Public Information Notice No. 02/3

Public Information Notice: Managing Director Reports to IMF Board of Governors on Possible General SDR Allocation

January 10, 2002

On December 26, 2001, the Managing Director of the International Monetary Fund (IMF) reported to the Board of Governors and the Executive Board of the IMF regarding a general allocation of Special Drawing Rights (SDRs). Based on consultations with SDR participants, the Managing Director concluded that there is substantial interest in considering the usefulness and implications of a general SDR allocation for the Eighth Basic Period (2002-2006), but at this time there is not sufficiently broad support to make a specific proposal. However, in view of the interest in further consideration of this matter, the Managing Director indicated his intention to bring the issue of a general allocation of SDRs before the Executive Board for further discussion when appropriate.¹

Background

The SDR is a reserve asset created by the IMF to supplement existing reserve assets [SDR-A factsheet]. The IMF's Articles of Agreement provide for periodic consideration and decisions to allocate SDRs during basic periods which run consecutively and are five years in duration. The eighth basic period (2002-2006) will commence on January 1, 2002, following the current seventh basic period on December 31, 2001. The Articles also provide that before the end of each basic period, the Managing Director submit a report to the Board of Governors regarding proposals for a general allocation in the next basic period. This report must either indicate that the Managing Director is making a specific proposal for an allocation, concurred in by the Executive Board, or that there is no such proposal that would attract the necessary broad support. Decisions of the Board of Governors approving a proposal by the Managing Director require an 85 percent majority of the total voting power of participants in the SDR Department, which now encompasses all members of the Fund. In order to make the judgment on whether there is broad support among participants for a proposal, the Managing Director is to consult with the members.

A decision to allocate SDRs is based on a determination that there is a long-term global need to supplement existing reserve assets. Since the introduction of the SDR mechanism in 1969 there have been two general SDR allocations. The first (SDR 9.3 billion) took place in 1971-73 during the first basic period and the second (SDR 12.1 billion) in 1979-81 during the third basic period. There have been no general allocations since then.

In 1997, the Board of Governors adopted the Fourth Amendment of the Articles of Agreement providing for a special one-time allocation of SDRs amounting to SDR 21.4 billion. This allocation will become effective when three fifths of the membership (110 countries) accounting for 85 percent of the total voting power have accepted the amendment.

Executive Board Discussion

Mr. Shigemitsu Sugisaki, Deputy Managing Director and Acting Chairman, made the following remarks at the conclusion of the December 12 Executive Board meeting:

"Executive Directors had a wide-ranging discussion of the basic considerations underlying a possible general SDR allocation during the eighth basic period, which will begin on January 1, 2002. While there is substantial interest among many Directors to consider the usefulness and implications of a general SDR allocation, there was not, at this time, sufficiently broad support for the Managing Director to make a specific proposal to the Board of Governors. Most Directors, however, wished to keep the issues related to an SDR allocation under review.

"Directors recognized that consideration of a general SDR allocation was guided by the framework set out in the Articles of Agreement. Within this framework, the criterion to be assessed was whether there was a long-term global need to supplement existing reserve assets that would be consistent with the Fund's purposes and avoid deflationary and inflationary consequences for the world economy. Noting the small and declining share of SDRs in the reserve holdings of members, some Directors also emphasized the objective of making the SDR the principal reserve asset in the international monetary system.

"Most Directors considered that there was likely to be a sizable increase in the demand for reserves over the five years of the next basic period. They pointed to the strong tendency for reserve holdings to increase broadly in line with the growth of international trade, and agreed that this traditional indicator of reserve adequacy remained relevant. They also noted that alternative indicators of reserve adequacy, based on total external debt and short-term external debt, suggested that the demand for reserves would increase over the next five years, albeit more slowly than implied by trade-related indicators. Some Directors considered that growth in the demand for reserves could be expected to slow as more countries adopted flexible exchange rate regimes, although it was recognized that the trend toward greater exchange rate flexibility had not yet been accompanied by a widespread reduction in reserve holdings.

"Directors agreed that the case for an SDR allocation to meet the projected increase in reserve demand did not rest on an allocation being the only way to meet a long-term global need to supplement reserves or on all members having such a need. In this connection, it was noted that on a global scale the international system has been capable of generating the reserves it needs. Directors expressed diverging views, however, on whether potential reserve stringencies in a number of countries could have an adverse global impact, as well as on the adequacy of alternative mechanisms to meet the reserve needs of members.

"Directors recognized that the rising reserve needs of most advanced economies were likely to be satisfied by accumulating owned reserves or by borrowing from the markets at interest rates that were only marginally higher than the return on reserve assets. These countries therefore had no need for an SDR allocation to supplement borrowed reserves, although they might be willing to hold additional SDRs.

"A number of Directors argued that reserve stringencies in other countries had become severe and could justify an SDR allocation. They stressed that most such countries with meaningful access to international capital markets faced substantial and highly uncertain costs in acquiring and holding reserves. Moreover, experience had shown that the terms and conditions of access for emerging markets could fluctuate sharply in response not only to conditions in these countries, but also to developments in mature markets. These Directors saw the wide spreads facing emerging market borrowers as a sign of market imperfections; they also viewed the risk of contagion as a significant source of uncertainty. They argued that an SDR allocation would give these countries greater scope to reduce their reliance on borrowed reserves, which presented risks to the countries themselves as well as to the international financial system.

"Other Directors were not convinced that international capital markets were pricing the risk of sovereign lending inappropriately. They noted that these markets were increasingly discriminating among sovereign borrowers, offering more creditworthy countries access to borrowed reserves more freely and at lower cost. These Directors emphasized that the cost of borrowing from the markets generally reflected country-specific risk premia, which countries could reduce through implementation of policies to enhance their creditworthiness.

"During the discussion it was recognized that a large segment of the membership--most of them low-income countries--had little or no prospect of access to international capital markets in the foreseeable future. A number of Directors considered that an SDR allocation would assist these countries in meeting their growing reserve needs without excessive domestic adjustment that could harm their growth prospects. In these circumstances, an SDR allocation would be consistent with the Fund's mandate to facilitate the expansion of trade and contribute thereby to the growth prospects of all its members, and could be viewed as a global public good.

"At the same time, other Directors felt that the implications of reserve stringencies in low-income countries were less clear. On the one hand, these countries had a need for additional reserves to support their adjustment efforts. On the other hand, the provision of unconditional liquidity through an SDR allocation might not be the most appropriate solution for low-income or other reserve-constrained countries. Experience had shown that most of these countries tended to use SDRs allocated to them over a prolonged period, rather than hold them in reserves as a shock absorber. Furthermore, even if reserve stringencies among these countries were sufficiently severe to give rise to a global need, an SDR allocation would be an inefficient means of addressing this need, as SDRs were allocated to members on the basis of quota rather than reserve need. A few of these Directors also saw an SDR allocation as potentially sending the wrong signal to the markets at a time when, in their view, the Fund needed to emphasize the limited availability and strict conditionality of its resources. These Directors therefore felt that the provision of conditional Fund liquidity to support needed policy adjustments remained the most appropriate means of addressing the reserve needs of countries facing high costs of borrowing from private markets or having no access to international capital markets. Many Directors noted that interest charges on net SDR use were at market related rates, and considered that for low-income countries increased concessional financial assistance was a more effective way to help these countries build up reserves.

"Directors had differing views on the implications of conditions in the world economy for an allocation of SDRs. A number of Directors made the argument that the constellation of factors relevant to consideration of an SDR allocation was stronger today than it had been for many years, and in this regard they pointed, in particular, to the difficulty and high cost of obtaining reserves through borrowing in more risk-averse capital markets. While agreeing that the near-term prospects for the world economy remained unfavorable, other Directors emphasized that the global need for reserve supplementation had to be considered in a medium-term perspective. According to this view, current projections for the evolution of the world economy over the five years of the next basic period did not support the case for an SDR allocation at this time. Directors recalled that the current World Economic Outlook projection was for a recovery in the world economy next year, with the likely prospect of a resumption of private capital flows to emerging market countries. In this context, they were encouraged by recent signs that capital markets were differentiating among sovereign borrowers, indicating that the risk of further contagion had been reduced.

"Most Directors expressed concern about the delay in implementing the Fourth Amendment of the Articles of Agreement providing for a special one-time allocation of SDRs which had been approved by the Board of Governors in 1997. They strongly encouraged members that had not done so to ratify the Fourth Amendment as soon as possible.

"Some Directors saw merit in further consideration of various proposals that had been made outside the Fund on the redistribution of SDRs--even in the absence of a new SDR allocation. Other Directors, however, considered that such proposals often had the character of development assistance, which could call into question the monetary character of the SDR. They noted that there were no legal obstacles preventing members from voluntarily making available some or all of the SDRs allocated to them to other members.

"As indicated at the outset, the Executive Board discussion revealed substantial interest among Directors in a general SDR allocation, but not the broad support necessary for the Managing Director to make a specific proposal at this time. As provided by the Articles of Agreement, the Managing Director will submit a brief report to the Board of Governors by the end of the year. This report will indicate the results of today's consultation with the Executive Board and include the summing up of this discussion. In view of the interest expressed in further consideration of this issue, it is proposed that the Managing Director bring the matter of a general allocation of SDRs to the Executive Board again when he deems this appropriate," Mr. Sugisaki stated.