Current Legal Issues Affecting Central Banks, Volume IV.

1C. Issues Regarding the Special Drawing Right of the International Monetary Fund

Robert Effros
Published Date:
April 1997
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Intensive discussions took place from 1992 to 1994 on Special Drawing Right (SDR) issues following an unprecedented expansion of the International Monetary Fund’s membership. There were two distinct rounds of discussions. First, a proposal for an allocation of SDRs was discussed. Interest focused on the criteria that are relevant to justify an allocation. The second round focused on the possibility of targeting increased amounts of SDRs to particular groups of members, specifically new members of the Fund. This renewed interest in the SDR is a very positive development for the Fund.

History of the Special Drawing Right

The SDR Department was created 25 years ago through the First Amendment of the Articles of Agreement. In the period from 1969 to date, only two decisions to allocate SDRs were adopted. SDRs were allocated in the period from 1970 to 1972 and from 1979 to 1981. The reasons for the absence of more regular allocations are easy to explain: developments did not turn out the way that was initially expected.

The SDR was created against a background of a perceived potential shortage of reserves, in an environment characterized by growing tension in the monetary system and a declining role of gold. The idea was that a mandatory credit-line mechanism backed by a large number of participants, in particular by the major reserve countries, and based on objective distribution criteria, such as Fund quotas, might assist in supplying the reserves that a growing world economy might require. It was also thought that such a supply of reserves should provide unconditional liquidity rather than conditional credit.

When the First Amendment was adopted and when the first allocation decision was approved in 1969, it was expected that the role of the SDR would grow over time as the need for additional reserves rose, and that SDRs would be allocated at a rate that would also be most conducive to attain the Fund’s purposes, in particular to assist in the financing of the expansion of trade. However, the early and mid-1970s produced a huge increase in other sources of liquidity and saw the emergence of the Euromarkets. Therefore, when the Fund in 1977–78 turned to a further allocation discussion, it had to assess the justification for an allocation, particularly in light of the other sources of liquidity that were available to the world economy.

The criterion for an allocation that had been established by the First Amendment had not been changed by the Second Amendment of the Articles in 1978. That criterion requires a finding that there is a long-term global need to supplement reserves through the allocation of SDRs. It was argued by a large group of members that, in light of the abundant availability of liquidity in capital markets, such a need for supplementation did not exist. Ultimately, however, the view prevailed that the particular quality of the SDR, that is, its greater reliability and stability compared to borrowed reserves, needed to be taken into account, and that the finding of global need could not rely exclusively on proving that the need could be met only through SDRs.

In addition, the Second Amendment had added to the Articles the objective of making the SDR the principal reserve asset, and the manner in which that objective should be taken into account in the context of the decision to allocate was explored. When the objective of making the SDR the principal reserve asset was adopted, it was made clear that this objective was not intended to have quantitative relevance, that is, a reduction in the volume of other reserve assets, currencies, or gold would not be required. It was ultimately agreed, however, that in a limited sense there could be a quantitative relevance in that it would be incompatible with the Articles to let the SDR fade away altogether. However, the objective would only be relevant once a finding of global need had been made, and it would not justify an allocation by itself in the absence of global need.

Proposal for a General Allocation

When the Fund returned to an allocation discussion in 1992–93, that discussion focused on a general allocation and, most important, on the reasons that would justify such an allocation. In particular, it was explored whether the needs of a large group of the membership, specifically, countries that had joined the Fund recently, could justify an allocation. The relevant aspect in the provisions on allocations was therefore the concept of “global” need. At that time, the record of that concept was reviewed, and it was confirmed, as had already been explained in the early stages of the establishment of the SDR Department, that the need of individual members or groups of members could not justify an allocation. It was the need of the world economy as a whole for supplementation of reserves that would form a basis for an allocation of SDRs. Moreover, in these discussions, the competition between the SDR and other sources of liquidity was again reviewed, and the same views that had been expressed in the 1978 discussion were reiterated.

The second round of discussions, in 1993 and 1994, focused more specifically on the issue of targeting SDRs to the new members of the Fund, or in a broader sense, to participants that had not received all allocations of SDRs. It was recalled that, under the Fund’s Articles, SDRs can be allocated only through general allocations and only to those members that are participants at the time of the allocation. If a member joins the SDR Department after an allocation, it will receive SDRs only prospectively in future allocations. Moreover, SDRs are allocated on the basis of current quotas of members. There is no selective element in the allocations and no mechanism for catching up through increased rates of allocation with past allocations. Conversely, if a member joins the SDR Department, it will not receive SDRs because of its participation. This treatment of new members, namely, the absence of any selective element or possibility of catching up with past allocations, reflects a deliberate choice by the creators of the SDR. More specifically, this treatment is a function of the nature of the SDR as a mandatory credit-line mechanism, which is backed only by the participants in the SDR Department and therefore requires a broad participation at any point in time, based on objective criteria.

In light of these constraints, a proposal was made to cancel all or part of the existing SDRs and to allocate at least the equivalent amount of SDRs on the basis of current quotas. This proposal, however, faced two main difficulties. First, while the Fund is entitled to cancel SDRs, it can do so only when there is no longer a need for the SDRs created previously to meet the need for additional liquidity. Therefore, the bases for allocation and cancellation are findings in opposite directions, one for more liquidity and one for less liquidity, and it is not possible to make these findings in good faith at the same time. Second, the treatment of new participants in the SDR Department was a result of a deliberate choice made by the membership when the SDR Department was established, and it was therefore not found possible to remedy this result through interpretation or through the application of implied powers.

The Executive Board was again invited to report on SDR issues to the Interim Committee in September 1994, which shows that the effort to increase the volume of SDRs and to make SDRs available to all members continues.

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