Definition
Special Drawing Rights (SDRs) is an international reserve asset established by the International Monetary Fund (IMF). It represents a claim to currency held by IMF member countries for which they may be exchanged. The SDR is not a currency, but a potential claim on the freely usable currencies of IMF members.
Key Takeaways
- Special Drawing Rights (SDRs) are supplementary foreign exchange reserve assets defined and maintained by the International Monetary Fund (IMF).
- SDRs are not a currency, but rather a claim to currency held by IMF member countries for which they may be exchanged.
- The value of an SDR is based on the values of five major currencies: the U.S. dollar, Euro, Chinese renminbi, Japanese yen, and the British pound.
Importance
Special Drawing Rights (SDRs) are important in global finance because they represent an international type of monetary reserve currency, created by the International Monetary Fund (IMF), that member nations can use to supplement their official reserves.
They are used to supplement foreign exchange reserves of countries, helping to stabilize their economies and improve liquidity.
An increase in SDRs can offer borrowing countries greater flexibility, and supplement a country’s official reserves, leading to increased confidence in the global economic system.
SDRs play a crucial role in providing liquidity to the global economic system by providing countries with potential access to foreign currencies.
They are used by governments and international institutions to adjust their balance of payments, fostering stability in the international economy.
Explanation
Special Drawing Rights (SDRs) is an international reserve asset, which was created by the International Monetary Fund (IMF) in 1969 to supplement its member countries’ official reserves. The purpose of the SDR system is to provide liquidity to the global economic system, to prevent scenarios of liquidity crunch.
SDRs represent a claim to foreign currencies for which they may be exchanged in times of need. In other words, the mechanism is intended to provide countries with temporary substitutes for national currencies.
SDRs are allocated by the IMF to its member countries and are used essentially as a potential claim on the freely usable currencies of IMF members. Countries can exchange their SDRs for these currencies, improving their balance of payments and shoring up their foreign exchange reserve positions.
This provides them with a form of protection or buffer against financial crisis. In essence, the SDR facilitates exchanges amongst countries and promotes monetary cooperation, thereby promoting the stability of the global financial system.
Examples of Special Drawing Rights
International Monetary Fund (IMF): The most prominent example of using Special Drawing Rights (SDRs) is the International Monetary Fund itself. The IMF created SDRs in 1969 as a supplementary international reserve asset to complement the existing official reserves, which were then largely held in gold and U.S. dollars. Each of 190 member countries are assigned an amount of SDRs that they can use as a reserve currency, or even lend to, or exchange with other governments for their own currency.
Response to Global Financial Crisis: In 2009, in response to the global financial crisis, the IMF issued new SDRs equivalent to $250 billion to provide liquidity to the global economic system by supplementing the Fund’s member countries’ foreign exchange reserves. This served as a tool for governments to bolster their depleted foreign exchange reserves without needing to borrow money at high interest rates.
Covid-19 Pandemic Relief: In a more recent example, in August 2021, the IMF distributed $650 billion worth of SDRs to member countries in response to the COVID-19 pandemic. The aim was to help countries, especially those who are economically less developed, to support their economies and recovery efforts by increasing their foreign exchange reserves and reducing their reliance on more expensive domestic or external debt.
FAQ: Special Drawing Rights
1. What are Special Drawing Rights?
Special Drawing Rights (SDRs) is an international reserve asset, created by the International Monetary Fund (IMF), and its value is based on a basket of five key international currencies. It is not a currency itself, but a claim to currency held by IMF member countries for which they may be exchanged.
2. How are SDRs distributed?
SDRs are allocated to countries by the IMF. The allocation of SDRs is based on a country’s quota in the IMF, which in turn is based on the relative size of its economy.
3. What currencies are included in the SDR basket?
The SDR basket includes five currencies: the U.S. dollar, the Euro, the Chinese yuan, the Japanese yen, and the British pound sterling.
4. How often is the SDR value reviewed?
The value of the SDR is reviewed every five years by the IMF, or earlier if justified by a significant change in the role and status of one of the basket currencies in the world’s trading and financial system.
5. How can a country use its SDRs?
A country can exchange its SDRs for freely usable currencies, providing it with a source of foreign exchange reserves. This can be done in two ways: either directly between two members, or through a voluntary arrangement where a member or a designated agency with a strong external position agrees to buy or sell SDRs.
Related Entrepreneurship Terms
- International Monetary Fund (IMF)
- Foreign Exchange Reserve
- Sterling, US Dollar, Chinese Yuan, Euro, and Japanese Yen
- Reserve Tranche
- Exchange Rate
Sources for More Information
- International Monetary Fund (IMF): The IMF provides detailed information about Special Drawing Rights as it is an international financial organization involved in implementing Special Drawing Rights.
- World Bank: This is another international financial institution that provides loans and grants to the governments of poorer countries for the purpose of pursuing capital projects. They also have valuable insights on Special Drawing Rights.
- Investopedia: A website that provides a detailed and comprehensive definition of Special Drawing Rights and related financial concepts.
- Encyclopedia Britannica: A trusted source of information which can provide some insightful context about the historical and functional aspects of Special Drawing Rights.
