Context: RBI and the government seem to have a diverging opinion regarding IMF’s plan to issue $500 billion of fresh special drawing rights (SDRs) as a key tool to attack the worldwide spread of the financial fallout.
More on the news:
- A fresh SDR issue by the IMF would have helped the least developed and developing countries facing foreign exchange crises.
- In the last month, India agreed with the US to oppose the International Monetary Fund’s (IMF’s) plan to help member countries combat the economic fallout of the coronavirus pandemic.
- However, India extended its support to lending by the IMF from existing facilities.
- India also supported the proposal to task the G20 International Financial Architecture Working Group.
- The Group is mandated to look into these issues and come up with a clear set of recommendations for the consideration of the FMCG (Finance Ministers and Central Bank Governors) within a definite time frame.
- The proposal was dropped as the US enjoys a unique veto power at the IMF with 16.52% voting rights.
- A supermajority vote at the IMF for major policy decisions requires 85% of votes.
- India has a voting right of 2.6%.
- The Reserve Bank of India (RBI) governor seems to have supported the move during the same IMF-World Bank virtual spring meeting.
- He suggested that IMF can also think of coming up with SDR allocations and with a non-stigmatized short-term liquidity swap facility which could be rapidly deployed.
- He also requested the countries to quickly get into collective action through the IMF towards creation of a global financial safety net (GFSN)
- He also talked of bringing forward the timeline of l6th GRQ (General Review of Quotas).
Basis of India’s objection to SDR Issue
- India is of the view that in the current context of illiquidity and flights to cash, the efficacy of an SDR allocation was not certain.
- India’s SDRs rose by $2 million to $1.4 billion that tantamount to 2.76 percent of the total SDRs.
- It also observed that in the absence of a global safety net, national forex reserves should be the first line of defence against market turmoil.
- So, extraneous demands for these reserves, that are independent of domestic monetary and financial stability, would come costly.
Criticism of the IMF’s move
- The allocation would be made according to IMF quotas, which implies that only a fraction of the allocated SDRs would go to developing and emerging economies.
- SDRs are an unconditional resource, and even the case for such an allocation is very strong during a crisis like COVID-19 pandemic but there lies a worry that countries could use them as a substitute for sound policies, mixing structural adjustment and austerity.
- A global health emergency and liquidity crunch is not the time for those policies, but rather for the massive countercyclical monetary and fiscal policies that are being adopted by developed countries.
Forex reserves of India which is used to back liabilities and influence monetary policy, chiefly comprises of
- Foreign currency assets
- Gold reserves
- SDRs (Special Drawing Rights)
- Reserve Tranche in the IMF
Need to maintain forex reserves:
- First, countries use their foreign exchange reserves to keep the value of their currencies at a fixed rate.
- To maintain liquidity in case of an economic crisis.
- To meet external obligations.
- Foreign exchange reserves are a nation’s backup funds in case of an emergency, such as a rapid devaluation of its currency.
- Foreign-exchange reserves act as the first line of defense for India in case of economic slowdown.
Special Drawing Rights(SDR)
- The SDR is an international reserve asset, created by the IMF in 1969 to supplement its member countries’ official reserves.
- The SDR is neither a currency nor a claim on the IMF.
- Rather, it is a potential claim on the freely usable currencies of IMF members.
- SDRs can be exchanged for these currencies
- The value of the SDR is based on a basket of five currencies—the U.S. dollar, the euro, the Chinese renminbi, the Japanese yen, and the British pound sterling.
Role of the SDR
- It was created as a supplementary international reserve asset in the context of the Bretton Woods fixed exchange rate system.
- The collapse of the Bretton Woods system in 1973 and the shift of major currencies to floating exchange rate regimes lessened the reliance on the SDR as a global reserve asset.
- However, SDR allocations can play a role in providing liquidity and supplementing member countries official reserves.
- The SDR serves as the unit of account of the IMF and some other international organizations.
How do Special Drawing Rights Work?
- SDRs are allocated to each of the countries that are IMF members. The amount of SDRs that are allocated to each country is based on their individual IMF quotas.
- IMF quotas are based broadly on the relative economic position of the country in the world economy. The quota is essentially a country’s financial commitment to the IMF and its voting power.
- SDRs can be traded for freely usable currencies between IMF members through voluntary trading agreements.
- It is important to understand that SDRs are neither a currency nor a financial claim on the IMF. SDRs are a potential claim of IMF members on freely usable currencies.
Global Financial Safety Net (GFSN)
- The GFSN consists mainly of the country's own reserves and external public sources of insurance and financing.
- To provide countries with insurance against crises
- Financing in times of shock
- Incentives for sound macroeconomic policies.
- National Level: Countries can self-insure against external shocks using foreign reserves or fiscal space.
- Bilateral level : Swap lines among countries.
- Regional level : Regional Financing Arrangements.
- Lastly a global financial backstop by the IMF.