A year into the COVID-19 pandemic, the International Monetary Fund (IMF) is about to agree to supplement member countries' foreign exchange reserves through a new allocation of Special Drawing Rights (SDR) of $650 billion. This action will benefit directly about 75 lower-income countries with about $62 billion to help them address the external financial consequences of the coronavirus pandemic. At the same time, it will benefit all countries indirectly by relaxing external constraint on policies to boost their economies and thereby the global recovery.
US signals support for the new SDR allocation
The IMF allocates SDRs to members in proportion to their quota shares. Members receiving SDRs can then transfer them to other members in exchange for convertible or hard currencies to meet their external financial needs.. Many economists have endorsed this tool over the past year, including authors posting on the Peterson Institute website and other scholars, including Lawrence H. Summers. But the initiative required US support, which the Trump administration withheld. Treasury Secretary Janet Yellen on February 25 signaled to the G20 countries a reversal of US policy. The IMF executive board embraced the proposal on March 23. The next step on April 8 will be the IMF’s International Monetary and Financial Committee of finance ministers’ endorsement of the proposal for implementation, expected by early September.
Global benefits of the SDR allocation
The substantial indirect benefits of the SDR allocation for the global economy were foreseen when the tool was designed in the late 1960s. In 1973, the Committee of Twenty on Reform of the International Monetary System and Related Issues created a Technical Group on the SDR/Aid Link. Its report flagged this role while examining a proposal that a portion of any SDR distribution to industrial countries first be allocated to developing countries. The Committee’s report concluded: “A link would contribute to the smooth functioning of the adjustment process, since, by enabling developing countries to run larger current account deficits, it would tend to relieve the tensions involved in the pursuit by developed countries of the current account surpluses that many of them prefer.”
Current proposals to recycle part of the impending SDR allocation from richer Fund members to support IMF lending programs for lower-income countries also echo earlier discussions of aid to developing countries. Moreover, emerging-market and developing countries in 2021 will receive a larger share of the new SDR allocation than they did in the allocation in 1970–72. At that time, 22 industrial countries received 73 percent and all other countries only 27 percent. In September 2021, those same industrial countries plus Switzerland, which was not an IMF member until 1992, will receive 57 percent, leaving 43 percent for other recipients.
Concerns about the adjustment process are as acute today as they were five decades ago. All countries are struggling to counteract the economic recessions precipitated by the pandemic, and many face disrupted capital inflows. Many may be tempted to export their economic problems through currency undervaluation and austerity policies that weaken domestic demand, reduce imports, and hold back global recovery.
The SDR is like an insurance policy against unexpected external financial risks. But unlike a normal insurance policy, SDR insurance carries no premium until the policy is activated. And the premium for using SDR credit is very low. Most important, the SDR is an insurance policy that, even if not activated, still provides peace of mind – simply because it can be activated in case of need. Countries facing actual or perceived external constraints on their economic policies because of their limited access to foreign credit will become more confident in adopting bolder policies to speed economic recovery at home and abroad.
Many lower-income countries will benefit directly from drawing on the financial insurance provided by the SDR allocation. All countries will benefit indirectly from the availability of the insurance. Turbulent waters may lie ahead as the world struggles to emerge from the pandemic and adjust to its aftershocks. The benefits of the planned SDR allocation should not be underestimated.
1 The SDR’s value tracks a basket of currencies comprising the US dollar, Japanese yen, euro, pound sterling, and Chinese renminbi. Each member pays interest (currently 0.05 percent) on the difference between its allocation and its holdings of SDRs.