Special Drawing Rights – also known as SDR- is an artificial currency instrument used by the International Monetary Fund (IMF) built from a basket of several essential currencies. It serves as the unit of account for the IMF for internal accounting purposes. When SDR was first introduced, it was defined as equivalent to 0.888671 grams of fine gold or the equivalent to one US dollar. However, after the collapse of the Bretton Woods system, the SDR was redefined as a basket of currencies.
This Special Drawing Rights basket is reviewed every five years, or when warranted, to ensure that it reflects the importance of currencies in the financial systems. The US dollar, Euro, Yuan, Yen, and the UK pound are the five currencies that define SDRs’ value, which the IMF then uses for internal accounting purposes.
Since it’s not money, how can SRD help countries?
As mentioned above, Special Drawing Rights (SDRs) are an asset, not money, in the classic sense. They can’t be used to buy things and can’t be used by individuals or private entities. So they are neither a currency, a cryptocurrency, nor a financial claim on the IMF. What happens is that countries exchange their SDRs for hard currencies with other IMF members. This is usually done voluntarily, which means that member countries in a stronger financial position use SDRs to support low-income countries.
The Special Drawing Rights allocations are distributed in proportion to countries’ participation in the IMF capital, which is closely related to the size of their economies where low-income countries can receive more than 6% of their GDP. As the pandemic wrecks havoc in different countries and limited resources are stretched thinner, governments are in acute need of financial support to manage the crisis. That’s why the IMF is working with the US Department of the Treasury and other members toward a $675 billion general allocation of SDRs to countries in need. By addressing the challenges brought by Covid-19, reserve assets can support the global recovery from the crisis.
How does the Special Drawing Rights (SRD) market work?
The SDR market functions purely on a voluntary basis. This means that various Fund members and SDR holders have agreed to buy and sell SDRs whenever needed. The IMF plays the role of the facilitator of transactions between these members. What happens if there are not enough voluntary buyers? In this case, the International Monetary Fund designates those members with a solid financial balance to provide freely usable currency in exchange for SDRs. This is called the “designation mechanism” and ensures that participants can use their SDRs to readily obtain an equivalent amount of currency if needed. However, such a mechanism has not been activated since 1987.
What are some criticisms against Special drawing Rights (SRDs)?
While many agree that SRDs can really help countries overcome the crisis similar to the pandemic, there is still some controversy. Firstly, when SDR becomes a hot topic, this is a warning sign of the financial system having issues. Moreover, one of the biggest criticisms is that SDRs can give an unconditional cash injection to governments that need to focus instead on necessary reforms to get their economies in better shape. Countries that have put off essential reforms in the financial, political, and human rights fields shouldn’t be handed funds to help them weather the storm because this doesn’t give them a long time solution. It’s similar to trying to fix a broken glass with bandaids.
For instance, Lebanon has 195.78 million in SDR, but its politicians have been accused of corruption allowing half of the population to sink into poverty. Another example is Venezuela which has 9.32 million SDRs, where mismanagement has led to a massive increase in consumer prices this year, according to IMF data, leading to a mass exodus. Moreover, those opposed to creating more SDRs argue that it is not an efficient way to help poorer countries. Why? Because those who benefit more are the more prosperous and middle-income countries since the allocation is distributed according to a country’s position within the global economy.
While nobody on the surface suffers, behind closed doors, the value of the national currencies will continue to decrease. The US dollars, Euros, RMB, Yen, Pounds will be created out of thin air. What does this mean? Their value will be decreased at a faster rate than ever before. All this happens indirectly, allowing it to be relatively hidden from the citizens of the world. The price of assets like stocks and real estate will continue to rise. People feel they are getting richer, but in reality, the value of their money is decreasing quietly, and most people will never realise it. That’s why this global currency is so genius.
