ActionAid factsheet:

Special Drawing Rights (SDRs) & the

Global Reserve System

[2009]
 1. SDRs hold great potential for addressing
financial crisis impact on developing countries

Special Drawing Rights (SDRs), which the International Monetary Fund (IMF) refers to as “an
international reserve asset,” were until recently one of the more obscure elements of the global
economy. But then the G20 met at the London Summit in April 2009, and in their communiqué
said they “have agreed to support a general SDR allocation which will inject $250 billion into the
world economy and increase global liquidity.”

That sounds good. In fact, given that there is no cost associated with creating SDRs, and little
cost in converting them to real money and using them, it could be an innovative approach to
relieving the intense pressures that countries have come under as the financial crisis dries up
investment and immigrants’ remittances, pushes down commodity prices, and discourages
banks from making loans. ActionAid believes that SDRs could be a key part of addressing the
impacts of the crisis on developing countries, and that ways must be found to increase their
availability and flexibility.

2. What are SDRs?

But of course nothing is quite as simple as it sounds, so we should be aware of the potential
complications in using them. How do these SDRs really work?

Until the London Summit, they were usually seen only in references to the way IMF
denominates its loans. A recent IMF press release, for example, announces the board’s
approval of “a 12-month, SDR 218.79 million (about US$336 million) arrangement for Tanzania
….” But even IMF staff would typically speak of the loan as being for $336 million, since they –
like everyone else -- are far more likely to know the value of a dollar.

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 The value of the SDR is calculated by averaging a “basket” of four major world currencies – the
US dollar, UK pound, euro, and Japanese yen – in a weighted formula that is re-evaluated every
five years to ensure it represents the relative importance of each. But this unit only exists as an
accountant’s tool, a formula. No SDRs are printed; you can’t hold one in your hand.

The SDR was created in 1969, when world currencies were still based on the “dollar-gold”
system – but the world was running short of both dollars and gold, so needed to agree on
another asset that would serve as reserves. About $9 billion in SDRs were created between
1970 and 1972. Once the dollar-gold system was abandoned in 1973 and currency values
allowed to float, they became less essential. There was only one additional “emission” of
SDRS, in 1979-81, bringing the total to about $21 billion.

The IMF does not require that its SDRs be backed by any assets, and they do not represent a
claim on the IMF. The assets – the SDRs -- are created simply by the will of the board (though
large or exceptional allocations may require approval by member governments’ legislatures).
They are, in a sense, backed by the consensus of the IMF member governments.

3. How Can Countries Use Their SDRs? What Are

the Costs?

The SDRs allocated to a particular government are put into its account at the IMF. The
government can convert them to hard currency through voluntary arrangements with
governments issuing hard currencies, who get additional SDRs in return, and earn interest on
any amount above what they received in the general allocations. No conditions are attached to
the use of such funds, in sharp contrast to the money the IMF lends to countries in crisis.

There is a cost, however: the government must pay annual interest charges on any SDRs it has
converted that bring the total in their account below the amount they’ve received in official
allocations. The interest charge is based on the basis of interest rates on short-term debt for
the four basket currencies and is re-calculated every week. At the moment, with the driving
down of interest rates in response to the financial crisis, the rate is very low – less than 0.5%. It
can vary a great deal, however, and has been as high as 9%. The interest charges continue
until the country replenishes its SDR account by re-converting hard currency.

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 While the SDRs are left on account at the IMF, they are essentially reserves. They will be
universally recognized as part of the governments’ assets, and so will make that country more
creditworthy. Holding the SDRs costs nothing, and can make it more likely that a country will be
able to get finance from private sources.

But for countries with the fewest options, countries for which a marginal amount of additional
reserves is unlikely to attract substantial new finance, the significant attraction of SDRs is that
they can be an affordable and condition-free way to access resources which can be used for
whatever the government prioritizes. At a time of crisis, the funds can be used to stimulate a
stagnant economy, shore up spending for social programs, or substitute for investments for
development that may have dried up.

4. ActionAid’s recommendations

ActionAid therefore welcomes the G20’s call for a new general allocation of SDRs. We also urge
those discussing solutions to the crisis at the United Nations Conference on the World Financial
Crisis and at upcoming meetings of the G8 and the G20 to examine ways of making the SDR a
unit that could be exchanged freely among countries and used for a range of international
obligations.

We further call for allocations to happen regularly, perhaps annually, at least in times of financial
crisis.

A general allocation is done according to countries’ quotas, which means the richest countries
get the biggest share of the pie, since they hold the highest quotas. The US, therefore, gets
over 16% of the total number of SDRs issued, Japan about 10% and so on. With the $250
billion allocation, only some $81 billion will go to developing countries, and only about $19 billion
to low-income countries (about $10 billion for Africa – less than 5% of the total value of the
emission). The G7 countries, which have many more financing options, are rewarded with over
45% of the SDRs.

Special allocations, for example for all developing countries, or all low-income countries, are
possible if the Board amends its Articles of Agreement to allow it to happen. There is a
precedent for this: in 1997, the board decided to amend its Articles in order to distribute SDRs to

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 countries which had joined the IMF after 1981 and thus never received any SDRs (this included
most of the Soviet-bloc countries, for example). Because it was an amendment to the
institution’s charter, it had to be approved by legislatures, and specifically the US’s (since the
US is the only country with enough shares to veto a measure, its Congress is where the
decision is usually made). The amendment has languished in the US Congress for 12 years,
but after the G20 called for its immediate enactment, President Obama requested that Congress
take action, and it is likely to do so soon.

The urgency of providing resources to developing countries should be sufficient motivation for
another amendment, allowing special allocations of SDRs to the countries that most need them.

In the meantime, with the general allocation called for by the G20 expected to be approved by
the IMF Board shortly, ActionAid calls for wealthy countries to transfer their SDRs to those with
greater need for the resources. There has reportedly been some discussion of such a move by
a few countries already.

For all the attraction of the SDR, the costs associated with converting them have the potential to
become expensive. ActionAid calls for, at the least, a fixing of the charges for using SDRs,
whether as a fee or a fixed interest percentage, so that countries can predict their costs into the
future. There are reported instances of governments which have paid more to use converted
SDRs than they would have if they had borrowed the money at concessional rates (and the
loans might have been eligible for reduction or cancellation under the HIPC or MDRI debt
programs).

ActionAid therefore believes that the best solution would be for the costs of converting SDRs to
be eliminated for the most vulnerable countries, or subsidized by other IMF funds, such as the
profits realized from the sale of IMF gold.

5. SDRs could also lay the basis for a new Global

Reserve System

New allocations of SDRs were advocated by the first set of recommendations published by the
Commission of Experts of the President of the UN General Assembly on Reforms of the

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 International Monetary and Financial System – the so-called “Stiglitz Commission” which was
set up in conjunction with the call for the June UN Conference on the World Financial Crisis and
its Impact on Development. The G20 decision followed a couple weeks later (though no cause-
and-effect relationship should necessarily be inferred!).

But the Stiglitz Commission went further than the G20. It advocates that the entire global
reserve system be dramatically reformed. It describes the rapid accumulation of reserves by
many emerging economies – China being the paragon, the leading holder of dollars in the world
– as a natural reaction to potential instability in the global economy, and a way for countries to
guard against having to borrow from the IMF in times of crisis. But at the same time, it freezes a
huge portion of the world’s potential asset base – an amount equivalent in 2007 to 11.7% of the
world’s GDP, as compared to 5.6% in 1997. It also leads to reduced aggregate demand to keep
the world economy running, and can create deflationary pressures in times of crisis.

The commission calls for a system that would not be based on a single currency – the US dollar
is now nearly the de facto reserve currency, constituting about 70% of reserve holdings – and is
skeptical that expanding to three or four such currencies (in more equitable portions than hold
today) would be substantially more stable. Rather it holds that a currency designed specifically
for reserves to be used, and that the SDR might be the best basis to work from. It also suggests
that if the IMF is not judged to be neutral enough, or to have the capacity, that a Global Reserve
Bank could be created.

The latest draft of the Stiglitz Commission’s full report offers the following description of the
benefits of a well-managed global reserve currency:

It would be possible to regulate the creation of global liquidity, and reduce the ability of
a reserve currency country to create excessive liquidity. And the system can be
designed in ways to put pressure on countries to reduce their surplus and thus reduce
their contribution to the insufficiency of global aggregate demand. This would
contribute to the reduction of global imbalances.

And it isn’t just the independent spirits on the Stiglitz Commission who are having such
thoughts. On June 6, Bloomberg reported that John Lipsky, the number-two official at the IMF,
told a conference in St. Petersburg, Russia that “there are many, many attractions in the long

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 run” to the introduction of a new global reserve currency. But while the Stiglitz Commission
emphasizes that the move could be implemented quickly, Lipsky emphasized that “this is not a
quick, short or easy decision,” and indeed that it would be “quite revolutionary.”

While perhaps not quite the revolution we would envision, such a reform of the global reserve
system could make a real, positive, and permanent difference in global governance and
economic stability for all countries.

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