This paper describes how the changed conditions in the international monetary system have undermined the role originally envisaged for the SDR. It argues that the concept of a global stock of international liquidity, which was fundamental to the creation of the SDR, is now no longer relevant. Nonetheless, there are good reasons to satisfy part of the growing demand for international reserves with SDR allocations: (i) there are efficiency gains, as SDRs can be created at zero resource cost, and thus obviate the need for countries to run current account surpluses or engage in expensive borrowing to obtain reserves, and (ii) there would be a reduction in systemic risk, as SDRs would substitute to some extent for borrowed reserves, which are a less reliable and predictable source of reserves, especially in times of crisis. [JEL F33, F41]
The introduction in 1969 of the special drawing right (SDR), the reserve asset issued by the International Monetary Fund, was prompted by the desire to establish a mechanism for the deliberate creation of international reserves that would supplement existing reserve assets. In the 1960s these assets were mainly in the form of U.S. dollars, the supplies of which were constrained by the Bretton Woods system of fixed exchange rates, and of gold. The SDR was seen as a way out of the so-called Triffin dilemma whereby additions to official dollar holdings were seen as undermining the stability of the system, given the tendency on the part of some central banks to convert their dollar reserves into gold, thereby drawing down the limited U.S. gold stock.
The first allocation followed shortly after the establishment of the SDR in broadly equal installments on January 1, 1970, 1971, and 1972, with the total amounting to SDR 9.3 billion. The second allocation, totaling SDR 12.1 billion, took place in three similar annual installments on January 1, 1979, 1980, and 1981. Since that time there have been no further allocations. The Fourth Amendment of the IMF Articles of Agreement, which provides for a special onetime allocation of SDR 21.9 billion and was approved by the IMF Board of Governors in 1997, still awaits ratification by the U.S. Congress before it can go into effect. Most recently, in December 2001, the IMF Executive Board discussed the question of whether there should be an SDR allocation in the period 2002–2006 and (as it had done on many previous occasions) registered insufficient support for it. With no allocation for over two decades, the share of SDRs in total world reserve assets has declined to about 1 percent.
That figure is a far cry from the initial expectations for the future of the SDR. Thirty-five years ago, one of us, using the kind of calculations that entered into the Managing Director’s proposal for the first allocation, ventured the forecast that SDRs might account for over half of total world reserves before the end of the twentieth century (Polak, 1967). The figure also puts into question the degree of conviction with which the membership, some 10 years later as part of the Second Amendment, embraced (not just once but twice) the “objective… of making the SDR the principal reserve asset in the international monetary system.”1
While the opposition on the part of most industrial countries continues to prevent a general allocation of SDRs, proposals for use of the SDR mechanism for purposes different from those contemplated by the Articles continue to be launched by some countries and in nonofficial circles. In the mid-1980s, Executive Directors from Belgium, France, and India each sponsored a slightly different plan under which creditor countries would lend to the IMF the SDRs allocated to them, for use by the IMF in conditional credits to developing countries. The Board as a whole saw no merit in this unorthodox method of financing the Fund’s business and rejected all three proposals (Boughton, 2001, pp. 948–49). In 1988, President Mitterrand of France proposed that the developed countries contribute their shares in a new allocation of SDRs to a special fund in the IMF that would guarantee the interest payments on certain obligations issued by debtor countries.
More recently, ideas have been put forward to use the SDR mechanism to enable the Fund to play the role of lender of last resort without having to worry about the means to do so. A Task Force sponsored by the Council on Foreign Relations suggested that a new “contagion facility” in the Fund be funded by a onetime, very large allocation of SDRs, with all members donating the SDRs received to that facility (Goldstein, 1999, p. 1112). Richard Cooper goes one step further. To provide the IMF with “sufficient resources to cover even the worst contingency,” he would amend its Articles of Agreement to allow it to create SDRs, on a temporary basis, as needed to deal with financial crises and to forestall creditor panic (Cooper, 2002, p. 99).
While SDR allocations have not found favor on the part of most industrial countries, they have recently received attention in nonofficial circles. For example, the Zedillo Report (United Nations, 2002) advocates a resumption of SDR allocations, and George Soros (2002) has put forward a proposal that would use part of the SDRs created under the Fourth Amendment, as well as of subsequent annual allocations, as a trust fund to finance the provision of global public goods and possibly other development assistance activities. These proposals were discussed at the UN International Conference on Financing for Development held in Monterrey, Mexico, in March 2002, but were not endorsed in the Monterrey Consensus.
Against this background, it would appear opportune to take stock of what role, if any, the SDR can play in the international monetary system. It needs to be recognized at the outset that the conditions in the international financial system that gave rise to the creation of the SDR no longer apply. The concept of a given stock of global international liquidity, which provided a constraint on the operation of the system of pegged rates, is no longer relevant. International reserves can now expand in response to demand, and the role of the SDR in relieving the constraint on the supply side has correspondingly diminished.
Notwithstanding the major changes in the international monetary system, we argue that the SDR can play a role in supplementing the growth of other reserve assets by providing essentially owned reserves to many Fund members at lower cost than they could achieve by borrowing on world capital markets. This lower cost is not likely to be matched by a correspondingly higher expected default risk borne by Fund membership in general. These owned reserves reduce the vulnerability of these holders to fluctuations in borrowing costs and thereby enhance the stability of the international monetary system, which benefits all countries. As the demand for reserves increases over time in response to the expanding scale on international transactions, modest SDR allocations are unlikely to result in significant drawdowns of total reserves (resource transfers), but countries may substitute out of SDRs into other reserve assets to obtain a higher return.
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)| false Ahluwalia, Montek S., 1996, “SDR Allocations and the Present Articles of Agreement,”in The Future of the SDR in Light of Changes in the International Financial System, edited by ( Michael Mussa, James M. Boughton, and Peter Isard Washington: International Monetary Fund), pp. 88– 100.
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)| false Goldstein, Morris, 1999, Safeguarding Prosperity in a Global Financial System—The Future International Financial Architecture, Report of an Independent Task Force Sponsored by the Council on Foreign Relations ( Washington: Institute for International Economics).
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)| false Mussa, Michael, 1996, “Is There a Case for Allocation Under the Present Articles?”in The Future of the SDR in Light of Changes in the International Financial System edited by ( Michael Mussa, James M. Boughton, and Peter Isard Washington: International Monetary Fund), pp. 57– 87.
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)| false Polak, Jacques J., 1988, “The Impasse Concerning the Role of the SDR,”in The Quest for National and Global Stability, edited by ( Weitze Eizinga, E. Frans Limburg, and Jacques J. Polak Dordrecht: Kluwer Academic Publishers), pp. 175– 90. 10.1007/978-94-009-1389-9_12
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)| false Yaqub, Muhammad, Azizali Mohammed, and Iqbal Zaidi, 1996, “A Focused SDR Allocation,”in The Future of the SDR in Light of Changes in the International Financial System, edited by ( Michael Mussa, James M. Boughton, and Peter Isard Washington: International Monetary Fund), pp. 202– 16.
Peter B. Clark was a Senior Advisor in the Research Department of the International Monetary Fund when this paper was written. Jacques J. Polak was the Director of that Department from 1958 to 1979. They wish to thank Barry Newman, Harry Trines, J. Onno de B. Wijnholds, and an anonymous referee for comments on an earlier draft.
In Article VIII, Section 7, and, again, in Article XXII.
The report mentions illustrative numbers of $45 billion and $100 billion. The leading proponent of the idea on the Task Force, David A. Lipton, aimed even higher, namely an allocation of $300 billion, with the participants in the New Arrangements to Borrow (NAB) depositing their allocations ($205 billion) in a trust fund to be used only “as a last line of defense to defend the international financial system in times of dire threat” (Lipton, 1999, p. 363).
Article IV, Section 7, of the original Articles of Agreement. The provision gave the United States, the United Kingdom, and, had it joined, the U.S.S.R. a veto on a decision for a uniform change of par values.
The most comprehensive collection of the profession’s views on the subject of international liquidity at that time is probably found in International Monetary Fund (1970).
In April 1968, the Group of Ten had decided to sever any link between their official gold stocks and the free gold market.
See, for example, the essay on “How Worrisome Are External Imbalances?,” in Chapter II of the IMF’s September World Economic Outlook (2002).
Looking at market-determined exchange rates, they find that it is difficult to detect any change in exchange rate behavior for many countries, with the demise of the Bretton Woods system manifested largely in the shift to floating of the U.S. dollar, the yen, and the deutsche mark.
See IMF Annual Report 2002, Appendix I, International Reserves.
Members may also have access to official sources of borrowing and grants, but these resources are typically earmarked for development purposes rather than held as reserves.
When the SDR interest rate was originally set at 1.5 percent, SDR allocations conferred significant seigniorage benefits, which generated proposals to link SDR allocations to aid for developing countries. Now that the SDR interest rate is market-determined, attention has shifted to the benefits accruing to countries that face costs of acquiring reserves substantially above the SDR interest rate.
The Fund automatically debits a member’s SDR account for the interest due. But once this account has been reduced to zero, the member must purchase enough SDRs to cover the interest cost.
There are currently six members in arrears on their SDR charges: Afghanistan, the Democratic Republic of Congo, Iraq, Liberia, Somalia, and Sudan (amounting to SDR 104 million or 0.5 percent of allocations). Such arrears do not give rise to an interest risk for net holders because the Fund is required under Article XX, Section 1, to pay SDR holders the full amount of SDR interest; this is achieved by issuing SDRs to meet any shortfall, which are cancelled as overdue SDR charges are settled.
Of course, there will always be some countries for which the opportunity cost of holding reserves is so high that even modest SDR allocations will exceed the secular increase in their demand for reserves (which may be close to zero), inducing them to spend most or all of any allocations they receive. For example, of all members that received allocations in the 1969–71 period, 10 held smaller total reserves in 1989 than in 1969. Six of these 10 countries were in arrears to the Fund in 1989.
Even if the countries that earned this rising amount of benefits from the operation of the SDR system decided to spend all of it in additional imports, the impact on world demand for tradables would be minimal, given the magnitude of the current level of world trade of around $6.5 trillion.
Its last sentence reads: “It is doubtful whether, in the circumstance of the world today, with world trade greatly expanded in volume and value, the Fund’s resources are sufficient to enable it fully to perform its duties under the Articles of Agreement” (p. 99).
Group of Ten, Communiqué of Ministers and Governors and Report of Deputies (1966), para. 29.
The 1994 proposal for the “equity allocation” did result from such a change in climate, as the main industrial countries became anxious to channel additional, but nonbudgetary, resources to the new members that had joined the Fund after the breakup of the Soviet Union.