Select Committee on International Development Minutes of Evidence


Supplementary memorandum submitted by HM Treasury

NOTE BY HM TREASURY ON SPECIAL DRAWING RIGHTS

What is the Special Drawing Right?

  1.  The Special Drawing Right (SDR) is an international reserve asset, created by the International Monetary Fund (IMF) to supplement its member countries' existing reserve assets (ie official holdings of gold and highly liquid assets denominated in foreign currencies). It is not a currency itself, nor is it a liability of the IMF. Rather it is a claim on the freely usable currencies of IMF members, such as the US dollar, the Euro, the pound sterling or the Japanese yen. The SDR's value as a reserve asset derives from the commitments of members to hold and accept SDRs. A member that makes net use of its allocated SDRs (ie a member who chooses to exchange its SDRs for usable currencies) pays the SDR interest rate on the amount used, while a member that acquires SDRs in excess of its allocation receives the SDR interest rate on its excess holdings. The SDR is valued daily on the basis of a basket of four currencies (the US dollar, the yen, the euro and sterling) and serves as the unit of account of the IMF. The current rate is around SDR 1.14: £1 or SDR 1: US$1.28. The SDR interest rate is determined weekly as the weighted average of the yields on selected 3-month $, euro, yen and sterling money market instruments.

  2.  The IMF Board of Directors has only twice made decisions to allocate SDRs. These were general allocations and were distributed to member countries in proportion to their IMF quotas. The first allocation was in 1970, for a total amount of SDR 9.3 billion. This followed concerns that the available supplies of gold and the US dollar, the two main reserve assets at the time, were not sufficient to finance the expansion of world trade and financial development. However, the collapse of the Bretton Woods system and the adoption of floating exchange rate regimes for the major economies together with the growth in international capital markets has reduced the need for SDRs in today's world. The second allocation was in 1981, and this brought the cumulative total to SDR 21.4 billion.

What is the process for allocating SDRs?

  3.  Decisions on general allocations of SDRs are made in the context of five-year basic periods, and are based on a three step approach. First, the Managing Director of the IMF has to determine that a proposal for an SDR allocation has widespread support given perceptions of a need to supplement existing global reserve assets. Second, the IMF's Executive Board must agree with the proposal. And third, the IMF's Board of Governors must, by a majority of 85 per cent of its total voting power, approve the proposal. The most recent basic period—the seventh—ended on December 31 2001, with the outcome that there was not enough support for another general allocation.

What is the Fourth Amendment for a special allocation of SDRs?

  4.  In September 1997, the Board of Governors adopted a resolution to amend the IMF's Articles of Agreement to allow for a special one-time allocation of SDRs, known as the Fourth Amendment. This proposal would equalise all members' ratios of cumulative SDR allocations to quota at a common benchmark of 29.3 per cent and would result in a doubling of the outstanding stock of SDRs to SDR 42.87 billion. It would enable all members of the IMF to participate in the SDR system on an equitable basis and correct for the fact that more than a fifth of the membership—those countries that have joined the IMF since the general allocation in 1981—have never received an SDR allocation. As of April 2002, 118 IMF members, representing just over 73 per cent of total voting share, had ratified this amendment. It requires however ratification by three fifths of the IMF membership (110 members) having 85 per cent of the total voting power. The US, which holds 17.16 per cent of the voting power, has not yet ratified the amendment, thereby effectively preventing it from coming into effect.

What is the UK's position on the Fourth Amendment and on proposals for a general allocation of SDRs?

  5.  The UK supports the proposal for a special one-time allocation of SDRs—the Fourth Amendment—recognizing the important reasons on equity grounds for its implementation and the benefits it would bring to developing countries. The UK is amongst those countries that have ratified this amendment, and it has actively sought to encourage its early implementation. For developing countries with access to international capital markets, the cost of acquiring and holding international reserves is substantial and subject to uncertainty. A special allocation of SDRs would increase reserves at a reduced cost from borrowing in the markets. For the majority of Fund members who do not have the option of borrowing foreign exchange reserves, the primary means of obtaining reserves is by compressing domestic demand, and therefore imports. In addition to supporting the SDR allocation related to the Fourth amendment to the Articles, the UK is also open to the arguments for another possible general SDR allocation—while acknowledging the need to demonstrate that such an allocation would be consistent with the IMF's articles. This means establishing a consensus that a long-term global need for extra liquidity exists, and that an SDR allocation is the most effective way to meet this need.

What is the US position?

  6.  Although the US originally supported the Fourth amendment proposal in the IMF Board of Directors, the US administration has not taken the subsequent necessary steps to seek Congressional approval to ratify the Fourth Amendment for a special one-time allocation of SDRs. Our understanding is that the current US administration does not view this as a priority issue. Furthermore, the US administration fear that any Congressional discussion of amendments to the IMF's Articles of Agreement might lead to additional demands by Congress for changes to the Articles.

What are the proposals to use SDRs for development?

  7.  There have been several proposals for SDRs to be used for development purposes in recent years. These include those made in the context of the UN Financing for Development (FfD) Conference by the High-level Panel on FfD, chaired by former Mexican President Ernesto Zedillo, and by the Hungarian financier and philanthropist George Soros. The Zedillo panel argued that allocations have stopped, at least in part, because industrial countries perceive no benefit from receiving SDR allocations. The advent of full capital mobility and the increase in the SDR interest rate means that advanced economies are able to borrow on the international capital markets on terms similar to those they would receive from an allocation of SDRs. The panel argued that this has severely prejudiced the interests of developing countries. Unlike the industrial countries, they cannot borrow additional reserves in the market on "SDR-like" terms. The conclusion of the Zedillo panel is that the IMF should resume SDR allocations to allow developing countries to hold reserves more cheaply, thus limiting the real costs now being imposed.

  8.  George Soros accepts Zedillo's case but takes the argument one step further. The IMF Articles of Agreement, as they stand, only allow for SDR allocations that are distributed to all member countries, ie to developed as well as developing countries. Soros argues that, if the Fourth Amendment were implemented, the developed countries should donate their share of $18 billion of the allocated SDRs to help finance development assistance. An independent board would determine which programmes would be eligible to receive SDR donations, but the initiatives and programmes would be generated from developing countries themselves. He proposed that SDR donations should be used in the first instance for the fight against communicable disease, particularly AIDS and TB, for education, judicial reform and initiatives to close the digital divide.

What is the UK position towards these proposals?

  9.  The UK accepts some of the arguments used by Zedillo and Soros on SDRs, and shares the goal (in both Zedillo and Soros proposals) to raise significantly the amount of Overseas Development Assistance to developing countries. The Chancellor has highlighted the need to raise an additional $50 billion a year for the achievement of the Millennium Development Goals, a view shared by the Zedillo panel, the UN and the World Bank. Not surprisingly, the allocation of SDRs would necessitate an ongoing cost for the UK and other developed countries. We pay interest on our SDR allocation (and receive interest on our actual holdings of SDRs). If developed countries donate their SDRs, as Soros proposes, this would still leave the obligation on the UK to pay a permanent flow of interest payments on the net amount by which our actual SDR holdings fall below our cumulative SDR allocations. We therefore believe that there may be more efficient and transparent ways to proceed to achieve the same outcomes. That is why the Chancellor has emphasized the need to discuss ways to finance the extra $50 billion per annum and proposed a financing mechanism for that purpose. The UK continues to advocate the need for developed countries to increase both the volume and effectiveness of ODA. We have taken significant steps in this direction for UK ODA and were instrumental in achieving an EU agreement to increase ODA prior to the Monterrey Conference on Financing for Development.

What is the US view, and what are the prospects for these proposals?

  10.  The US administration has not indicated support for the arguments raised by the Zedillo panel or George Soros. Soros has held conversations with US Congress members on his proposal and has received support from certain members. In the current climate however, it is difficult to see sufficient support for it to become a reality in the US or amongst other developed countries.

Has HMG support shifted from the SDR proposal to the International Development Trust Fund?

  11.  The international development trust fund or facility is one proposal that the UK believes is worth considering, just as the SDR proposal is worthy of consideration. The UK recognizes that to raise investment in developing countries by a total of $50 billion a year to 2015 this will require a step change in aid flows from the developed world. The SDR proposals are amongst several, including international transactions taxes and other global taxes, which seek to do this. The UK approaches further evaluation of all these options with an open mind. However, such international initiatives rely, ultimately, on consensus and approval from all national governments, and in order to proceed with the urgency that the scale of the challenge demands, the Chancellor has proposed, as one option for discussion, an International Development Trust Fund to build on the work of the World Bank, the IMF and regional development banks. This fund—essentially a new financing facility—requires donor countries to commit substantial additional resources. By pooling these funds with national governments offering a guarantee, backed by callable reserves or appropriate collateral as security, they could be leveraged through borrowing from international capital markets to meet the demand for large-scale assistance now.

  12.  In summary, the UK will continue to make the case for increased and more effective aid, which is essential for the Millennium Development Goals to be achieved. This includes seeking to broaden support for the Chancellor's initiative on the International Development Trust Fund. The UK will also keep an open mind to proposals on SDRs, recognising the need for the IMF's Articles of Agreement to be respected in any decision on allocations. We will also continue to support the early implementation of the Fourth Amendment for a special one-time allocation of SDRs.

HM Treasury

June 2002




 
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