Context: Recently, the Finance Minister of India opposed a general allocation of new Special Drawing Rights (SDR) by the International Monetary Fund (IMF) because it might not be effective in easing Covid-19 driven financial pressures.

• The Finance Minister was concerned that such a major liquidity injection could produce potentially costly side-effects if countries used the funds for irrelevant purposes.
• The new SDR allocation will provide all 189 members with new foreign exchange reserves with no conditions.
• In the current context of illiquidity and flights to cash, the efficacy of an SDR allocation is not certain, she said, adding that most countries rely on national reserves as a first line of defense.

Key Points

• The SDR is neither a currency nor a claim on the IMF. Rather, it is a potential claim on the freely usable currencies of IMF members. SDRs can be exchanged for these currencies.
• The SDR serves as the unit of account of the IMF and some other international organizations.
• The currency value of the SDR is determined by summing the values in U.S. dollars, based on market exchange rates, of a SDR basket of currencies.
• The SDR basket of currencies includes the U.S. dollar, Euro, Japanese yen, pound sterling and the Chinese renminbi (included in 2016).
• The SDR currency value is calculated daily (except on IMF holidays or whenever the IMF is closed for business) and the valuation basket is reviewed and adjusted every five years.
• Quota (the amount contributed to the IMF) of a country is denominated (expressed) in SDRs.
• Members’ voting power is related directly to their quotas.
• India's Foreign exchange reserves also incorporate SDR.

Review

• The SDR basket is reviewed every five years, or earlier if warranted, to ensure that the basket reflects the relative importance of currencies in the world’s trading and financial systems.
• The reviews cover the key elements of the SDR method of valuation, including criteria and indicators used in selecting SDR basket currencies and the initial currency weights used in determining the amounts (number of units) of each currency in the SDR basket.