What are Special Drawing Rights?

Special drawing rights or SDRs are a form of reserve currency that was created at the end of the 1960’s by the International Money Fund, also known simply as the IMF. The currency works as a supplement or support to the reserves owned by each country that is a member of the IMF, and functions to alleviate concerns about the backing of the currency of any of the member countries. The original reason for the creation of special drawing rights was to ease worries regarding the use of dollars and gold as being the only means of settling accounts between countries, which up to that time was often the standard for trade in many parts of the world.

The general idea of special drawing rights is derived from the concept of what is known as the Bretton Woods system of fixed exchange rates. Essentially, this approach created a group or basket of national currencies, with each having their own resources to back the value of their currencies. The collective currencies represented in these reserve assets that are gathered in the IMF are not currencies in the strictest sense, but more of pledges of currencies as a means of supporting international trade. The creation of special drawing rights effectively creates an additional level of backing that eases some of the tensions and speculation regarding international trades, and thus encourages the process of free trade between a wider range of nations.

Each nation that is a member of the International Money Fund is allocated a certain amount of special drawing rights. These rights are very helpful with managing debt financing on a global scale, while also providing a strong sense of security for both the lender and the borrower. In order to finance the ongoing function of the IMF and the extension of special drawing rights, each member nation is assessed an interest rate that is calculated on a weekly basis, thus allowing for shifts in the value of different currencies. Interest is applied on the difference between the current allocation allowed the country and the current amount of SDR holdings in their possession. Member nations pay the interest on a quarterly basis.

The actual use of special drawing rights has been somewhat limited since the creation of the currency pledge in 1969. Only a single allocation was made in the period between 1973 and early 2009, with an additional allocation made later in 2009. Over the years, more nations have joined the IMF and thus have access to special drawing rights, although the process for defining each SDR unit still focuses on the weighted sum of contributions from the four core currencies of the original plan.