The EU, Africa, and SDRs: More Can Be Done

The EU-AU summit is an important moment where the European Union could announce an ambitious plan to recycle its Special Drawing Rights—which our analysis shows there is plenty of room to do. While some EU countries have been at the forefront of advocating for recycling, as a group the EU member states could do much more to advance the global recycling goals set by the G20 as a first step. And they have the flexibility to be even more generous in their financial support of vulnerable countries in Africa and elsewhere if they act together.

In August 2021, the International Monetary Fund (IMF) effected a special allocation of $650 billion of Special Drawing Rights (SDRs), a reserve asset meant to provide a needed financing cushion to global economy as it weathered and recovered from the economic crisis induced by the COVID-19 pandemic. While every country in the world got some portion of the allocation, IMF rules dictated that higher-income countries got more (about $450 billion) and low- and middle-income countries less (about $200 billion).

Higher-income countries didn’t really need the SDRs, as they had sufficient fiscal and monetary flexibility to cushion the impact of the pandemic on their economies by running up spending by about 8 percent of GDP. Low- and middle-income countries (LMICs) were much more constrained in how they could react, and their already weak budgets, higher indebtedness, and limited ability to “print money” meant that their populations suffered more. The World Bank estimates that 97 million people were thrown into extreme poverty in LMICs because of the pandemic.

Economists and politicians quickly recognized that the global economy would benefit from recycling some of the higher-income countries’ SDRS to LMICs. In April 2021 the G20 pledged to reallocate $100 billion of SDRs to more vulnerable countries and G20 and other countries’ pledges are now being made. Most of the vulnerable countries who would benefit from such a recycling are in Africa and Latin America.

In this blog, we look at the situation of the EU member states, individually and as a whole, to see how they benefited from the SDR allocation, the extent of their commitment to SDR recycling, and whether more could be done either with SDRs or reserves.

How did EU countries benefit from the SDR allocation?

SDRs are allocated proportionately to IMF quotas—a rough gauge of each country’s importance in the global economy. Counting both the most recent and previous allocations, EU member countries have been allocated 27 percent of the world’s SDRs (chart 1), amounting to SDR175 billion, with a value of about €217 billion (one SDR is worth about €1.24). Of this SDR 119 billion (€148 billion) were allocated on August 23, 2021, more than tripling the total. Among EU member countries, Germany, France, Italy, the Netherlands, and Belgium have been allocated the most SDRs (table 1).

Table 1

SDRs can only be used in transactions with the IMF, other countries, and a small set of prescribed holders, like the European Central Bank (ECB). If countries want to use SDRs for other purposes they need to convert SDRs to one of five reserve currencies (euro, dollar, sterling, yen, renminbi) through exchange with another country. Thus, the actual holdings of SDRs differ from the allocated amounts depending on what exchanges the country has engaged in. Holdings of SDRs as of end-December 2021 for EU member countries and the ECB are shown in table 2, alongside the allocation. Countries who are holding more SDRs than their allocation (net buyers of SDRs) are shown first and those with fewer SDRs than their allocation (net sellers of SDRs) follow.

Table 2

Source: IMF SDR Holdings Data

How do SDRs figure in overall reserves of EU countries?

For many LMICs, the 2021 allocation was an important supplement to their central bank reserves, allowing them increased maneuvering room to manage their economies. For example, in Zambia, SDRs contributed to an 89 percent increase in reserves (table 3) and in Ghana reserves increased by 18 percent thanks to the SDR allocation.

For EU member states, SDRs played a much smaller role. SDRs boosted member state foreign reserves by about 12 percent, bringing SDRs share in total reserves from just under 5 percent to 15 percent (see table 4). This ratio stays roughly the same when ECB reserves are pooled with member country reserves.

While this seems like a substantial boost for the EU, it is worth noting that as the pandemic took place, EU reserves increased from $968 billion at the end of February 2020 (pre-covid) to $1,080 billion at the end of July 2021 (before the SDR allocation). Reserves were simply not a problem for the EU and the SDRs’ cushion was not needed.

What commitments have the EU countries made to recycle their SDRs?

As noted above, the G20 have committed to recycle as much as $100 billion of SDRs to vulnerable countries. While there have been calls by EU leaders, particularly France, in support of the recycling effort, some observers feel that their rhetoric has not been matched by action. Only four EU member states have made a public commitment to recycling some of their SDRs, with France leading the charge in committing 20 percent of its August 2021 SDR allocation, equivalent to $6 billion (Table 5). Spain also committed to recycle 20 percent of its new allocation. The total recycling commitment of EU member countries of just over $13 billion is a large share of the current public global commitment of $36 billion, but this stands well short of the $100 billion G20 objective. It is worth noting that China has indicated its intention to recycle 25 percent of its SDR allocation to Africa alone.

Some constraints on recycling

It is important to understand that each country has its own laws and regulations governing the use of its SDRs. For example, in Germany the SDRs belong to the Bundesbank, which entirely independent of the German government. While the government has been supportive of the recycling effort, it is unable to commit the German SDR allocation.

Another possible hindrance to recycling commitments is that governments are as yet unsure as to exactly how the recycled SDRs will be used. As of this date, there is only one way that SDRs can be recycled – through the IMF’s Poverty Reduction and Growth Trust (PRGT), which in turn onlends the SDRs to low-income countries in need of balance of payments support. (The details of how recycling to the PRGT works can be found here.) The IMF is in the process of establishing a new trust, called the Resiliency and Sustainability Trust (RST) , which will benefit a wider group of countries that are facing challenges transitioning to a sustainable and equitable future, particularly in their adjustment to climate change and establishing robust health systems. Many countries have hesitated to make a commitment to recycle their SDRs the RST as they were unsure of how it would be designed, but with details now emerging perhaps countries will be more confident in doing so.

The IMF estimates that it can effectively use about $30 billion in SDRs for the PRGT and about $50 billion for the RST, at least initially. This leaves a question as to how the other $20 billion might be used, if the full G20 commitment is realized. One possibility is that G20 countries recycle their SDRs directly to other countries, as loans or gifts. There are reports that countries in the Middle East and North Africa region have recycled their SDRs in this way, but no hard figures are available. No EU member country has done so publicly.

Another alternative that the global community is exploring is recycling SDRs to multilateral development banks (MDBs), like the African Development Bank or the World Bank. The are some substantial technical constraints to using SDRs in this way, as G20 countries are insisting that the reserve asset characteristic of the SDR be maintained—essentially that the SDRs continue to be used as a central bank or monetary asset and be redeemable on demand. At a recent CGD event, several policymakers discussed the MDB recycling option. They noted that there were technical solutions to ensure that the SDR retains the needed flexibility, but more work is needed to bring them to fruition. Unfortunately, for EU member states the ECB has made it clear that recycling SDRs to MDBs is not permitted under current ECB rules and regulations, so this option is precluded for the moment for EU member countries. The discussion in the online event also indicated some willingness to find a way to accommodate EU restrictions yet allow some recycling to MDBs.

What more can EU member states do to support Africa through SDR recycling?

While there was considerable hope for the August 2021 SDR reallocation to provide immediate relief to vulnerable countries in African and elsewhere, the momentum seems to be stalled. No recycling has yet taken place and thus no additional SDRs have been received by vulnerable countries. While the rhetoric has been supportive, action has been slow.

There are three actions that the EU member states could take, either as a group or individually that would jumpstart the process of SDR recycling, thus providing a needed resource boost to African countries:

• Make an EU-wide commitment to recycle at least 20 percent of the Union’s SDRs. This would amount to $36 billion dollars and go a long way to making the G20 goal a reality. While not every country could contribute directly, some countries have sufficiently comfortable reserves and SDR positions to contribute more that 20 percent.

• Be precise about the amount of recycled SDRs to be committed to the IMF’s two trust funds. This will allow the IMF to plan its lending operations to maximum effect.

• Work within the Union and with the ECB to find alternative ways to recycle SDRs. This will take political and technical leadership. This will require EU countries to become active proponents of recycling rather than passively accepting the current recycling modalities as given.