Fix the System
How SDRs Can Bridge the Financing Gap
With just a quarter of the world’s unused Special Drawing Rights (SDRs), we could wipe out the entire debt burden of developing nations.
Imagine the global impact if we redirected this financial power to bridge the current financing gaps in sustainable development, tackling poverty and the climate crisis. So, what are SDRs, and why do they matter in the pertinent context of sustainable development?
SDRs are “an international reserve asset created by the IMF to supplement the official reserves of its member countries.”
Let’s break this definition down. It may help to go word by word. “Special” refers to the fact that these are unique from existing financial tools like loans. “Drawing” means the ability to access funds, the way you might withdraw funds from a bank account. Finally, “rights” represent a claim on something. In this case, a “claim,” means you have the right to exchange something for other things. They can be exchanged for actual money like US dollars, also known as liquidity, or for other things like trading goods, acquiring loans, or paying debts.
Therefore, SDRs are a special financial tool which allow IMF members to access liquidity and facilitate financial transactions. The value of an SDR is determined using a basket of the five most used currencies in global transactions. We can think of SDRs as a kind of special gift card, which allows you to shop from five of the most popular stores (representing the five currencies).
Remember, a gift card itself is not money, but can be exchanged for real money. In the same way, countries can exchange SDRs between themselves and convert them into money when they need to pay for things like trade or debt. Furthermore, you do not need to spend a gift card immediately, and may instead choose to hold on to it for the future or perhaps exchange it with a friend for another card of the same value at another store.
This function speaks to the role of SDRs as a “reserve asset.” A reserve asset is something that countries hold on to as a backup or safety net when they need it. Usually countries hold on to foreign currency as reserves, but SDRs expand the options they have.
When SDRs were initially designed in 1969 the global financial system was experiencing tumultuous change as countries began abandoning the gold standard. SDRs were envisioned as a supplement to the existing foreign exchange reserves countries already maintained. If they ran into a problem where they needed liquidity, SDRs were another resource they could rely on.
In the contemporary context where financing for development is a primary issue, SDRs can help countries receive financing without having to borrow money in the form of expensive loans.
How do countries receive SDRs?
The IMF allocates SDRs to its member states through a system called a “general SDR allocation.” To go back to our gift card analogy, it determines how many gift cards each country receives based on their financial contributions to the Fund. Since richer economies can contribute more financially to the IMF, they receive more SDRs.
You may already see the problem here; this system privileges richer countries that contribute more, with extra liquidity. In the current context, richer countries are relatively less in need of extra liquidity as poor countries.
Currently, almost $87 billion worth of SDRs remain unused among the G20. Emerging markets and developing countries only have 42.3% of the share of SDRs and within that, developing countries only have 3.3%. Moreover, evidence shows that developing countries are the predominant users of SDRs as compared to their developed counterparts.
Given the immense financing needs of developing countries, how can SDRs be channeled to those that need them most?
There are currently three proposals being forwarded in the process leading up the Fourth International Conference on Financing for Development (FfD4), including a new general allocation, the rechanneling of SDRs to Multilateral Development Banks (MDBs), and the creation of a SDR playbook. Let’s take a look at each.
The first proposal urges the IMF to issue SDRs under a new general allocation. For example, on 23rd August 2021, a general allocation of SDR 456.5 billion (approximately USD $650 billion) helped countries respond to the COVID-19 pandemic.
However, this is only possible if three conditions are met: there must be a long-term global need for liquidity, the issuance must meet the IMF’s goals of monetary stability, and there must be 85% approval among the IMF’s Board of Governors. This is often difficult to achieve, as richer nations like the US hold up to 16% of the votes which makes it difficult to reach consensus without them.
Individual nations can also voluntarily allocate or exchange their SDRs. IMF members are able to buy, swap, lend, and borrow SDRs through bilateral and multilateral mechanisms. They can also channel their SDRs to the IMF’s financing facilities, the Poverty Reduction and Growth Trust (PRGT) and the Resilience and Sustainability Trust (RST).
These trusts offer financing, usually in the form of loans, to countries in need. This first proposal argues that the IMF or its members with unused SDRs can allocate them to these countries.
However, allocations are not the only way developing countries can receive SDRs. There are two other proposals to use SDRs in novel ways which may assist developing countries.
The second proposal, put forth by the African Development Bank (AfDB) and the Inter-American Development Bank (IADB), seeks to rechannel SDRs from the high-income countries towards those that need them.
Remember the $87 billion worth of unused SDRs we mentioned above? MDBs like the AfDB argue that if the Global North were to lend these SDRs to them, they could transform them into something called hybrid capital. Put simply, if MDBs receive surplus SDRs, they are able to use that to convince investors to offer them more money. They can then use this money to expand how much and what they can offer to developing countries.
An important aspect of this proposal is that if the developed countries who are lending their SDRs ever need them back, they can reclaim them. Therefore this would be a relatively low-risk proposal for developed countries, and also reduces the strain on the IMF, while getting valuable financing to those that need it the most. However, this proposal faces pushback from the Global North, who are hesitant to rechannel their SDRs due to legal barriers.
The third proposal is to develop a new SDR “playbook.” This would be a set of rules-based recommendations that guide when and where to issue SDRs in response to specific crises. A playbook would decrease the time and confusion involved in determining a new issuance or allocation of SDRs. Such a proposal attempts to supplement the conditions for issuing SDRs mentioned above so that the IMF and its members can respond with targeted measures to countries facing crises.
Hopefully, at the end of this, it is more clear why SDRs are so important.
They sit at the intersection of many of the finance and development concerns facing the world today. Lack of liquidity, lack of access to finance, and inequity in the decision-making of the global financial architecture are all interlinked with the discussion around SDRs. If these issues aren’t addressed, the crises around debt, inability to meet SDGs, and growing poverty will continue.
What can you do in the midst of this?
The first step is to stay informed on developments in the FfD4 as SDRs are a major discussion point there.
You can then begin raising awareness about the importance of SDRs and their potential, as well as the different proposals on the table to expand their accessibility.
And if you find yourself particularly drawn to a proposal, find ways to advocate for it within your spaces. In order to do what they were made to do and stabilize the global financial system, SDRs must be allocated to the countries that need them most.
Hesitancy around this allocation is only allowing the problem to grow worse.
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