Special Drawing Rights MAIN (ADITYA)

8/10/2019 Special Drawing Rights MAIN (ADITYA)

1/28

SPECIAL DRAWING RIGHTS (SDR)

Page 1

CHAPTER NO.1

INTRODUCTION

As the topiccreation of SDR and its role in solving liquidity problemsuggests,

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 gold-

exchange 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, theI.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.


2/28


Page 2

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 supplementaryforeign exchange reserve assets

defined and maintained by theInternational 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 foreuros,Japanese

yen,pounds sterling,orUS 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 theunit of

account for the IMF has long been the main function of the SDR.
http://en.wikipedia.org/wiki/Foreign_exchange_reservehttp://en.wikipedia.org/wiki/International_Monetary_Fundhttp://en.wikipedia.org/wiki/Eurohttp://en.wikipedia.org/wiki/Eurohttp://en.wikipedia.org/wiki/Eurohttp://en.wikipedia.org/wiki/Japanese_yenhttp://en.wikipedia.org/wiki/Japanese_yenhttp://en.wikipedia.org/wiki/Pounds_sterlinghttp://en.wikipedia.org/wiki/United_States_dollarhttp://en.wikipedia.org/wiki/Unit_of_accounthttp://en.wikipedia.org/wiki/Unit_of_accounthttp://en.wikipedia.org/wiki/Unit_of_accounthttp://en.wikipedia.org/wiki/Unit_of_accounthttp://en.wikipedia.org/wiki/United_States_dollarhttp://en.wikipedia.org/wiki/Pounds_sterlinghttp://en.wikipedia.org/wiki/Japanese_yenhttp://en.wikipedia.org/wiki/Japanese_yenhttp://en.wikipedia.org/wiki/Eurohttp://en.wikipedia.org/wiki/International_Monetary_Fundhttp://en.wikipedia.org/wiki/Foreign_exchange_reserve


3/28


Page 3

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

weightedcurrency basket of four major currencies: the US dollar, the euro, the

British pound, and the Japanese yen. SDRs are denoted with theISO 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.
http://en.wikipedia.org/wiki/Currency_baskethttp://en.wikipedia.org/wiki/ISO_4217http://en.wikipedia.org/wiki/ISO_4217http://en.wikipedia.org/wiki/ISO_4217http://en.wikipedia.org/wiki/ISO_4217http://en.wikipedia.org/wiki/Currency_basket


4/28


Page 4

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

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) suggest that the SDRs attractiveness as a unitof account

for private sector use derives from the stability of its value relative to values

of alternative units. By virtue of their currency composition, SDR-

denominated 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.


5/28


Page 5

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. These

finance the General Department where IMF lending takes place. The SDR

Department is completely separate and has been provisioned by General


6/28


Page 6

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.


7/28


Page 7

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.


8/28


Page 8

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

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.5,6In the 1960s, the supply of reserve assetsmainly gold

and U.S. dollarswas 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.


9/28


Page 9

The international monetary system has changed substantially since the creation of

the SDR and the subsequent breakdown of the Bretton Woods system of fixed

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.


10/28


Page 10

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.


11/28


Page 11

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 ownerliability for cargo damages and oil pollution.

In Europe, the Euro is displacing the SDR as a basis to set values of various

currencies.


12/28


Page 12

CHAPTER 7

BUYING AND SELLING SDR`S

IMF members often need to buy SDRs to discharge obligations to the IMF, or they

may wish to sell SDRs in order to adjust the composition of their reserves. The

IMF may act as an intermediary between members and prescribed holders

to ensure that SDRs can be exchanged for freely usable currencies. For more

than two decades, the SDR market has functioned through voluntary

trading arrangements. Under these arrangements a number of members and

one prescribed holder have volunteered to buy or sell SDRs within limits defined

by their respective arrangements. Following the 2009 SDR allocations, the

number and size of the voluntary arrangements has been expanded to ensure

continued liquidity of the voluntary SDR market. The number of voluntary SDR

trading arrangements now stands at 32, including 19 new arrangements since

the 2009 SDR allocations.

In the event that there is insufficient capacity under the voluntary trading

arrangements, the IMF can activate the designation mechanism. Under this

mechanism, members with sufficiently strong external positions are designated by

the IMF to buy SDRs with freely usable currencies up to certain amounts from

members with weak external positions. This arrangement serves as a backstop to

guarantee the liquidity and the reserve asset character of the SDR


13/28


Page 13

CHAPTER NO.8

SDR VALUATION

The value of the SDR was initially defined as equivalent to 0.888671 grams offine

gold.At the time, this was also equivalent to oneU.S. dollar.However, after the

collapse of theBretton Woods system in 1973, the SDR was redefined as a basket

ofcurrencies. Today, this basket consists of theEuro (EUR),Japanese Yen

(JPY),British Pound (GBP)and U.S. Dollar (USD).TheU.S. dollar value of the

SDR isposted daily on theIMF's website. It is calculated as the sum of the specific

amounts of each componentcurrency valued inU.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 thegrowing 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.
http://www.wikinvest.com/wiki/Investing_in_Goldhttp://www.wikinvest.com/wiki/Investing_in_Goldhttp://www.wikinvest.com/wiki/U.S._dollarhttp://www.wikinvest.com/wiki/Bretton_Woods_Accordhttp://www.wikinvest.com/wiki/Currencieshttp://www.wikinvest.com/wiki/Euro_(EUR)http://www.wikinvest.com/wiki/Japanese_Yen_(JPY)http://www.wikinvest.com/wiki/Japanese_Yen_(JPY)http://www.wikinvest.com/wiki/British_Pound_(GBP)http://www.wikinvest.com/wiki/U.S._Dollar_(USD)http://www.wikinvest.com/wiki/U.S._dollarhttp://www.imf.org/external/np/fin/data/rms_sdrv.aspxhttp://www.wikinvest.com/wiki/IMFhttp://www.wikinvest.com/wiki/Currencyhttp://www.wikinvest.com/wiki/U.S._dollarshttp://www.wikinvest.com/wiki/European_Central_Bankhttp://www2.econ.iastate.edu/external/np/sec/pr/2000/pr0055.htmhttp://www2.econ.iastate.edu/external/np/sec/pr/2000/pr0055.htmhttp://www.wikinvest.com/wiki/European_Central_Bankhttp://www.wikinvest.com/wiki/U.S._dollarshttp://www.wikinvest.com/wiki/Currencyhttp://www.wikinvest.com/wiki/IMFhttp://www.imf.org/external/np/fin/data/rms_sdrv.aspxhttp://www.wikinvest.com/wiki/U.S._dollarhttp://www.wikinvest.com/wiki/U.S._Dollar_(USD)http://www.wikinvest.com/wiki/British_Pound_(GBP)http://www.wikinvest.com/wiki/Japanese_Yen_(JPY)http://www.wikinvest.com/wiki/Japanese_Yen_(JPY)http://www.wikinvest.com/wiki/Euro_(EUR)http://www.wikinvest.com/wiki/Currencieshttp://www.wikinvest.com/wiki/Bretton_Woods_Accordhttp://www.wikinvest.com/wiki/U.S._dollarhttp://www.wikinvest.com/wiki/Investing_in_Goldhttp://www.wikinvest.com/wiki/Investing_in_Gold


14/28


Page 14

CHAPTER NO.9

SDR INTEREST RATE

The SDR interest rateprovides 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.
http://www.imf.org/external/np/fin/rates/sdr_ir.cfmhttp://www.imf.org/external/np/exr/facts/howlend.htmhttp://www.imf.org/external/np/tre/tad/sdr_ir.cfmhttp://www.imf.org/external/np/tre/tad/sdr_ir.cfmhttp://www.imf.org/external/np/exr/facts/howlend.htmhttp://www.imf.org/external/np/fin/rates/sdr_ir.cfm


15/28


Page 15

CHPATER 10

MECHANICS OF SDR ALLOCATION

General allocations of SDRs are made as a percentage of a members quota with

all participants receiving the same percentagea members quota is based

broadly on its relative size in the world economy and determines both its

subscription to the capital of the IMF and voting rights in the organization; a

members quota has a bearing on its access to IMF financing.

Allocations under the special amendment to the Articles of Agreement would not

be made in proportion to quotas but rather pursuant to a methodology that would

bring participants net cumulative allocations-to-quota ratio to a specific

common benchmark.

SDR allocations provide each member with a costless asset. If a members SDR

holdings rise above its allocation (for example, if it purchases SDRs from

another member), it earns interest on the excess; on the other hand, if it holds

fewer SDRs than allocated, it pays interest on the shortfall at the officialSDR

interest rate.
http://www.imf.org/external/np/fin/data/sdr_ir.aspxhttp://www.imf.org/external/np/fin/data/sdr_ir.aspxhttp://www.imf.org/external/np/fin/data/sdr_ir.aspxhttp://www.imf.org/external/np/fin/data/sdr_ir.aspx


16/28


Page 16

CHAPTER NO.11

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


17/28


Page 17

that countries that joined the IMF after 1981more 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.


18/28


Page 18

CHAPTER NO.12

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.


19/28


Page 19

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).


20/28


Page 20

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 theprevailing 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 forthe 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


21/28


Page 21

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 pre-

war 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.


22/28


Page 22

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.


23/28


Page 23

CHAPTER NO.13

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.


24/28


Page 24

CHAPTER NO.14

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 tostimulate economic recovery during an international recession. Expansion of

international liquidity through the issue of SDRs requires an 85 percent majority

vote.


25/28


Page 25

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

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.


26/28


Page 26

CHAPTER 15

RECENT EVENTS

On 2 April 2009, theG-20 authorized theIMF to issue $250 billion in new SDRs

to augment the foreign reserves ofIMF members. While the G-20 portrayed this

new issuance as a quick way to channel resources intoemerging economies,SDRs

are allocated, as mentioned above, in proportion to members' existing IMF

quotas. As a result, $170 billion of the $250 billion new SDRs will go into the

reserves of rich countries, like the United States, Britain, France andJapan, that

have the lion's share of existingIMF quotas. In addition, countries like the United

States require approval from Congress to part with its share of SDRs. Nonetheless,

increases in the reserves of some emerging will be substantial i.e.South Koreas

will grow by $3.4 billion,Indias by $4.8 billion,Brazils by $3.5 billion,Russias

by $6.9 billion andChina's by $7.3 billion.
http://www.wikinvest.com/wiki/G-20http://www.wikinvest.com/wiki/IMFhttp://www.wikinvest.com/wiki/IMFhttp://www.wikinvest.com/wiki/Emerging_Marketshttp://www.wikinvest.com/wiki/Japanhttp://www.wikinvest.com/wiki/IMFhttp://www.wikinvest.com/wiki/South_Koreahttp://www.wikinvest.com/wiki/South_Koreahttp://www.wikinvest.com/wiki/Indiahttp://www.wikinvest.com/wiki/Brazilhttp://www.wikinvest.com/wiki/Brazilhttp://www.wikinvest.com/wiki/Russiahttp://www.wikinvest.com/wiki/Russiahttp://www.wikinvest.com/wiki/Chinahttp://www.wikinvest.com/wiki/Chinahttp://www.wikinvest.com/wiki/Russiahttp://www.wikinvest.com/wiki/Brazilhttp://www.wikinvest.com/wiki/Indiahttp://www.wikinvest.com/wiki/South_Koreahttp://www.wikinvest.com/wiki/IMFhttp://www.wikinvest.com/wiki/Japanhttp://www.wikinvest.com/wiki/Emerging_Marketshttp://www.wikinvest.com/wiki/IMFhttp://www.wikinvest.com/wiki/IMFhttp://www.wikinvest.com/wiki/G-20


27/28


Page 27

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, however, the IMFs surveillance

capabilities would need to be extended and its governance structure reformed.


28/28


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

Special Drawing Rights MAIN (ADITYA)

Documents

Transcript of Special Drawing Rights MAIN (ADITYA)