Special Drawing Rights: A currency which doesn’t look like one

What are exactly these Special Drawing Rights?

In a recent article, economist Dominique Strauss-Kahn was calling for the massive usage of Special Drawing Rights (SDRs) issued by the International Monetary Fund (IMF) in order to help emerging economies to overcome the current COVID-19 crisis effects.

It would seem that many countries have listened to him; since the beginning of April there has been a succession of announcements on this topic, Guinea kicking off the game with a withdrawal of 23.5 million dollars, then Madagascar with 166 million dollars, Morocco with the substantial amount of 3 billion dollars, Gabon for 147 million dollars, Tunisia for 745 million dollars and finally Senegal for 442 million dollars.

In less than a fortnight, the IMF has mobilized more than 4.5 billion dollars for emerging countries, and this number should grow fairly rapidly over the coming weeks.

The press release of the Moroccan administration is interesting because it also says that this withdrawal of 3 billion dollars does not constitute a public debt, which it justifies by the fact that the money went to the Central Bank and not to the Treasury.

So what is the nature of this dollar financing that would not be a debt?

In reality the question is wrong because this “instrument” is not really a financing and not really in dollars.

In order to understand how the IMF really operates, we must take a look, as often, at the history and the origins of this institution.

The IMF was formed in the frame of the 1944 Bretton Woods Conference. The latter aimed at organizing the new post-war financial order and avoiding leaving countries free to unilaterally modify their exchange rates, which has led to several conflicts in the past. Under the new system, each national currency had to be defined in relation to gold or the dollar, itself convertible into gold, with a fluctuation margin limited to 1%.

The IMF's primary role was to ensure that countries respected this limit by organizing a proper currency market allowing countries to stay withing the fluctuation bandwidth boundaries. In order to do so, each IMF member country deposited in the institution’s accounts its contribution, called “quota”, composed at 25% in gold and 75% in currencies. This quota was calculated, inter alia, on the basis of the GDP and the balance of payments. Today, the United States has the highest share with 17.46%, followed by Japan with 6.48%. Morocco, for example, has a quota of 0.19%.

The suspension of the dollar’s convertibility into gold in 1968 and its abolition in 1971, a process that led to the explosion of the fixed exchange rate regime in 1973 and the introduction of a floating exchange rate regime, which is currently in force, took out the IMF’s role as guardian of exchange rates.

However, and even before these events, all countries were questioning the sustainability of a financial system in which a single national currency, the dollar, was used internationally. In 1968, member countries enabled the IMF to create a new reserve asset: Special Drawing Rights or SDRs; the ambition was to create an international “quasi-currency” that could eventually replace the dollar as the main currency for trade.

We have referred to them as “quasi-currency” because these SDRs are not a full currency as they cannot be used directly to settle transactions.

SDRs are allotted without counterpart; they are not a claim on the IMF but rather a right to obtain currency from another IMF member country directly from that country.

On the other hand, SDRs are redeemable and bear interests. The recipient pays interest on the amount of SDRs allocated and receives interest on the amount of SDRs held. Thus, on the day of an SDR allocation, these interests are neutralized and there is no cost to the recipient; indeed, the number of SDRs allocated would be equal to the number of SDRs held. The recipient country does not actually pay interests until it begins to exchange its SDRs for other currencies and thus sees the amount held in SDRs reduced.

In addition, these SDRs have a value and this value is based on a basket of currencies and then translated into dollars for a better readability. The current basket consists of dollar, euro, yen, renminbi and pound sterling. At the time of writing this article, one SDR was worth 1.37 US dollar. Therefore, when we talk about Morocco’s drawdown of 3 billion dollars, we are in fact talking about an allocation of 2.2 billion SDRs.

However, the SDRs were never really able to play their role as the main international reserve asset because the whole Bretton Woods system moved towards the dollar system that we still know today. This is certainly also one of the reasons why STDs are so little known to the general public and have remained a subject for experts.

At their inception, SDRs were allocated by the IMF to countries on the basis of their respective quotas according to the principle of equal treatment among member countries. Therefore, industrialized countries were the main beneficiaries of the first allocations. With time and the development of capital markets where governments could finance themselves directly, emerging countries became the main beneficiaries of the allocations and that basically transformed the IMF into a development institution.

This has been achieved by allowing allocations to emerging countries at levels above their respective quota, which other member countries allowed under structural reform conditionality, such as deficit reduction. For example, the IMF intervened in Mexico in the mid-1990s at a level of seven times its quota. For Morocco's latest drawdown, the 3 billion dollars corresponds to 240% of its quota.

The financial crisis of 2009 gave the IMF again a central role in safeguarding the international financial system, being heavily endowed by the G20 countries with additional quotas and increased debt capacity, which enabled many European countries to benefit from the IMF support. Today, the IMF has nearly 500 billion SDRs in quotas and 500 billion SDRs in debt capacity, compared to 200 billion SDR in total in the early 2000s. China played a major role in this dynamic, certainly with the strong willingness to see a system emerging that would be less tied to the dollar.

As part of this process, the IMF created new facilities, making it possible to go very significantly beyond the quotas: (i) the Flexible Credit Line (FCL) which is unlimited and (ii) the Precautionary and Liquidity Line (PLL) which makes it possible to draw up to 500% of the quota. At this date, the FCL has been granted to Poland, Colombia and Mexico, not of them having used it yet, while the PLL has been granted to Morocco and Macedonia.

Is an SDR allocation a debt for the recipient?

It is a debt because SDRs are interests-bearing and repayable, both of which are consubstantial with the concept of debt; it is not because it is not really a tangible currency but a mere right. Moreover, the grantor, the IMF, does not account a receivable for this allocation.

There is indeed a real debate and it turns out that the doctrine has also evolved over the last few years.

Until 2008, the System of National Accounts (SNA), promoted by the European Commission, the United Nations, the OECD, the IMF and the World Bank, classified SDRs as assets without counterpart liabilities, such as gold, and therefore did not affect government debt.

In the new 2008 version, the SNA changed its approach in the following terms: ? SDRs allocations give their holders a guaranteed and unconditional right to obtain other reserve assets, especially foreign exchange, from other IMF members. SDRs are assets with counterpart liabilities, but these assets represent claims on the participants collectively and not on the IMF. The 2008 SNA recommends treating Special Drawing Rights (SDRs) issued by the International Monetary Fund as an asset of the country holding them and a claim on all participants in the system".

Thus, according to the SNA, a debt should be recorded that is not due to the IMF but to all member countries. Of course, each country is free to follow or not to follow the SNA recommendations in its own accounts.

In addition, from a purely economic point of view, as long as the SDRs held by a country would be swapped into other currencies which would subsequently be injected into the domestic economy through the banking system, the recipient country would therefore be paying interest on its SDR allocation; it seems reasonable to assume that the allocation of SDRs would be indeed a liability and therefore a debt.

One thing is certain: currency is not just a matter for institutions, it is above all a matter for everyone. The IMF would benefit from trying to explain more its currency and its operations, which I have tried to do here, albeit certainly clumsily.