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Finance & Development, March 1977
Article

Special drawing rights: a review of reconstitution, 1972-76: What is reconstitution? How has it worked in the five years since the SDRs were introduced?

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
March 1977
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Robert Dunn and Robert Ley

Special drawing rights (SDRs) were created to supplement international reserves. The first amendment of the Fund’s Articles of Agreement in 1969 established the Special Drawing Account and authorized the Fund to allocate SDRs to member countries that decided to participate. Over the following three years, 113 members became participants. Allocations were made at the beginning of 1970, 1971, and 1972, totaling SDR 9.3 billion (now equivalent to about US$10.8 billion) to all participants according to their quotas in the Fund; the Republic of China opted not to receive SDRs. By the end of 1976,121 of the 129 Fund members were participants in the Special Drawing Account, although some had received no allocations of SDRs because they became participants after the last allocation on January 1, 1972.

Under the Articles of Agreement, participants may use SDRs in a variety of ways—such as to obtain convertible currency to meet a balance of payments need, or to reduce indebtedness to the Fund. But they also accept an obligation that if they use SDRs they must rebuild their SDR holdings in accordance with the reconstitution rules adopted by the Fund. The basic rule is that participants must maintain their average daily holdings of SDRs at not less than 30 per cent of average allocations over five-year periods ending on the final day of successive calendar quarters. Participants are also required to pay due regard to the desirability of pursuing over time a balanced relationship between their holdings of SDRs and other reserve assets. When the proposed second amendment to the Articles becomes effective, the reconstitution obligation will remain, although the rules may then be amended, or even abrogated, by a majority of 70 per cent of total voting power as opposed to 85 per cent under the existing Articles.

Reconstitution was an essential element in the negotiated agreement that brought about the establishment of the SDR facility in 1969. It reflected a compromise between those who wished to see the SDR as a freely usable international reserve asset and those who argued that it should be a form of credit and therefore subject to repayment. Under the present rules, a participant may use all its SDRs, but if it does so, it will eventually need to reconstitute its holdings by acquiring an amount of SDRs sufficient to increase its average daily holdings to the 30 per cent level. Acquisition of SDRs by participants for reconstitution has become an increasingly important aspect of the Fund’s financial activity; in 1976, there were more than 100 reconstitution transactions totaling well over SDR 500 million.

The calculations

To maintain their average holdings at the 30 per cent level, participants need to reconstitute if they make net use of more than 70 per cent of their allocations. In order to establish whether this need arises for any participant, the Fund makes calculations at the end of each month. The calculations cover 20 overlapping five-year periods, extending from the one that is almost over to the one that will end five years hence. They take into account actual daily SDR holdings and allocations up to the present, and assume no further allocations and no further use of SDRs other than the annual settlement of net charges in the Special Drawing Account. (Net charges are charges payable on average allocations of SDRs, less interest earned, at the same rate, on average daily SDR holdings.)

If a participant’s average daily holdings are projected to be less than 30 per cent of its average allocation for any of the 20 reconstitution periods, the calculations indicate the amount of SDRs it would need to obtain to raise average daily holdings to the required level. The calculated amounts for each period are shown in two ways: first, as a series of equal quarterly installments that will meet the requirement if obtained on the fifteenth day of each calendar quarter remaining in the period; and, secondly, as a single amount that will achieve the same effect if acquired within the next calendar month (see box). A participant may have needs relating to several reconstitution periods, but the acquisition of the largest of the single amounts will meet the requirement for all the periods covered by the calculations, provided no further use of SDRs is made.

Once a participant has a need to reconstitute its holdings, the amount it needs to acquire for this purpose will grow with time. Any amount of SDRs acquired early in a five-year period and held throughout the remainder of that period will have a greater effect on average daily holdings than acquisition of the same amount at a later date. It follows that for a later acquisition to have the same effect on average holdings it must be larger in amount. As the end of a five-year period approaches, the amount needed for that period increases very rapidly; for example, if a reconstitution need could be met by acquiring SDR 5 million two months before the end of the period, the amount required would increase to SDR 10 million when only one month remained and would continue to double as the time remaining was halved.

When calculations were first made on December 31, 1971, there were 16 participants with modest reconstitution needs. Since then, both the number of participants concerned and the amounts they needed to acquire have grown substantially; by the end of 1976, 45 participants had reconstitution needs totaling SDR 361 million.

This growth can be explained partly by the absence of any further allocations of SDRs since 1972, but mainly by the continued use of SDRs by many participants, few of which have since acquired SDRs except in reconstitution transactions. Table 1 shows that from 1970 to 1972, SDRs were used most heavily in transactions to obtain convertible currency from other participants “designated” by the Fund, and as a substitute for gold or convertible currency in making repurchases in the General Account (that is, reducing indebtedness to the Fund). More recently, SDRs have been principally used in lieu of gold to pay charges in the General Account, reflecting both the rapid expansion in use of the Fund’s resources by many members and the higher rates of charges. Another cause of reconstitution needs in the last two years has been the growth of net charges in the Special Drawing Account, due to the increased net use of SDRs and to the effect of the higher rates of interest paid on the SDR since mid-1974. Until July 1974 the interest rate on the SDR was 1½ per cent per annum, but since then it has been determined on the basis of a market-related formula and has varied between 3½ and 5 per cent per annum.

Table 1Use of SDRs by participants(In millions of SDRs)
1970197119721973197419751976
Transfers to other participants
By designation291.2362.2230.243.8448.6188.7220.3
By agreement180.5480.0328.5855.8378.640.4353.0
471.7842.2558.7899.6827.2229.1573.3
Transfers to the Fund’s
General Account
Repurchases292.2301.6494.245.418.237.1445.8
Charges91.921.735.127.952.7275.1628.9
Assessment 10.90.91.00.71.01.21.6
385.0324.2530.374.071.9313.41,076.3
Net charges21.09.121.629.329.598.993.9
Total857.71,175.51,110.61,002.9928.6641.41,743.5

These amounts represent reimbursement of the Fund’s General Account for expenses incurred in the operation of the Special Drawing Account.

These amounts represent the totals of net charges (i.e., charges paid minus interest received) for participants paying net charges in the Special Drawing Account, and are the source for net interest received by other participants and the General Account.

These amounts represent reimbursement of the Fund’s General Account for expenses incurred in the operation of the Special Drawing Account.

These amounts represent the totals of net charges (i.e., charges paid minus interest received) for participants paying net charges in the Special Drawing Account, and are the source for net interest received by other participants and the General Account.

Since it is the net use of SDRs which is critical, some participants that have made heavy use of SDRs have avoided reconstitution needs by acquiring SDRs in other ways. For example, the potential reconstitution effects of several large repurchases in SDRs by the United Kingdom were offset by its purchases of SDRs from the General Account and by its receipts of SDRs from other participants in transactions unrelated to reconstitution. In addition, many of the transactions by agreement between participants have been offsetting over time, especially those arising from intervention in the foreign exchange markets under the European “snake” arrangement. In transactions by agreement, SDRs have been used exclusively by industrial countries. The amounts transferred, although large in absolute terms, have been small in comparison with those countries’ allocations. Thus, while these transactions totaled more than SDR 2.6 billion up to the end of 1976, only one of the participants using SDRs in this way had developed a reconstitution need.

An illustration of reconstitution calculations

A participant with an allocation of SDR 10 million used SDR 9 million on January 1, 1975. Thus, its average daily holdings are calculated to be SDR 2,799,014 for the five-year period ending December 31, 1978 (i.e., SDR 10 million X 365 days + SDR 1 million X 1,461 days ÷ 1,826 days). Average daily holdings must therefore be raised by SDR 200,986 to 3,000,000 (i.e., 30 per cent of the average allocation of SDR 10 million). Calculations as of May 31, 1977 would show:

(1) A single amount to be acquired on the last day of the following month, calculated as follows:

where 1,826 is the number of days in the five-year period and 550 is the number of days remaining in the period over which the participant must hold the SDRs so acquired.

(2) A series of quarterly installments over the six remaining quarters, calculated as follows:

where 1,838 represents the sum of the number of days over which successive quarterly acquisitions must be held beginning with the fifteenth day of the next calendar quarter: thus, the amount acquired on July 15, 1977 is held for 535 days, the amount acquired on October 15, 1977 is held for 443 days, and SO forth (535 + 443 + 351 + 261 + 170 +78 = 1,838).

For most participants, however, there have been few opportunities to obtain SDRs other than through reconstitution transactions. One mechanism for rebuilding SDR holdings is the designation process, but many participants have never been subject to designation to provide currency in exchange for SDRs because they have not been considered to have sufficiently strong balance of payments and reserve positions. In addition, many of the participants actually designated have received only small amounts of SDRs. As a result, the continued use of SDRs after the last allocation in January 1972 has caused the holdings of many participants to fall toward or below the reconstitution level. This trend is evident even if acquisitions for reconstitution are taken into account; from 1972 to 1976 the number of participants holding less than 50 per cent of their allocations of SDKs grew from 39 to 58 (see chart). Most industrial countries, however, remain among the diminishing number of participants with holdings close to, or above, their allocations.

Distribution of SDR holdings

Acquisitions for reconstitution

Participants enjoy broad discretion regarding the acquisition of SDRs for reconstitution. They may acquire a small amount early in a reconstitution period or a larger amount later in the same period. They may make occasional acquisitions of some size, or smaller acquisitions more frequently. But acquisition cannot be delayed indefinitely. Participants that enter the final quarter of a reconstitution period are expected, under procedures endorsed by the Fund’s Executive Directors, to take early action to acquire the amounts of SDRs needed to meet the requirement for that period. Generally, only a few participants have been in this position at the beginning of each calendar quarter and most have acquired sufficient SDRs early in the quarter. In addition, when the calculated quarterly amount exceeds 10 per cent of its allocation, a participant becomes subject to designation, normally on a priority basis, to provide currency for SDRs to the extent of the quarterly amount. Though several participants have become subject to designation in this way, none has actually been designated since all have voluntarily acquired SDRs when informed of the position by the Fund.

Most participants acquiring SDRs voluntarily prefer to obtain the single amount that meets their needs for all periods included in the latest calculations. Less than 10 per cent of acquisitions in 1976 took the form of quarterly installments. At first sight, it may appear that acquiring the single amount is advantageous because it is usually about half the sum of the quarterly installments. In fact, there is no comparative advantage, provided the yield differentials between the SDR and alternative reserve assets remain constant. Since the effect on average daily balances of holding any amount of SDRs over a certain period of time is identical to the effect of holding twice that amount for half the time, the cost of doing so must be similarly identical.

More than 50 participants have acquired SDRs for reconstitution and many have done so frequently; 11 participants have acquired SDRs on 10 or more occasions. These examples have not been limited to those participants that have made acquisitions by quarterly installments. More often, repeated acquisitions have been made because, after obtaining enough SDRs to meet their reconstitution needs in full, participants have used SDRs—mainly to pay charges—and thereby cause their average holdings to fall again below the required level.

Until recently, the maximum amount of SDRs that could be acquired in any month in a reconstitution transaction was the largest of the single amounts shown by the calculations at the end of the preceding month, less any amount of SDRs acquired during the month in any other kind of transaction. Thus, participants that used SDRs to pay charges in the same month as they acquired the maximum amount found themselves with another reconstitution need at the end of that month because the calculations assumed no use of SDRs following the date on which they were made. To avoid this, the maximum amount was increased by a decision of the Executive Board in August 1976, to include the total amount of any charges to be paid to the General Account and any repurchase obligations in SDRs to be discharged by the participant prior to the next calculations.

Sources and financing

Participants can acquire SDRs for reconstitution from the Fund’s General Account or in a transaction by agreement with another participant. Until October 1976, however, all such acquisitions were made from the General Account. These transactions were of two types: about three fourths of the total amount was acquired with convertible currency acceptable to the Fund, while the balance was obtained as part of drawings from the Fund. Some participants might have found it difficult to finance their acquisitions if they had been unable to draw on the Fund.

In August 1976, the Executive Board adopted another decision relating to SDR transactions. Under this decision, the user or transferor of SDRs in a bilateral transaction by agreement between participants is now exempt from the requirement that it have a balance of payments need to use SDRs. The decision allows transactions between participants, without the requirement of need, for the purpose of reconstituting the recipient’s holdings of SDRs or to bring the SDR holdings of both participants closer to their respective allocations. This has provided the first opportunity for the use of SDRs by participants with strong balance of payments and reserve positions and large holdings of SDRs in relation to their allocations. It has also provided a vehicle for participants with low holdings of SDRs to build up their holdings so they can meet future obligations in SDRs without giving rise to a reconstitution need. Early indications are that participants with a need to reconstitute their SDR holdings find acquisition in a bilateral transaction to be an attractive alternative to acquisition from the General Account. During the last three months of 1976, transactions under the new decision exceeded SDR 50 million (see Table 2).

Table 2Summary of acquisitions to promote reconstitution(In millions of SDRs)
From the Fund’s General Account
Total number of acquisitionsIn exchange for convertible currencyAs part of drawingsParticipants in exchange for currency 1Total amounts acquired
(1)(2)(3)(4)(5)
19723539.364.20103.5
197369140.038.00178.0
19746591.628.40120.0
197587124.465.80190.2
1976121442.771.751.3565.7
377838.0268.151.31,157.4

Includes transactions to bring holdings closer to net cumulative allocations.

Includes transactions to bring holdings closer to net cumulative allocations.

When the proposed second amendment to the Fund’s Articles of Agreement becomes effective, the rules for reconstitution may be reviewed at any time. The rules may then be changed, or even abrogated, by a majority of 70 per cent of the voting power of the Executive Directors. Assuming the 30 per cent requirement is maintained, the need to acquire SDRs will continue to arise for a large and possibly lengthening list of member countries. This would mainly reflect the continued use of SDRs to pay charges on members’ indebtedness to the Fund which is unlikely to decline in the near future from its present high level. Participants acquiring SDRs to meet reconstitution needs may increasingly prefer to do so in transactions by agreement with other participants rather than with the Fund’s General Account since the proposed second amendment will provide maximum scope for transactions between participants.

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