Rescue by Helicopter Reserves

The world woke up on Monday 23 with higher international reserves for all countries. A new allocation of US$650 billion (SDR450 billion) in Special Drawing Rights (SDRs) by the International Monetary Fund (IMF) to its member countries has entered into force.

SDRs are an international reserve asset created by the IMF and added to the countries' other foreign reserves. It is not a currency that can be used by private agents. Governments, on the other hand, can – unconditionality – exchange them for currencies from other countries and thus make payments with them. It is, therefore, a supplement to the countries' foreign reserves, without depending on the issuance of external or domestic debt for its acquisition.

The SDR value is calculated daily by the IMF based on a basket of international currencies which, in fixed proportions, currently includes the US dollar, Japanese yen, euro, pound sterling and Chinese renminbi. The composition of the basket is reassessed every 5 years.

It is an asset that simultaneously pays and charges interest. It all depends on the balance between the allocations received by the country and their use. If it does not use its SDRs, interest income and payments outweigh each other, and the cost is zero.

The SDR interest rate is set weekly as a weighted average of interest rates on short-term government bonds in the money markets of the countries of the basket. It is currently at its floor: 0.05% (Figure 1). At least in the case of non-advanced economies it is still below the rates charged by the markets.

Figure 1 - SDR Composite Interest Rate

Source: Ramos, A. and Moreno, D. (2021). IMF Ready for Sizeable “Helicopter Reserves” Allocation, Goldman Sachs, July 20.

There is, therefore, even a potential pecuniary advantage of using SDR to redeem other external debts. Everything depends, however, on institutional arrangements within countries, particularly regarding who holds foreign reserves and manages foreign exchange flows, as well as the transfer of resources from central banks to the Treasury. About 70% of countries have their central banks as SDR recipients, while in the US, for example, SDR assets and liabilities are recorded on the government balance sheet.

President Lopez Obrador of Mexico, for example, has already referred to using the opportunity to prepay external public debt. Although local law does not allow transfers from the central bank to the executive, the government can acquire reserves other than SDR if it has balances in Mexican pesos with the central bank, as part of public debt management. Basically, this would result in an exchange of reserves in hard currencies for the added SDR.

SDRs were created in 1969 and their general allocations are made to IMF member countries according to their quotas in the Fund. The IMF has the prerogative to ask for its cancellation, but that never happened. Previous general allocations occurred in 1970-72, 1979-81 and 2009, in the latter case accompanied by a special allocation. The extraordinary character of the allocation initiated this time is seen in the fact that its amount corresponds to more than double the sum of all allocations made to date.

The exceptional circumstances of the pandemic crisis, putting the external accounts of many economies in a precarious situation, were the motivation. However, as allocations follow country IMF quotas, relief for those in need of reserves will come as an excess in other cases.

China has added another $41.6 billion to its already high reserves, Brazil another $15.1 billion and 35 advanced economies another $399 billion. On the other hand, the arrival of reserves in the form of SDRs will be extremely welcome and will give some breath in cases such as Argentina, Ecuador, and El Salvador, in Latin America, as well as several countries in other regions (Sri Lanka, Zambia, Liberia etc.). Venezuela will receive its allocation, but without unconditional access, given the Maduro government's non-recognition as legitimate by more than 50 member countries, including the largest shareholder, the US.

The increase in reserves globally will not have a great impact, being equivalent to something around 0.7% of the world GDP. However, it will provide a lifeline, temporary or not, for countries facing low reserves and high external financing requirements ahead.

Sub Saharan Africa received a small share of the newly created SDR (Figure 2, left side). However, they will be substantial as a share of GDP in some cases (Figure 2, right side).

Figure 2 - Sub Saharan Africa’s share of newly created SDRs and their share to countries’ GDPs.

Source: Hilgenstock, B. and Sezercan, D. (2021). The 2021 SDR Allocation’s Effect on SSA, Institute of International Finance – IIF, June 14.

As a next step, the IMF set out to find ways in which countries with SDR surpluses can voluntarily channel them to those in need. For example, they can be lent to the fund that the IMF uses to make concessional loans to low-income countries (Poverty Reduction and Growth Trust - PRGT), as well as to another fund to be created to support more vulnerable countries to undertake structural transformation, including adaptation to climate change (Resilience and Sustainability Trust – RST).

Surplus SDR could also be channeled to support lending by multilateral development banks and even donations to the concessional arm of the World Bank: The International Development Agency (IDA). The development impact of the SDR allocation can be magnified. The fact is that creation of SDR following IMF quotas provided a very small share for low-income countries (69 economies that will receive US$ 21.2 billion), while they are precisely the most negatively affected by the crisis, with slower vaccination and the worst debt problems.

As noted in a report by Alberto Ramos and Daniel Moreno (Goldman Sachs, July 20), the increase in SDR stocks does not automatically correspond to an increase of money supply in the global economy. The use of SDR only transfers hard currency from one country to another, with corresponding changes in the composition of reserves. There will only be such an increase if the central bank that issues the hard and convertible currency granted in exchange for the SDR does not sterilize its monetary impact.

SDRs, therefore, do not constitute money thrown from a helicopter, as in the famous image used by Nobel Prize-winning economist Milton Friedman in 1969 and cited in Ramos and Moreno's “Helicopter Reserves” report. But one cannot deny that this allocation fell from the sky at a good time for economies struggling with a shortage of reserves and immediate needs for external financing.

Otaviano Canuto, based in Washington, D.C, is a senior fellow at the Policy Center for the New South, a nonresident senior fellow at Brookings Institution, a professorial lecturer of international affairs at the Elliott School of International Affairs - George Washington University, and principal at Center for Macroeconomics and Development. He is a former vice-president and a former executive director at the World Bank, a former executive director at the International Monetary Fund and a former vice-president at the Inter-American Development Bank. He is also a former deputy minister for international affairs at Brazil’s Ministry of Finance and a former professor of economics at University of São Paulo and University of Campinas, Brazil.