SDR. Coats (1990) suggests that the SDRs attractiveness as a unit of account for private sector use derives from the stability of its value relative to values of alternative units. By virtue of their currency composition, SDRdenominated securities can serve as a diversification vehicle and as a partial hedge against currency risk. For example, at the time the first SDR was created in 1969, 1 SDR was equivalent to 0.888 grams of fine gold and/or $1.00.

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CHAPTER NO.3.HISTORY OF SDR

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

The SDR

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

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CHAPTER NO.4.ROLE & CHARACTERISTICS OF SDR

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

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

The SDRs value is based on a basket of key international reserve currencies issued by IMF members (or monetary unions that include IMF members) whose exports of goods and services had the largest value over the previous five-year period, and which have been determined by the IMF to be freely usable currencies. The composition of currencies (and their weights) in the SDR basket is currently: U.S. dollar (44 percent), euro (34 percent), Japanese yen (11 percent), and pound sterling (11 percent). The IMF Executive Board reviews the SDR basket every five
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years; the next review is expected by the end of 2010. The IMF publishes the SDR exchange rate daily.

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

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

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

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

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CHAPTER NO.5. WHY WAS SDR CREATED

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

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CHAPTER NO.6. USES OF SDR

SDRs are used as a unit of account by the IMF and several other international organizations. A few countries peg their currencies against SDRs, and it is also used to denominate some private international financial instruments. SDRs acts as credits that nation with balance of trade surpluses can 'draw' upon nations with balance of trade deficits. Eliminates the logistical and security problems of shipping gold back and forth across borders to settle national accounts. SDRs are the basis for the international fees of the Universal Postal Union, responsible for the world-wide postal system. SDRs are also used to transfer roaming charge files between international mobile telecoms operators and charges for some radio communications. SDRs limit carrier liability on international flights as well as ship owner liability for cargo damages and oil pollution. In Europe, the Euro is displacing the SDR as a basis to set values of various currencies.

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CHAPTER NO.7.SDR VALUATION

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

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

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CHAPTER NO.8.SDR INTEREST RATE

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

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CHAPTER NO.9. SDR ALLOCATION TO IMF MEMBERS

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

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

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CHAPTER NO.10. ADVANTAGES & DISADVANTAGES OF SDR

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

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

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

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CHAPTER NO.11.THE SDR DEPARTMENT WORKS

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

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

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CHAPTER NO.12 SDR AND WORLD LIQUIDITY:

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

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

IMFs focus on Expansion of International Liquidity by Allocating SDRs In keeping with its purpose, the IMF could and perhaps should contribute to financial stability and the promotion of international trade by allocating SDRs to stimulate economic recovery during an international recession. Expansion of international liquidity through the issue of SDRs requires an 85 percent majority vote. In the past, some industrial countries have opposed even modest allocations of SDRs on the grounds that they would be inflationary. Today, in the face of a
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widespread recession, a decline in the rate of growth of international liquidity, and the need to expand liquidity to support the expansion of international trade, it would be very difficult to make that argument. There would thus appear to be a strong case for supplementing the creation of liquidity and meeting the needs of the international economy by allocating SDRs. Under the Articles of the IMF, SDRs are allocated to member countries in proportion to their quotas. Thus the G-7 would receive more than 47 percent of any allocation, and industrial countries as a group would receive 61 percent. However, recipient countries may donate their SDRs to developing and emerging economy countries or to a trust fund to benefit eligible countries (that is, countries that are prepared to invest the funds in capacity-building projects and to adopt appropriate policies). Recipients of SDRs would, of course, cover the interest on the funds received at the SDR rate of interest, the weighted average of the short-term Treasury bill rates of France, Germany, Japan, the United Kingdom, and the United States (currently 2.25 percent a year). Recipient countries, which in most cases have little access to financial markets and then only at much higher rates, would find these terms very attractive. As recipient countries experienced an improvement in their reserve position, they would be able to sustain higher levels of investment and imports, with the consequent increase in economic activity and international trade. Allocating SDRs would thus also help avert new financial crises.

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CHAPTER NO.13.CONCLUSIONS

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

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CHAPTER NO.14.REFERENCE

BIBLIOGRAPHY

Foreign Exchange International Finance Risk Management, - Rajwade. A.V. International Financial Management, PHI publication, 2010. -Sharan

WEBSITES

www.google.com www.wikipedia.com

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