Introduction
The SDR is an international reserve asset that was formed by the IMF in 1969 to augment the official reserves of its member nations.
However, the worldwide supply of the U.S. dollar and gold, the two primary reserve assets, was insufficient to sustain the expansion of global commerce and the associated financial activities. This spurred member nations to establish an international reserve asset under IMF supervision. In response to concerns about the constraints of gold and dollars as the exclusive method of settling international accounts, SDRs supplement the standard reserve currencies to increase international liquidity.
The Special Drawing Rights is neither a currency nor an IMF claim. It is rather a prospective claim against the freely useable currencies of IMF members. These currencies may be exchanged for SDRs. The SDR serves as the unit of account of the IMF and some other international organisations.
Valuation
The SDR was initially defined as equivalent to 0.888671 grammes of fine gold—which, at the time, was also equivalent to one U.S. dollar. After the fall of the Bretton Woods system, the SDR was recast as a basket of currencies. Its value, expressed in U.S. dollars, is derived from a weighted basket of five major currencies: the Japanese yen, the U.S. dollar, the Chinese yuan, and the euro.
Two requirements must be met for a currency to be included in the SDR basket: the export criterion and the freely useable criterion. A currency satisfies the export condition if its issuer is a member of the IMF or a monetary union that includes IMF members, as well as one among the top five exporters in the world. For a currency to be determined “freely usable” by the IMF, it has to be widely used to make payments for international transactions and widely traded in the principal exchange markets. Freely usable currencies can be used in Fund financial transactions.
The SDR basket is revised every five years, or sooner if deemed necessary, to ensure that it accurately represents the relative significance of the world's trade and financial currencies.
Allocation
IMF quota shares are used to determine the distribution of SDRs to each member nation. The greater a country's quota share, the stronger its economy. For instance, the United States own 82,994 shares whereas Afghanistan possesses 323 shares. The greater a country's quota shares, the more it contributes to the IMF, which grants it greater voting power.
Use of SDR
After SDRs have been allocated to each country, they have a few options on how they can manage them. They may keep the SDRs as part of their foreign exchange reserves, sell their reserves, or use their reserves. A member state may, for instance, trade an SDR for a freely useable currency. Members can also use SDRs for other reasons, such as the repayment of loans, payments of obligations, pledges, the payment of interest on loans, or paying for increases in quota amounts.
It can be held and used by member countries, the IMF, and certain designated official entities called “prescribed holders”—but it cannot be held, for example, by private entities or individuals. Its status as a reserve asset derives from the commitments of members to hold, accept, and honor obligations denominated in SDR.