International Monetary Fund,World Bank,AIIB, ADB and India

SDR general allocation by IMF

Note4Students

From UPSC perspective, the following things are important :

Prelims level : SDR mechanism

Mains level : Issues with SDR mechanism

  • Finance Minister has said that India could not support a general allocation of new Special Drawing Rights (SDR) by the IMF because it might not be effective in easing coronavirus-driven financial pressures.
  • FM Nirmala Sitharaman has stated that such a global liquidity boost by the IMF could produce potentially costly side-effects if countries used the funds for “extraneous” purposes.

Details of SDR mechanism:

What is SDR?

  • The SDR is an interest-bearing international reserve asset created by the IMF in 1969 to supplement other reserve assets of member countries.
  • To participate in this system, a country was required to have official reserves.
  • This consisted of a central bank or government reserves of gold and globally accepted foreign currencies that could be used to buy the local currency.
  • It is based on a basket of international currencies comprising the U.S. dollar, Japanese yen, euro, pound sterling and Chinese Renminbi.
  • It is not a currency, nor a claim on the IMF, but is potentially a claim on freely usable currencies of IMF members.
  • The value of the SDR is not directly determined by supply and demand in the market but is set daily by the IMF on the basis of market exchange rates between the currencies included in the SDR basket.

Who can hold SDRs?

  • SDRs can be held and used by member countries, the IMF, and certain designated official entities called “prescribed holders”.
  • It cannot be held, for example, by private entities or individuals.
  • Its status as a reserve asset derives from the commitments of members to hold, accept, and honour obligations denominated in SDR.
  • The SDR also serves as the unit of account of the IMF and some other international organizations.

General allocation of SDRs

  • An SDR allocation is a low-cost way of adding to members’ international reserves, allowing members to reduce their reliance on more expensive domestic or external debt for building reserves.
  • The IMF has the authority under its Articles of Agreement to create unconditional liquidity through “general allocations” of SDRs to participants in its SDR Department (currently, all members of the IMF) in proportion to their quotas in the IMF.

The SDR Interest Rate

  • The interest rate on SDRs, or the SDRi, provides the basis for calculating the interest rate that is charged to member countries when they borrow from the IMF and paid to members for their remunerated creditor positions in the IMF.
  • It is also the interest paid to member countries on their own SDR holdings and charged on their SDR allocation.
  • The SDRi 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 five basis points.

How many SDRs have been allocated so far?

The general SDR allocation of August 28, 2009 is by far the biggest allocation to date:

  • SDR 9.3 billion was allocated in yearly installments in 1970–72.
  • SDR 12.1 billion was allocated in yearly installments in 1979–81.
  • SDR 161.2 billion was allocated on August 28, 2009.

What happens to the SDRs once they are allocated?

  • The IMF’s SDR Department keeps records of members’ SDR allocations and holdings; the SDR Department is also the channel through which all transactions and operations involving SDRs are conducted.
  • Once allocated, members can hold their SDRs as part of their international reserves or sell part or all of their SDR allocations.
  • Members can exchange SDRs for freely usable currencies among themselves and with prescribed holders; such exchange can take place under a voluntary arrangement or under designation by the Fund.
  • IMF members can also use SDRs in operations and transactions involving the IMF, such as the payment of interest on and repayment of loans, or payment for future quota increases.

Issues with new allocations

  • New reserves are allocated according to members’ quotas — or shares in the IMF.
  • A great deal of the benefit in 2009 went to advanced economies that didn’t need help in accessing markets or financing fiscal deficits.
  • If the same system is being used now, only 40 per cent of the total would be given to the emerging economies. That is not good enough.

Other reasons

  • The possible extraneous purposes FM could be referring to maybe misuse of resources for terror funding or some such purpose by neighbours.
  • This may seem far-fetched to some, but is par for the course for the government.
  • The other possibility is that India is merely trying to prove its loyalty to the Trump administration.
  • India has already requested to access the US Fed’s currency swaps.
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