What Special Drawing Rights mean for Bangladesh

When it comes to money and foreign reserves, the international reserve asset called Special Drawing Rights (SDRs) deserve a mention, despite not being a currency per se.

SDRs emerged at a time when there were concerns about the limitations of gold and dollars as the sole means of settling international accounts. To this day, they serve as the unit of account of the intergovernmental financial institution International Monetary Fund (IMF).

Several other international organisations including African Development Bank, Arab Monetary Fund, Bank for International Settlements, and the Islamic Development Bank also use SDRs.

While individuals and private entities do not have rights to hold SDRs, the IMF members — and the IMF itself — hold SDRs and the IMF has the authority to approve other holders, such as central banks.

SDRs operate as assets that holders can exchange for currency when needed. Also, they can provide a country, or the global economy in general, with liquidity in times of crisis.

Now, let's explore the history behind SDRs and what they mean for Bangladesh.

The creation of SDRs

In the post-World War-II international monetary system, the US dollar had been serving as a reserve asset as good as gold.

But then, at one point, there was not enough supply of the US dollar and gold internationally to keep sufficient reserves for the IMF, which was founded in 1945 as part of the Bretton Woods system agreement, to function properly.

As a result, the system faced acute problems of international liquidity, such as balance of payments difficulties, inadequate growth of monetary reserves, and fragility of the gold exchange standard.

To solve this problem, the IMF introduced the SDR as a supplementary international reserve asset in 1969, defining them as equivalent to a fractional amount of gold that was equivalent to $1.

However, this arrangement could not last long.

On 1 March 1973, there was a showdown at the meeting of the Bundesbank's Central Bank Council. On the following day, the Bretton Woods system of fixed exchange rates was abolished. In response to this new development, the IMF redefined SDRs as equivalent to the value of a basket of world currencies.

Right now, the basket comprises five currencies — the US dollar, the euro, the Chinese renminbi, the Japanese yen, and the British pound sterling.

The value of the SDR

As mentioned already, the value of an SDR was initially the equivalent of $1 at the time or 0.88671 grams of gold.

However, with the gold standard changing over to a floating currency system, the SDR became valued as a basket consisting of five world reserve currencies.

The components of the currency basket is reviewed every five years, or earlier if warranted, by the IMF to ensure that the most widely used global currencies are being represented by its holding.

As of 27 February 2023, one SDR stood equivalent to $1.326290, according to the IMF's official website.

How SDRs can provide a country with liquidity

SDRs are, in particular, a blessing for the developing countries, as they can provide a country with liquidity, i.e., how quickly an asset or security can be converted into ready cash without affecting its market price.

It is possible because even though SDRs are not a currency, they are a potential claim against the freely usable currencies of IMF members.

Due to the fact that an SDR allocation is a low-cost method of adding to IMF member nations' international reserves, it can allow members to reduce their alliance on more domestic or external debt.

Developing countries can be the major beneficiary of this system by using SDRs as a cost-free alternative to accumulating foreign currency reserves through more expensive means, such as borrowing or running current account surpluses.

On 2 August 2021, the IMF allocated SDRs worth $650 billion, the largest in its history, in a bid to boost global liquidity during the coronavirus pandemic. 

As part of this allocation, Bangladesh received the equivalent of about $1.4 billion in SDRs.

Infographic: TBS

The allocation provided additional liquidity to the global economic system, supplementing countries' forex reserves and reducing their reliance on more expensive domestic or external debt.

Although Bangladesh was not a distressed country like Sri Lanka, still it could benefit heavily by receiving such an amount for mitigating its many challenges such as rising import cost, decline in the remittance inflow and cost for vaccinations.

Bangladesh's SDR policy

An IMF member's SDR holdings are documented as an asset, whereas the incurrence of an SDR allocation is recorded as a liability of the member receiving the SDRs. 

The allocation of SDRs depends on the member's IMF quota shares. The stronger a country's economy, the higher the quota share it has.

Bangladesh, however, did not make the direct use of its previous SDR allocations. Rather, the Bangladesh Bank chose to keep the allocation as part of its forex reserves.

The reason behind such policy is that this provides the country a buffer against any unforeseen developments in the future.

It can also give them a boost while getting approval of loans from the IMF, like what we have seen earlier this year. 

How SDRs helped Bangladesh get approval of additional loans 

In January 2023, the IMF approved an additional $200 million in loan to Bangladesh against its proposal for $4.5 billion.

SDRs had a lot to do with that additional amount. 

Bangladesh received the approval for the additional amount due to the stronger position of SDRs against the dollar. Reportedly, the IMF approved a loan of 3.5 billion SDRs for Bangladesh, which the country will accept in USD.

Given the calculation, Bangladesh's debt will go up if the dollar depreciates further in the future. However, if the dollar strengthens against the SDR, the amount of debt in dollars will also decrease.

At the time the loan was proposed, the dollar rate against the SDR amounted to $4.5 billion. However, at the time of the approval, 3.5 billion SDR was equal to $4.7 billion due to the depreciation of the dollar.

This is how SDRs helped Bangladesh get approval of additional loans from the IMF.