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Special drawing rights (SDRs) were created by the IMF in July 1969, chiefly to meet the international liquidity crisis. This event could also be looked at as an important element of the ‘New International Economic Order’. SDRs are ‘paper’ gold and they augment the volume of international liquid reserves.

Originally an SDR account worth US$3.5 billion was set up. By 1972, its value rose to about $9.5 billion.

Since 1 July 1974 the value of the SDR account is given every day by a basket of sixteen major currencies.

The functions of the SDR units are the same as those under gold and stable dollar standards. The SDRs are liquid; they are convertible in any other currency; their value is stable; they can be used as a medium of exchange to settle international transactions. It is easily seen that the SDRs can be regarded as the type of international currency which Keynes had in mind when he advocated the idea of issuing Bancors through an international clearing bank. The basic features of such a currency would be to promote international liquidity, stability and confidence in the international monetary system. The creation of SDRs has helped to achieve some of these objectives. Indeed, in some ways, the SDRs as reserve assets could be regarded as superior to gold holdings. For instance, the supply of SDRs could be suggested to meet an increased demand for international liquidity while the supply of gold is inelastic. Since the value of the SDRs is linked to an international basket of major currencies, the degree of fluctuations in their value is likely to be much less than for any other single currency. Just like gold, SDRs could be held as a store of value or spent to settle net deficits in international trade. The action of an individual country would not diminish the value of SDRs though this could easily happen with gold. As an international asset SDRs are durable unlike, say, the dollar or pound they will not disappear if one country spends them, say, in the USA or UK. Indeed, if India spends SDRs to acquire goods from the UK the SDR earnings by the UK will rise. The SDRs are practically permanent assets because they will disappear only under the extreme assumption of their collective cancellation.

The principle of distribution of the SDRs

Given the importance of the creation of SDRs as an international reserve asset, their distribution has attracted considerable attention, particularly in the LDCs. The existing principle allows the DCs (twenty-five) to obtain about $7.5 billion while ninety-three or more LDCs (with a huge population) can obtain only about $2.5 billion. This is because the SDRs are allocated on the basis of a country’s quota with the IMF.

Since the quota of the DCs is much greater than that of the LDCs, it is understandable that the DCs get a

much larger proportion of the SDRs. This principle of distribution has caused resentment in the LDCs.

Although the original quota with the IMF was fixed in line with a country’s economic strength, it is undeniable that such quotas hardly reflect the needs of the poor countries. This apart, several other criticisms could be levelled at the present criterion for distributing the SDRs (Haan 1971).

First, the existing principle fails to economize the amount of reserves to be set up. SDRs could be accumulated indefinitely and eventually ‘dehoarded’ by a single country without any effective collective supervision.

Second, although the adjustment costs incurred by the LDCs (e.g. deflation and unemployment) in general are higher than those incurred by the DCs, the present system of SDR distribution does not take into account the distribution of adjustment costs in proportion to their disequilibria (Cohen 1966).

Third, since the global distribution of income and wealth is far from being equal, it may be argued that the collective saving in the form of SDRs should accrue to the LDCs in proportion to their needs (say, on a per capita basis) rather than on the basis of existing quotas.

Fourth, to distribute the SDRs on the basis of quotas is to accept the static arguments for initial quota allocation among different countries with total disregard to the dynamic changes that have taken place so far in the world economy. This is considered as unacceptable.

Fifth, Triffin argues that ‘internationally agreed SDRs should serve internationally agreed purposes’ and thus SDR distribution on the ground of quotas is regarded as ‘morally repugnant, economically wasteful and politically unviable’ (Triffin 1971).

From these criticisms, it is clear that the existing principle of SDR distribution should be changed considerably from the standpoint of global redistribution of income and the needs of the LDCs. However, global redistribution of income is a noble principle which is rather difficult to achieve in practice, given the nature of present international relations. But if one of the major objectives of the international institutions is to establish a fairer system of existing international assets, then the present principle of SDR distribution on the basis of quotas is rendered very weak.

The link between SDRs and foreign resources

The idea of linking the SDRs to assist development plans and projects in the LDCs has received considerable attention (for an early proposal see Stamp 1958; see also Scitovsky 1966; Kahn 1973; Helleiner 1974; Maynard 1973; Machlup 1968; Triffin 1971; UNCTAD 1965; Johnson 1972, 1977; Bauer 1973;

Thirlwall 1976a; Williamson 1973; Bird 1976). The main arguments for and against the ‘link’ could be summarized as follows (see, in particular, Maynard 1973).

Arguments in favour of the ‘link’

1 Linking of the SDRs to aid development projects at a minimum cost would enable the LDCs not to resort to painful adjustment procedures (e.g. deflation, unemployment) to rectify persistent difficulties in their balance of payments.

2 The ‘link’ will ensure a smooth long-term flow of development finance along with global growth of output and trade.

3 When the ‘link’ would operate through an international agency, the delays in bilateral negotiations would be avoided.

4 The volume of untied multilateral flow of foreign resources is likely to rise in the event of a ‘link’ in such a way as to reduce the balance of payments and reserve costs of the donor countries substantially.

Arguments against the ‘link’

1 Development finance and creation of international liquidity are regarded as two separate issues which are designed to realize separate objectives. But this criticism is not very compelling because the development within the LDCs could be achieved by the use of SDRs and no serious damage is likely to be inflicted on the international monetary system if one instrument (SDR creation) attains two objectives (meeting the shortage of international liquidity and aiding the development of the LDCs).

2 It is argued that since the SDRs are reserve monetary assets they should not be used for the transfer of real resources from the DCs, nor to finance spending within the LDCs. To the extent that deficits are historically financed by the creation of new money this argument loses some force. However, it is important to control the money supply firmly, particularly because in the LDCs supply tends to be rather inelastic.

3 The ‘link’ is supposed to be inflationary. This is a more serious criticism to the extent that the claims of the LDCs on the real resources of DCs could not be met without paying a high cost. Critics argue that most DCs try to acquire international reserve assets via export surpluses which does involve transfer of real resources. To the extent that the DCs have the capacity to meet demand, inflation is unlikely to occur.

Further, the amount of SDR creation is so negligible as a proportion of total FR flow to LDCs that its additional impact is likely to be small—although it is sometimes maintained by the critics of the link scheme that the present global inflation is partly the result of too much international liquidity rather than too little (Johnson 1977). Here, it should be pointed out that the major reason for global inflation was the high rise in oil price in 1973–4 and again in 1978–9, not the creation of SDRs. Notice that the LDCs do not obtain SDRs simply to raise their demand and transfer of resources depends upon the net use rather than the allocation of SDRs. Some LDCs may decide to accumulate SDRs to guard themselves against uncertainties and evidence of SDR use by the LDCs up to 1977 seems to support this statement (see IFS 1970–82). Also it has been well argued that

the burden on non-reserve currency countries implied by the transfer of real resource to LDCs through the link would be greater than in the pre-SDRs situation; the transfer would be made to the LDCs rather than to gold producers and reserve currency countries. The need for these countries to pursue appropriate demand management policies to make available the real resources for obtaining an increase in foreign exchange reserve would be no different.

(Maynard 1973; see also Machlup 1968) 4 It is contended that in the presence of the ‘link’ DCs who offer foreign resources to LDCs will cut their individual or collective offer. This argument is difficult to accept, logically or empirically. To the extent that the allocation of SDRs is free of resource cost, some DCs may actually be induced to offer more.

5 The link scheme is sometimes criticized as undemocratic as its burden could be distributed over the taxpayers of the DCs without their assent. This point is also very weak as it could be directed against all forms of untied or even tied aid which are not wholly effective.

6 It is maintained that link would reduce the confidence in SDRs as an asset. Further, the LDCs will be induced to put pressure upon the IMF to create more SDRs than would be indicated by the principles of international monetary policies. Neither of these two objections seems to be sound. The SDRs are safeguarded by the principle of acceptance; also no country is allowed to accumulate the SDRs by more than thrice the amount of its initial allocation or spend more than 70 per cent of its allocation. Moreover, when 85 per cent of the voting power in the IMF rests with the DCs, it is difficult to see how effective the pressure of LDCs on the IMF could be.

On balance, it seems that the arguments against the link are not very compelling. Indeed, it could be pointed out that if one of the major objectives of international monetary policy is to set up a fairer system of distribution of international assets on the basis of needs, then the arguments against the link clearly become rather weak. As regards the inflationary effect of the link, it can be mentioned that such an effect is likely to be smaller in comparison with, say, the dollar standard because, in the case of the link, collective supervision of liquidity will replace the decision made by a single country, say the USA. Further, the link may actually economize on SDR creation because, once the DCs are under pressure to ‘earn’ the SDRs by increasing their share in the world export market, they would be obliged to hold down the prices (Thirlwall 1976a).

The link could be developed in different ways. A direct link can be established by directly allocating more SDRs to the LDCs which would be greater than their long-run demand for reserves. This would imply, inter alia, an increase in LDCs’ quotas with the IMF. The link could be organic if the SDRs are allocated to the LDCs through, say, an International Development Agency (IDA) for financing development programmes. Any DCs which would export to the LDC will earn SDRs in the credit account of the IDA while the LDCs’ account will be debited by the value of such imports from the DC.

The link could be inorganic if the DCs decide to contribute voluntarily to any multilateral agency providing FR to the LDCs with every new allocation of the SDRs. In comparison with other forms of link, this plan has some major defects. For instance, since the scheme is voluntary, some DCs may decide not to provide anything. Also, if a DC, say the USA, suffers from a balance of payments deficit, it may decide not to contribute to the multilateral fund. It appears that either a direct or an organic link would be superior to an inorganic link.

Empirical evidence about the allocation, use and resource transfer of SDRs

Empirical evidence available so far provides some idea about the allocation, use and resource transfer of SDRs. On the basis of net acquisition of SDRs by the DCs and net use by the LDCs, Helleiner has argued that real resources have been transferred form the DCs to the LDCs between 1970 and 1973. Out of the total allocation of $2,348 million SDRs by July 1973, the LDCs taken together have used $835 million. By this time, the allocation to the DCs was $6,967 million and their net use was $308 million (Helleiner 1974). It is true that the system of allocation and use of SDRs has resulted in an informal link between SDRs and aid, but the use of net acquisition data of the LDCs could be quite misleading for showing accurately the extent of such a link (Bird 1976). The permanent potential real resource gain over a period (G_p) should be equivalent to 70 per cent of the initial allocation of SDRs (A) minus interest charges for full potential SDRs net use (I). Thus,

where Q is the value of the quota. Notice that in the above equation G varies directly with Q and A and inversely with I. If r is the interest rate charged to actual net users of SDRs then I and r would vary directly.

However, the actual real resource gain (G_a) should be equivalent to quota allocation of the SDRs Q(A) minus the transfer to the general account of the IMF (T_g) to pay some charges or for repurchases and the proportion of SDRs which is to be added to reserves (Z). More formally,

Ga=Q(A)−Tg−Z

Helleiner has assumed unrealistically that T_g or Z or both are equal to zero so that G_a=_Gp. In practice, it turned ou_t that T_g=$527.5 million and Z=$1,512.8 million by the end of July 1973, and therefore, recalculating Helleiner’s figure, we obtain G_a=$307.7 million. Thus, the overestimation of the actual

resource transfer by Helleiner is wholly accounted for by the transfer to the general account by the LDCs (Bird 1976).

The use of the SDRs could be explained by both demand and supply factors. Assuming that the supply of SDRs is exogenous and given by the allocation of SDRs, the demand use of SDRs (S) could be stated in a simple form as follows (Leipziger 1975):

S=S(B_t−₁, DR, G, A)

where B_t−1 is the net deficit in balance of payments with one-year lag since delays are involved in actual payments following trade flows; DR is the reserve variable expressed as the change in non-SDR reserves over the past year; G is the foreign exchange to gold ratio in a country’s portfolio and A is the SDR allocation to a country in millions of US dollars.

In theory, if it is expected that

(to test whether the SDRs are substitutes for either gold or foreign exchange) and ∂S/∂A>0. Linear least squares regression for forty-three LDCs in 1971 yielded the following equation (Leipziger 1975):

(The figures in parentheses show the relevant t values.)

As hypothesized, most of the explanatory variables except G have the right signs and the estimated coefficients are statistically significant at 99 per cent confidence levels. The proportion of explained variation is 63 per cent and this is not very high. However, when the LDCs are divided between the Latin American and other LDCs, such a model fared well for the Latin American countries though failed to explain very well the SDRs’ use by the other LDCs. This is illustrated in the following two regression equations (Leipziger 1975):

Latin America:

Other LDCs:

where ** indicates significance at the 95 per cent confidence level or better and * indicates significance at the 90 per cent confidence level or better; n is the number of observations.

The Chow test (Chow 1960) indicates that the determinants of the use of SDRs by the Latin American and the other LDCs are significantly different (the calculated F value being 9.12). Thus, although the above model has some interesting features, it fails to explain adequately the determinants of the SDRs’ use by ‘other’

LDCs. Further, it is not very clear why SDR allocation has been dropped as an explanatory variable in the equation for the Latin American countries. Thus, more caution and further research is needed to analyse the pattern of SDRs’ use by the LDCs. Since the LDCs are not a homogeneous group, it may be necessary to carry out country- or region-wide (within which LDCs show similar characteristics) studies to obtain more unbiased estimates by avoiding the problem of linear aggregation.

The ‘link’ is an important and useful idea for establishing a ‘new international economic order’. Most of the arguments against the link are not very compelling. Internationally supervised, the scheme has considerable promise to assist the LDCs in their efforts to achieve a better standard of living. As Williamson observes:

The international community has few instruments to improve the world distribution of income, and therefore it should utilize such opportunities as arise. One of these is the seigniorage resulting from the production of fiduciary reserve assets. There is a long and unfortunate tradition in economics of dismissing this type of argument just because it involves a value judgment additional to that embodied in the Pareto criterion. The degree of egalitarianism needed to justify preference for the link rather than neutrality is minimal, given the existing facts on world income distribution.

(Williamson 1973:278) 6.11