The IMF’s Shareholders Disappoint on SDRs

There was a very disappointing development at the IMF Executive Board earlier this month—the postponement of a formal decision on whether special drawing rights (SDRs) could be recycled to the hybrid capital scheme proposed by two multilateral development banks (MDBs), the African Development Bank (AfDB) and the Inter-American Development Bank (IDB). This adds fuel to the fire of the many advanced countries turning away from helping vulnerable developing countries, as evidenced by the recent announcements of decreased aid from France, Germany, the European Union, and others.

But there is hope that the IMF Board will approve the proposal in the coming months. My colleagues and I have written elsewhere on what hybrid capital is and why recycling SDRs to fund hybrid capital at the AfDB and IDB is the best use of SDRs. But, from informal reports, these arguments seem not to have landed with members of the IMF Executive Board, particularly some of those representing their countries’ central banks.

Central banks are right to be skeptical about spending SDRs, which are part of their reserves, on development projects in other countries. All central banks fight against crossing the monetary/fiscal divide. But there are good reasons for them to put aside their central banking doctrine for a minute and look carefully at the AfDB/IDB proposal:

• Central banks will make a profit from their SDR holdings. Countries will lend their SDRs to the AfDB/IDB. In turn they will receive interest on their loan that exceeds the SDR interest rate.

• The SDRs will not be spent or lent to vulnerable countries. The SDRs that advanced countries loan to the AfDB/IDB will be held in the MDBs’ SDR account at the IMF and will be part of the MDBs’ capital. Only in the highly unlikely event that one of the banks has a capital crisis would the claims be liquidated, and they wouldn’t be first in the capital stack.

• Central banks can get their SDRs back when they are needed. A liquidity support fund will underpin the hybrid capital scheme. This will allow central banks to “cash out” of the scheme if their countries’ economic situation is dire. This preserves what central bankers refer to as the “reserve asset status” of the SDRs.

• Central banks already invest in MDBs. Central banks are the biggest buyers of MDB bonds. And the funds raised by the MDBs through bonds are directly lent to support projects in developing countries.

• The financial power of the SDR is magnified by the hybrid capital scheme. Unlike directly lending to MDBs, lending to hybrid capital allows the MDBs to leverage the SDRs on financial markets and mobilize 2 to 4 times the amount of hybrid capital invested.

• And it costs the taxpayer nothing! The SDRS already exist and are sitting idle on many central bank or ministry of finance balance sheets. They just have to be mobilized. It does restrict immediate reserve management flexibility a bit, but the effect is small and can be managed.

Central banks are not development institutions. Their purpose is to fight inflation and protect the value of their countries’ currency. But they need to invest their reserves wisely. The SDR hybrid capital scheme is a wise investment. And it has the added benefit of boosting the lending power of institutions charged with development. It seems to be a win-win-win for the central banks, the MDBs, and vulnerable countries desperately in need of financial support.

Update: The point about the riskiness of central bank buying MDB bonds has been updated thanks to a reader’s comment.