A deep dive into Special Drawing Rights (SDR)

Rupee’s performance since 2020 has not been encouraging. The domestic currency has depreciated about 6%. Incumbent, it hovers in 74-76 ball park. In line with the principles of managed floating exchange system – RBI intervenes only in days of acute volatility. Theoretically the exchange rate system is trifurcated. Fixed, floating & managed floating system of exchange. Under fixed – a currency stands pegged at a constant rate against another, generally greenback ($). There exists absolute government intervention & support to finalize the pegged rate. Floating system involves minimal or is devoid of intervention from the government. Managed floating blends the features of the former two systems. To put it succinct, prices arrived by the market is subject to government intervention. Fixed and floating rate systems are generally rendered not pragmatic. There have been circumstances where “Chinese Yuan” & “Saudi Arabian Riyal” were pegged against the greenback. Yuan was pegged at 8.28 units per $, for about a decade; 3.75 Riyals in exchange for a $, were the rates used. The latter was in practice, when crude gleamed alike gold. Days in the past, stated “Crude as liquid gold”. Saudi Arabian exchange rate was well maintained, until oil demand and prices nosedived. The discovery of shale reserves within US contours, made the economy less dependent on imports of crude. Under dramatic circumstances in the recent times, crude prices dipped into the negative territory – owing to overflowing storage spaces & subdued demand. Meaning, Crude sellers had to pay, for buyers to take delivery of crude!! However, the retail prices, specifically in India continued to stay put. The GoI (Government of India) astutely shored up its coffers by hiking the excise duty on crude products. Remarkably, Crude & Liquor doesn’t fall under the GST ambit. The maximum permissible threshold under the act stands capped at 18%. However, the aggregate of excise duty & state levied taxes (V.A.T) is way above 18% on the actual price. To avoid conundrum, the government chose to oust crude & liquor from GST ambit; retaining them under excise & VAT. Getting back to the system of exchange – prior to “Bretton wood conference” of 1944, currencies were pegged against ounces (a unit of measurement) of gold. A substantive credit in making greenback ($) as a global currency is owed to their then president Nixon. His government took a stand to redeem all dollars for gold. Since then, the practice of pegging currencies against greenback, stands prevalent hitherto. Fixed exchange systems have always been in practice as an interim. Seldom, it has lasted eternally. Since the inflation rate, trade deficit (Net exports/imports), fiscal pressures stands differentiated between economies, efforts to fix the pegging rate stands defeated.

To subdue the dominance of gold & greenback reserve building by world economies – IMF (international monetary fund) brought in SDR (Special drawing rights). SDR is an international reserve asset held by member countries. SDR comprises of Greenback, Euro, Pound Sterling, Japanese Yen and Chinese Yuan. Chinese Yuan – being the recent inclusion in the basket of currencies. All transactions pertaining to IMF are settled in SDR. SDR is not a currency per-se, it can be construed as a derivate, which receives its value from the basket of currencies comprising SDR. SDR rates are quoted in $ terms by IMF, based on the prevailing exchange rates of the currencies included in the SDR basket on a daily basis. In 1999, German Mark and French franc were part of the SDR basket, but later owing to the formation of EU (European Union) – Euro was brought into the basket. The SDR basket of currencies is revised quinquennially, forthcoming review is scheduled for 2021. Despite currency speculation by Japan & china to surge its exports, IMF has not expunged their currencies from the SDR basket. The uses of SDR is quite restrictive – primarily for interest payment / receipts with IMF based on a countries net holdings (Holdings less allocations). Allocations of IMF are akin to borrowings. The SDR can be exchanged for other currencies, provided the circumstances necessitate. For instance, a country with negative balance of payments with US can encash its SDR holdings $, to the settle the deficit. Remarkably, SDRs are not permitted to be held by private institutions / persons. India currently holds about 2.63% of the global SDR holdings and is ranked 13th. The countries get their voting share based on the amount of holdings. Every member country of IMF, has dual representation, namely the governor and an alternate. Indian incumbents are Ms. Nirmala SItharaman (Minster of Finance) and Mr. Shakthikantha Das (RBI governor) (*based on data from IMF site).

Duo caveats have to be satisfied before a currency can march into the basket. Primarily, the “export criteria” & secondly, “freely usable criteria”. The exports criteria requires the currency to be issue by top 5 exporters in the world. India currently ranks 11th in terms of export volumes, globally. “Free usable” criteria requires a currency to be traded & accepted globally. Also the stability of exchange rates of the currency in consideration, is taken into cognizance. Indian forex reserves have been at all time high, breaching $500 billion mark in the recent past, providing an additional comfort on RBI’s capacity to maintain stability of rupee. Hopes are high on currencies of developing countries marching into the SDR basket. Whether INR will make to the IMF basket of currencies, is question to be answered in 2021…

Published by adithyaarunachalam

I'm a millennial, from Chennai, India. Passionate about building up a career in finance, I follow and stay abreast on news feeds. I'm a novice blogger, So feel free to pass on your conjecture to me @adithyaarunachalam@Gmail.com

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