Special Drawing Rights (SDRs) are international foreign exchange reserve assets. Allocated to nations by the International Monetary Fund (IMF), a SDR represents a claim to foreign currencies for which it may be exchanged in times of need.
Today, the US Dollar is the world's primary foreign exchange reserve asset, and SDRs may be little used. Some nations, notably China and Russia (as well as the UN), favor increasing the substance and function of the SDR.
Although denominated in US dollars, the nominal value of an SDR is derived from a basket of currencies; specifically, a fixed amount of Japanese Yen, US Dollars, British Pounds and Euros.
SDRs are the International Monetary Fund's unit of account and are denoted with the ISO 4217 currency code XDR.
Created by the IMF in 1969 and originally intended to be the primary asset held in foreign exchange reserves under the Bretton Woods fixed exchange rate system, the Special Drawing Right has, after the collapse of that system in the early 1970s, taken on a far less important role.
When the Special Drawing Right was created, as now, the US Dollar was the world's principal foreign exchange reserve asset. But without a US deficit there would not have been enough Dollars to sustain the degree of market liquidity a foreign exchange reserve asset requires.
A deficit is necessary for the United States to supply world demand for its Dollars, but such a deficit will, in time, lessen the value of the Dollar and endanger the entire system. Known as the Triffin dilemma, it was this problem that the creators of the SDR sought to mitigate.
So, in order to supply world demand for a foreign exchange reserve asset that had sufficient market liquidity and simultaneously prevent any future crisis of confidence in the value of the US Dollar, the International Monetary Fund created a "synthetic reserve asset", the Special Drawing Right.
Starting in the early 1970s, the US reversed its conservative monetary policy and began to run a deficit, precipitating the collapse of the Bretton Woods fixed exchange rate system. In the face of an increased supply of US Dollars, the newer, less-preferred SDR fell into disuse.
Debt or Equity?
During its creation, it was debated if the Special Drawing Right should be a form of money or a type of credit. Nations, when asked to do so by the IMF, are supposed to purchase SDRs from other nations with weak foreign exchange reserves. As this means that SDR allotments may need to be repaid (although not to the IMF itself), the SDR could be considered a form of debt security. And like debt securities, SDR holdings do accrue interest. However, the SDR is used as a unit of account and is sometimes referred to as a "quasi currency".
The IMF acts as an intermediary in the voluntary trading of Special Drawing Rights as well as having the authority to order nations with strong foreign exchange reserves to purchase SDRs from nations with weak reserves. But the claim to foreign currency that SDRs represent is not a claim on the IMF, and it is not the IMF that pays out foreign currency in exchange for SDR.
When Special Drawing Rights were created in 1969 one SDR was defined as having a value of 0.888671 grams of gold, the value of one US dollar at that time. After the breakdown of the Bretton Woods system in the early 1970s, the SDR was redefined in terms of a basket of currencies. Today, this basket is composed of Japanese Yen, US Dollars, British Pounds and Euros, and the proportion each of these four currencies contribute to the nominal value of a SDR is reevaluated every five years.
For the period of 2006-2010, one SDR is the sum of 0.6320 US Dollars, 0.4100 euro, 18.4 Japanese yen and 0.0903 pound sterling.
Due to varying exchange rates, the relative value of each currency varies continuously and thus the value of the SDR fluctuates. The IMF fixes daily the value of one SDR in terms of US dollars based on the exchange rates of the constituent currencies. The latest US dollar valuation of the SDR is always available from the International Monetary Fund web site.
Special Drawing Rights are allocated to nations by the IMF. A nation's IMF quota, the maximum amount of financial resources that it is obligated to contribute to the fund, determines its allotment of SDRs.
Allocations are not made on a regular basis and have only occurred on a handful of occasions. One reason is that the IMF has considered the possibility of a reserve shortage remote as there has been a continued demand for, and sufficient supply of, US Dollars.
The first allocation, 1970–72, was made due to the possibility of an insufficient amount of US Dollars, as the US was reluctant to run the deficit necessary to supply future demand. While this situation was soon reversed, suspicion of the Dollar during the late 1970s lead to the 1979-81 allocation. The financial crisis of 2007–2010 precipitated the latest issuance of SDRs.
Like national currencies, the Special Drawing Right carries an interest rate. The SDR interest rate is determined weekly and is based on a weighted average of representative interest rates on short-term debt in the money markets of the SDR basket currencies. The current SDR interest rate is available from the IMF website.
SDR are used as the unit of account for the IMF and several other international organizations, such as JETRO and the Universal Postal Union.
In some international treaties and agreements, SDR are used to value penalties, charges or prices, as is the case with the Convention on Limitation of Liability for Maritime Claims, where personal liability for damages to ships are capped at SDR 330,000. The Warsaw convention, the Montreal Convention and other treaties also use SDRs in this way.
A few countries peg their currencies to the SDR.
The African Development Bank's own "currency", the Units of Amount (UA), equals the SDR currency basket.
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