Special Drawing Rights (SDR)

Reviewed by Annapoorna | Updated on Aug 27, 2020

What are Special Drawing Rights (SDR)?

Special Drawing Rights, usually denoted as SDR, were set up in the year 1969. It refers to a monetary reserve currency created by the International Monetary Fund (IMF) and used across the globe. It operates as a substitute for the present money reserves of the member countries of the IMF.

It was devised in response to concerns about the limitations of gold and dollars as the sole means of settling international accounts. The SDRs contribute to growth in global liquidity by enhancing the standard reserve currencies.

Understanding Special Drawing Rights (SDR)

The IMF uses an SDR as an artificial currency instrument and depends upon it for internal accounting purposes. SDR is set up from a basket of popular currencies across the globe. The IMF assigns SDRs to its member countries, showing full faith and support by their governments. The SDR is re-evaluated every five years.

The SDR was commissioned with a vision of becoming a highlighting aspect of international reserves. On the other hand, the gold and reserve currencies would form a minor marginal element of such reserves.

A member country must get access to official reserves to get involved in the SDR system. Such official reserve consisted of the reserves of gold and globally accepted foreign currencies belonging to the central bank or government. These could be used to buy the local currency in foreign exchange markets to maintain a stable exchange rate.

However, the international supply of the two principal reserves, such as the U.S. dollar and gold was not sufficient to support growth in global trade and the ongoing related financial transactions. This lacking prompted member countries to form an international reserve asset under the guidance of the IMF.

The value of the SDR is calculated from a weighted basket of major currencies, including the U.S. Dollar, Chinese Yuan, Japanese Yen, the Euro, and British Pound. Its value is outlined in U.S. Dollars.

The IMF uses the SDR interest rate (SDRi) as the basis for calculating the interest rate charged on the borrowings made by member countries from it. Also, compensation shall be paid to the members for their remunerated creditor positions in the IMF at the same rate.

How Does Special Drawing Rights Work?

The SDR is not a currency or a claim against the IMF assets. Rather, it is a prospective claim against the openly usable currencies belonging to the IMF member states. The IMF’s Articles of Agreement fixes a freely usable currency as broadly used in international transactions and is often traded in foreign exchange markets.

The member states of IMF that hold SDRs can swap them for freely usable currencies by two methods. They can agree among themselves for voluntary swaps. Alternatively, the countries with stable economies or more substantial foreign currency reserves may buy SDRs from the less-privileged country members as per the IMF’s instructions.

The IMF member countries can borrow SDRs from its resources at favourable interest rates. It is mostly done to adjust their balance of payments to advantageous positions. Apart from acting as a supplemental reserve asset, the SDR acts as the unit of account of the IMF.