About $110 billion of the combined allocations will go to emerging market and developing countries, including over $20 billion to low-income countries (IMF photo)
Combating the Global Crisis
The allocation, equivalent to $250 billion, was made on August 28 and will be followed by an additional, albeit much smaller, allocation of $33 billion on September 9. With the two allocations totaling roughly $283 billion, the outstanding stock of SDRs would increase nearly ten-fold to total about $316 billion.
There are no notes or coins denominated in SDRs, nonetheless the SDR does play a role as an interest-bearing international reserve asset. The allocation of SDRs by the IMF boosts member countries’ reserves because SDRs can be turned into usable currencies. Once the SDRs have been added to a member country’s official reserves, the country can voluntarily exchange its SDRs for hard currencies, such as the U.S. dollar, euro, yen, or pound sterling, through voluntary trading arrangements with other IMF member countries.
Some countries have already volunteered to set up trading arrangements that will facilitate the buying and selling of SDRs.
SDR allocations respond to G-20’s call
It was at its April summit in London that the Group of Twenty (G-20) industrial and emerging market countries called for an SDR allocation of $250 billion. The proposed general allocation was approved by the IMF’s Board of Governors on August 7, 2009, and came into effect on August 28. The allocation is based on a long-term global need to supplement IMF members’ existing reserve assets and it provides liquidity to the global economic system.
The G-20 had also called for urgent ratification of a long-pending amendment to the IMF’s Articles of Agreement. This so-called Fourth Amendment was proposed to enable all Fund members to participate in the SDR system on an equitable basis and correct for the fact that countries that joined the Fund after 1981—now more than one-fifth of the current IMF membership—have never received an SDR allocation.
The amendment to the Articles had originally been set in motion over ten years ago, but it needed to then pass successfully through the legislatures of three-fifths of the Fund’s members, having 85 percent of the total voting power. Recently amended U.S. legislation paved the way for making the amendment effective in August.
The amendment provides for a special one-time allocation that will be separate and additional to any SDRs allocated to members under the general allocation of SDRs. The special one-time allocation of about $33 billion, will be made on September 9, 2009.
Mechanics of SDR allocations
General allocations of SDRs are made as a percentage of a member’s quota with all participants receiving the same percentage—a member’s quota is based broadly on its relative size in the world economy and determines both its subscription to the capital of the IMF and voting rights in the organization; a member’s quota has a bearing on its access to IMF financing.
Allocations under the special amendment to the Articles of Agreement would not be made in proportion to quotas but rather pursuant to a methodology that would bring participants’ net cumulative allocations-to-quota ratio to a specific common benchmark.
SDR allocations provide each member with a costless asset. If a member’s SDR holdings rise above its allocation (for example, if it purchases SDRs from another member), it earns interest on the excess; on the other hand, if it holds fewer SDRs than allocated, it pays interest on the shortfall at the official SDR interest rate.
Low-income countries to benefit significantly
While an allocation of SDRs increases the international reserves held by each IMF member, it will not increase the Fund’s resources available for lending. It will, however, provide members with an additional method to obtain hard currencies. This can be a way for countries to augment their reserves in times of need, and also a means for countries to obtain other currencies that they may use in international transactions.
About $110 billion of the combined allocations will go to emerging market and developing countries, including over $20 billion to low-income countries. Many of these countries currently face difficult spending decisions as they decide how to address the fallout from the global crisis. For them, the SDR allocation means potential access to unconditional financial resources that could limit the need for adjustment through contractionary policies and allow greater scope for countercyclical policies in the face of recession and rising unemployment.
“The general SDR allocation is a key part of our response to the global crisis, demonstrating the value of a cooperative multilateral approach,” IMF External Relations Director Caroline Atkinson said. “The Fund’s low-income members will benefit significantly,” she added. Despite a smaller number of SDRs going to the IMF’s low-income members, the allocation will result—in most cases—in a proportionately bigger increase in reserves for them than it will for the advanced economies, which already have a substantial cushion of reserves.
Exchange of SDRs expected to rely on voluntary trading arrangements
Once the SDRs have been allocated, members can decide to keep them in their reserves or exchange them for hard currencies as their individual situations dictate. In order to accommodate the expected increase in the volume of SDR transactions, the IMF has called for expanding the capacity of voluntary trading arrangements.
Under the voluntary trading arrangements, individual Fund members stand ready to buy and sell SDRs within certain limits, thereby effectively establishing an SDR market. The IMF acts as a broker and arranges transactions between prospective buyers and sellers of SDRs at no cost. These voluntary arrangements have ensured the liquidity of the SDR for more than two decades.
A number of members with sufficiently strong external positions have already stepped forward, saying they will establish a new voluntary arrangement or expand the capacity of their existing arrangements in light of the new allocations.
In the event that there is insufficient capacity under the voluntary trading arrangements, the IMF can activate a designation mechanism to guarantee the liquidity of the SDR. Under this mechanism, members with sufficiently strong external positions are designated by the Fund to buy SDRs with freely usable currencies up to certain amounts from members with weak external positions. This arrangement serves as a backstop to guarantee the liquidity and the reserve asset character of the SDR.
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