The COVID-19 pandemic and the consequent lockdown has severely impacted economic activities across the world. As per the IMF’s World Economic Outlook, the global economy is expected to contract sharply by –3 % in 2020. This makes it the worst recession since the Great Depression, and far worse than the Global Financial Crisis of 2008.
[You may also read: The Global Financial Crisis 2008 Explained] & [The Great Depression of the 1930s]
Hit by the pandemic, around 102 countries have approached the IMF for emergency funding due to Balance of Payment issues. In this respect, IMF Managing Director Kristalina Georgieva floated a move last month to allocate SDRs to its member nations. This was done to boost the liquidity of the member nations and enable them to meet payment obligations.
[You may read: Balance of Payment (BOP) Explained]
To review a possible SDR allocation of 500 billion, the International Monetary and Financial Committee met virtually in the third week of April, but it was blocked by the US and India.
What is Special Drawing Rights (SDR)?
Before coming to SDRs, let us first understand what IMF quota is.
International Monetary Fund (IMF) has 189 member countries. When a country joins the IMF, it is assigned an initial quota.
Quotas basically determine the amount of money (financial resources) that a member country has to give to the IMF. The quota is the main source of funding for the IMF.
The size of the quota depends on the financial and economic importance of the country in the world. The percentage of the quota of a country is calculated taking into account the following factors:
- GDP
- Openness
- Economic variability
- International reserves.
This is the quota formulae- (0.50 * GDP + 0.30 * Openness + 0.15 * Variability + 0.05 * Reserves)compression factor
[The IMF conducts general quota reviews at regular intervals (no more than five years).The current formula was agreed in 2008]
The amount of borrowing a member can obtain from the IMF depends upon its quota. It also determines the voting power of the member.
Quotas are denominated in SDRs. Also, members are allocated SDRs in proportion to their quota. The total quota funds in IMF is about SDR 477 billion. The US has the highest quota of 17.46 % or 82,994.2 million SDRs. India has the eighth highest quota of 2.76 % or 13114.4 million SDRs.
Now let’s come to SDRs.
The SDR is an international reserve asset created by the IMF in 1969 to supplement the foreign exchange reserves of its member nations.
[Read: Foreign exchange reserves of India]
The SDR also serves as a unit of account of the IMFs. All IMF transactions are denominated in SDRs.
The value of the SDR is based on a basket of five currencies—the U.S. dollar, the euro, the Chinese renminbi (added in 2015), the Japanese yen, and the British pound sterling.
[Read: IMF Adds Renminbi in the SDR basket]
The SDR is neither a currency nor a claim on the IMF. It serves as a unit of account and can be exchanged for these 5 currencies.
To sum up, quota determines the allocation of SDRs, which determines the borrowing capacity of the member nations.
Why did the US and India oppose SDR allocation?
- The US opposed stating that 70% of the funds created through an SDR allocation, would go to G20 countries, while only 3% would go to low-income countries. (This is because SDRs would be allocated based on respective quotas). It also said that the IMF should use other facilities to help the poorer nations.
- India opposed because it might not be as effective. It was also concerned that the money might be used for ‘extraneous purposes’ (not related to the intended purpose of maintaining domestic monetary and financial stability).
If member countries had approved new SDR allocations by a minimum 85 % vote, it would have provided additional foreign exchange reserves to member countries.
Already 25 countries have been provided SDR 5.54 billion assistance by the IMF under other facilities. The SDRs would have supplemented their resources. Further, they wouldn’t have had to repay these allocations with interest. It would have served as debt-free, unconditional funding.
The IMF last approved a $250-billion new allocation of SDRs in 2009, in the wake of the global financial crisis.
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