In the wake of the liquidity and fiscal crisis across developing countries generated by the global pandemic, the role of Special Drawing Rights (SDRs) has formed an important part of the discussion on economic recovery. During the crisis, developed countries have accounted for nearly 80 per cent of all fiscal efforts, while many low-income countries (LICs) have cut spending or have directed more funds to repaying creditors than they have to their own health sectors.

In the 15 months since the start of the pandemic in March 2020, multilateral efforts have not sufficiently accelerated comprehensive efforts to respond to the multiple dimensions of health and economic crises in developing countries, particularly through financing and provision of immediate liquidity. The unequal distribution of vaccines and the emergence of new variants of the coronavirus threaten to prolong the crisis, with developing countries continuing to bear the brunt of the exacerbation of poverty and inequality. Progress towards the Sustainable Development Goals (SDGs) by 2030 has effectively been derailed, with many developing countries set back by years or decades when it comes to achieving the Goals.

In this context, there has been ample discussion of the possible role of SDRs – an international reserve asset issued by the International Monetary Fund (IMF) – when it comes to responding to the crisis. It now appears that, later this year, the IMF will allocate countries with SDRs worth a combined total of US$ 650 billion. However, there remains much debate about precisely how SDRs can support the pandemic response and recovery, how SDRs can be directed to those countries most in need and what kind of institutions could be set up to draw on SDRs in the pandemic response.

With these questions in mind, a group of 16 civil society organisations organised a webinar titled SDRs: Saving the global economy and bolstering recovery in pandemic times on 21 May 2021.

Opening remarks were made by His Eminence Cardinal K.A. Peter Turkson, Prefect of the Vatican’s Dicastery for Promoting Integral Human Development. Speakers included:

• Vera Songwe, Executive Secretary of the UN Economic Commission for Africa
• Jose Antonio Ocampo, former Finance Minister and Central Bank Board Member of Colombia
• Daouda Sembene, Distinguished Non-Resident Fellow, Center for Global Development, and former IMF Executive Director for a group of African Countries
• Ana Corbacho, Assistant Director of Strategy, Policy and Review Department, IMF
• Esteban Perez Caldentey, Chief, Financing for Development Unit, Economic Commission for Latin America and the Caribbean (ECLAC), and
• Jayati Ghosh, Professor of Economics, University of Massachusetts Amherst.

The following presents a summary of the key themes discussed during the event. A recording of the discussion is available here.

The purpose of SDRs

Global reserve funds in the form of SDRs are a vital tool to provide swift and unconditional support to the global pandemic response without increasing debt. Civil society organisations and experts have called for a new allocation of US$ 3 trillion in SDRs. Earlier this year, the IMF membership conveyed broad support for an allocation of US$ 650 billion in SDRs. They will consider a formal proposal in June, while the issuance will likely occur in August. Of this amount, low-income countries would receive US$ 21 billion – crucial relief, but not close to the US$ 450 billion in financing needs identified by the IMF to step up the pandemic response and accelerate growth. Developing countries would receive US$ 230 billion – far short of IMF estimates that last year placed emerging economies’ financing needs at US$ 2.5 trillion.

During the event, Ocampo said that the most positive aspect of SDRs is that they are essentially foreign exchange reserves for developing countries, providing them with international liquidity. In light of the very limited international cooperation on debt and liquidity that has taken place, SDRs are constructive for pandemic response and recovery in developing countries. Corbacho of the IMF clarified that SDRs will boost international reserves and that this is of vital importance as an insurance mechanism in times of crisis. Expanding reserve assets also strengthens global financial resilience and confidence by sending a powerful signal of macroeconomic stability.

Corbacho went on to outline the immediate uses of SDRs in developing countries, which include building up reserve buffers, providing financial backstops and freeing up financial liquidity for urgent balance of payment needs. The creation of additional liquidity can occur either by the addition of SDRs to reserves freeing up other foreign currency reserves or by countries converting their SDRs to hard currency. When countries convert their SDRs to currency, they are required to pay an interest rate to the IMF. Given that the normative interest rate is at a record low of 0.05 per cent, using SDRs is currently very affordable. If – or rather, when – rich countries start to normalise and unwind their expansionary policies, interest rates may rise, which countries should bear in mind.

Sembene said that, if they are well-calibrated and timely, SDRs can provide useful liquidity, but that historically SDRs have not played this role. Mechanisms to recycle and transfer SDRs must be designed to maximise impact and use. While the immediate priority for developing countries is vaccine access and procurement, there are other priorities that should not be forgotten, such as debt sustainability and climate change. Governments across the global south need financial resources to bolster economic recovery, counter wealth and income inequality, and to tackle rising poverty.

Recycling rich country SDRs

The core inequity in SDR allocation is that they are distributed according to IMF quotas, or financial contribution shares, rather than need. As a result, over 60 per cent of SDRs go to a handful of wealthy countries, while developing countries with the greatest need receive the least.

In response, IMF membership asked the institution to explore mechanisms for rich members to voluntarily transfer SDRs to vulnerable countries. Different stakeholders have proposed a number of forms for such mechanisms, which are not mutually exclusive. For instance: contributing to the IMF Poverty Reduction and Growth Trust facility; financing expanded debt relief through the Catastrophe Containment and Relief Trust; strengthening the financial capacity of multilateral or regional financial institutions; and creating new vehicles – such as the Liquidity and Sustainability Facility, vaccine financing vehicles or the Covid-19 Economic Relief Fund. The key question is how can the design of SDR recycling mechanisms maximise positive impacts for all countries that need support, while avoiding harm?

According to Perez Caldentey of ECLAC, recycling SDRs needs to proactively include middle-income countries (MICs). Despite being home to more than 75 per cent of the global population, a majority of the world’s poor and accounting for almost 96 per cent of the external debt of all developing countries (excluding China and India), MICs have so far not been granted access to G20 debt relief. Reallocation, he stressed, should also be used as a way to boost the lending capacity of regional financial institutions and regional banks, such as the FLAR (Fondo Latinoamericano de Reservas) and the Eastern Caribbean Central Bank, among others.

Ocampo emphasised that SDRs should be lent to low- and middle-income countries without conditionality and with attention paid to how exactly to spend the SDRs. For Corbacho at the IMF, the central question is how SDR recycling mechanisms can supplement and meet global reserve needs. The IMF requires broad support from its members, she stressed, as the process of reallocation can only be made effective once the IMF’s Executive Board gives its approval.

Donating SDRs

Civil society and many other policy-makers and academics have stressed the importance of maintaining the inherently benign properties of SDRs of being non-debt creating and unconditional. The best way to maintain these properties would be direct donations of SDRs from rich countries to developing countries. However, Ocampo warned that such donations are not easy, as the donating country will have to pay interest on the donated SDRs to the Fund. As a long-term approach to overcome this hurdle, Ocampo proposed this interest should be paid out of the general IMF budget, although he acknowledged that this would be unlikely to occur for this allocation.

Corbacho reiterated the point, noting that the interest costs would be permanently incurred by the donor country. That is why it makes more sense for rich member countries to on-lend their SDRs, rather than donate them. On the other hand, Ghosh countered that the budgetary implications of paying this interest for G7 countries are minor. As such, the issue is convincing rich country governments to agree to donations.

On-lending SDRs

The IMF is reportedly considering its Poverty Reduction and Growth Trust (PRGT) lending facility as a central SDR recycling mechanism. Many civil society advocates have concerns over PRGT loans, however, several of which were mentioned by speakers. The PRGT facility is currently accessible only to LICs and should be made accessible to all developing countries in need, as Ocampo noted. Conditionalities attached to loans, many of which promote fiscal consolidation measures, should be removed, in the same way as the Fund’s debt relief scheme for LICs, the Catastrophe Containment and Relief Trust (CCRT), is unconditional, argued Ghosh.

Ghosh underscored that, while the PRGT can provide much-needed liquidity, the emphasis within PRGT loans on cutting fiscal expenditure should be unacceptable in the recycling of SDRs. Ghosh noted that, while IMF leadership and management have made statements that Covid financing should be non-conditional, this point has not yet been incorporated into the Fund’s lending facilities.

Countries’ use of SDRs

Corbacho remarked that SDRs are an unconditional reserve asset that sit on the balance sheets of countries’ central banks. It is the IMF’s job to advise countries on how to use SDRs transparently and to foster recovery and long-term resilience. But, in her own words “it is up to the members how they will utilize the SDR allocation”, a decision which is up “to their best judgement”.

Vaccine funds

Songwe emphasised that the priority for the African continent is vaccine access and distribution. As such, as well as supplementing the PRGT, SDRs should be on-lent to create a vaccine fund, Songwe argued. While the first priority was to get more countries and companies to produce the vaccine, after production the problem for developing countries would be vaccine affordability. Ghosh stated that SDRs should be specifically recycled into the World Health Organization’s Access to Covid-19 Tools (ACT) Accelerator, which addresses diagnostics supplies, personal protection equipment and medical needs, among other areas.

Corbacho reiterated that ultimately it is up to IMF member countries how they employ unused SDRs. Channelling SDRs for specific purposes such as vaccines and climate change, either through another trust or through Special Purpose Vehicles (SPVs), will need willing creditors as well as satisfying certain criteria, such as the additionality and complementarity of new trusts to existing IMF tools.

A fund outside the IMF

Sembene said that, while the IMF is important, it is not the only institution and process by which SDRs can be recycled. Should there be a role for multilateral development banks (MDBs) and mechanisms within these institutions that can leverage SDR resources for use over the long term? Sembene noted that an SDR recycling mechanism that should be brought to the table is on-lending via SPVs that are not yet prescribed holders of SDRs. This would require a decision from the IMF to designate new prescribed holders of SDRs. He also stressed that one key area that SDR recycling conversations may not be focusing on as much is the role of SDRs in reducing debt burdens across the developing world.

Liquidity and Sustainability Facility

There was debate within the panel on the value of using SDRs to contribute to a Liquidity and Sustainability Facility (LSF) for Africa, which has been proposed by UNECA. The LSF would mobilise private finance for the SDGs through mechanisms such as SDG Covid-19 bonds. According to the ECA, the LSF would be financed by official development assistance, multilateral development banks and/or by the central banks of members of the Organisation for Economic Co-operation and Development (OECD). The LSF is a response to the African context of sovereign debt, where countries often have to pay higher interest rates than non-African countries with similar macroeconomic fundamentals (often called the ‘African premium’), in that the facility hopes to reshape misperceptions about credit risk for African sovereigns.

As Vera Songwe of ECA previously mentioned in a June 2020 Financial Times article, “Africa needs its own repo market, [...] that would attract a new class of investors while shaving off the higher borrowing costs that African nations face because of age-old stubbornly sticky perceptions that they are especially risky.” The LSF “modelled on existing market-based and commonly used facilities in Europe and the US [...] would help cut borrowing costs for African governments by providing incentives for the private sector to increase their portfolio investments on the continent.”

Ghosh had concerns about these types of facilities for Africa. She noted that, while it was good to leverage existing resources for additional finance, the design of the LSF meant that it was pro-cyclical, dependent on market behaviour and would lead to a loss of domestic monetary and fiscal policy. Ghosh pointed to the experience of middle-income countries in Asia, which had opened up to bond markets over recent decades and had experienced net losses.

Songwe responded that the LSF was not pro-cyclical and that its role was in correcting market distortions. The LSF is necessary because Africa has not yet deepened its capital markets, meaning that it currently has to borrow at high rates.

A broader discussion of the LSF and its limitations can be found in the Eurodad and partners report The Liquidity and Sustainability Facility for African sovereign bonds: who benefits?

Long-term reforms to maximise the benefits of SDRs

An underlying current during the event was a range of voices calling for a more ambitious reformulation of how SDRs can be used to support developing countries. Ocampo identified three long-term solutions. First, eliminating the dual accounting of SDRs – counting as both assets and liabilities – within the IMF’s SDR account and its general resources account. In this way, SDRs that have been issued but have not been used by states can be used by the IMF to finance its products. This, for Ocampo, was the most important potential reform. His second proposal was changing the distribution formula for IMF quotas so that the need for foreign reserves is taken into account. This would lead to more SDRs being allocated to low- and middle-income countries. And third, allowing for the private use of SDRs. While these options can move the needle forward for SDRs to achieve their purpose in assisting countries in need, all of them require changes in the IMF’s Articles of Agreement, which currently constrains all of these options.

In a similar vein, Ghosh argued that there should be automatic mechanisms within the IMF that keep issuing SDRs over time and that we need to think of reasonable ways of reallocating SDRs to support global public goods. Today we are talking about the pandemic; in the future it will be climate change. We need cross-border public trusts to ensure some degree of economic resilience, but they cannot be based on the on-lending IMF facilities that are necessarily conditional.

We are all thinking within the constraints of what is possible right now, but ultimately this is no time for business as usual. We need to rethink and step outside of the box, if we are to do anything to tackle the massive challenges the global economy is facing today.