Development Policy Analysis No. 10

An International Monetary Fund Currency to Rival the Dollar? Why Special Drawing Rights Can’t Play That Role

To alleviate the global recession, the G-20 group of nations recently agreed to authorize the International Monetary Fund to allocate $250 billion worth of Special Drawing Rights — the IMF’s unit of account — to its member states. This sparked much discussion on whether the SDR could become a new international currency, rivaling the U.S. dollar. Speculation was further fueled by the suggestions of Chinese officials that SDRs could displace the dollar in foreign exchange reserves. However, the SDR is not a currency and has no chance of becoming one.

Today the SDR has two roles: as a unit of account, and as a line of credit between IMF members. Neither role makes it a currency. The SDR’s value is defined as equal to that of a basket of four currencies: the U.S. dollar, the euro, the yen, and the pound sterling. Member-states occasionally agree to issue SDRs to themselves, and these serve as mutual lines of credit, providing needy countries access to hard currency. SDR allocations represent purchasing power through a credit facility, not through creation of a new currency.

Chinese officials and some leading economists want a greater role for SDRs in foreign exchange reserves. This would shift currency risk away from China to the IMF. But other IMF members would have to pick up that risk, and there is no reason for them to subsidize China. Underlying the SDR issue is a global struggle for political power. But China has a large and growing GDP and tax capacity, which may overtake that of the United States one day. Before then, the Chinese yuan will probably become convertible, and become a highly sought-after reserve currency in its own right. The real currency challenge to the dollar will come from the yuan, not the SDR.

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Swaminathan S. Anklesaria Aiyar is a research fellow at the Cato Institute’s Center for Global Liberty and Prosperity and has been editor of India’s two biggest financial dailies, The Economic Times and Financial Express.