Special Drawing Rights (SDRs) are a type of foreign exchange (forex) reserve asset, created and administered by the intergovernmental financial institution the International Monetary Fund (IMF). They are meant to help supplement other forex reserves held by the central banks of the IMF’s member countries. However, they also differ fundamentally from all other type of forex assets – be these bonds, treasuries, currencies or gold. Basically, SDRs have both an asset and a liability component. It therefore makes sense to think of SDRs as resembling a revolving credit line rather than any other type of forex reserve asset.  Any country has to right to access its allocation of SDRs at any time.

The IMF allocates SDRs according to a country’s quota share. The amount of allocation varies from country to country. Allocations are not made on a regular basis but they happen whenever 85% of the total voting power of all IMF members agrees on an allocation. This last happened in August 2021 when the IMF allocated USD 650 billion worth of SDRs to its members to boost global liquidity. As part of this allocation, Bangladesh received the equivalent of about USD 1.4 billion in Special Drawing Rights (SDRs) as part of the IMF’s new SDR allocation, bringing its total allocation to about USD 2.9 billion.[1] As of April 2022, Bangladesh still has about USD 2.7 billion available for use.

Bangladesh’s SDR policy

Bangladesh’s central bank, the Bangladesh Bank, is the focal government body dealing with SDR issues. Recently, Bangladesh announced that it was not planning on using any of the remaining SDR allocation. Bangladesh has also not made much direct use of its previous SDR allocations. Instead, the country’s central bank has chosen to keep the allocation as part of its forex reserves. The rationale for this policy is that this provides a buffer against possible future shocks.

Bangladesh could benefit from making greater use of Special Drawing Rights than it has done in the past.

The IMF has received this decision positively. Bangladesh is not exceptional in this regard as it mirrors the strategy India and Nepal have taken. But it also stands in contrast with how some other comparable countries have used their respective allocations. For example, Pakistan announced that it would use up 70% of its new SDR allocation (which is about USD 2 billion out of USD 2.75 billion) for vaccine financing as well as to reduce its reliance on expensive government debt issuance. Similarly, Sri Lanka has already used 85% of its new allocation, of USD 780 million, for debt repayment and forex interventions.

Seen in this light, it seems worth asking if Bangladesh is truly making the most of its SDR allocation. Bangladesh could benefit from making greater use of SDRs than it has done in the past. This does not mean that Bangladesh should have a nonchalant approach to using these instruments. In particular, there are two areas where SDRs might be put to good use:

  • As a source to finance public investment. This can either be part of the newly established Bangladesh Infrastructure Development Fund (BIDF) or as an earmarked source of funding to mitigate the future consequence of climate change.
  • As a tool to refinance the expensive Treasury Bonds, thereby decreasing ongoing budget expenditures on interest payments.

However, to properly appreciate the advantages and disadvantages of SDR usage, one needs to understand the basic technicalities of the SDR system, especially how it is different from the IMF’s usual lending/borrowing schemes.

The SDR system is not the IMF

The SDR system should not be confused with the regular activities of the IMF. Since the introduction of SDRs in 1969, a dedicated account called the General Resource Account (GRA) has operated the IMF’s non-concessional lending and borrowing facilities. Since 2000, Bangladesh has used borrowing via the GRA twice: in 2008, when it borrowed USD 182 million, and in 2020, when it borrowed USD 486 million.

At the same time, the IMF offers concessional loans for low-income countries. The IMF’s main arm for this lending is the Poverty Reduction and Growth Trust (PRGT). Since 2011, the interest rate for borrowing via the PGRT has been zero. Bangladesh has interacted regularly with the PRGT since 1984. In fact, in the four decades since, Bangladesh has only once, in 2007, neither borrowed from nor made a repayment to the PGRT. Over the course of these years, Bangladesh has cumulatively borrowed USD 2.3 billion, of which USD 1.8 billion has already been repaid.

How does the SDR system work?

The IMF’s SDR system is best understood as an alternate parallel system to regular IMF lending/borrowing schemes. The SDR system was designed to complement the IMF’s regular lending and borrowing channels. Thereby, SDRs would add liquidity into the international monetary system.

Today, the SDR system has exactly 206 members. These members fall under three categories:

  • One institution of each IMF member state. These institutions are referred to as ‘participants.’ In the case of Bangladesh, this participant is the country’s central bank, the Bangladesh Bank;
  • The IMF itself, represented by its General Resources Account (GRA);
  • A group of 15 ‘Prescribed Holders,’ which include multilateral development banks and intergovernmental monetary institutions such as the Bank for International Settlement, the European Central Bank and the Asian Development Bank.

The SDR system involves idiosyncratic accounting and language. For starters, the term ‘SDR’ is interchangeably used to refer to three different things. First, it is an accounting unit whose value is derived from a basket of the world’s five leading currencies. Second, SDR can refer to a central bank’s liability, which is also called ‘SDR allocation.’ This liability cannot be traded. It is basically the allocated borrowable amount through the SDR system. Third, SDR refers to what is called ‘SDR holdings,’ a tradable asset. When countries use ‘SDR holdings,’ they essentially borrow these funds from the SDR system.

Members of the SDR system accept these instruments as a direct form of payment. Or they agree to exchange these for usable currency. SDRs are sometimes seen as some kind of ‘world money.’ They are also seen as a form of free financing. But this is incorrect. Only as long as SDRs remain unused are they costless. Using SDR holdings in any way means a country will have to make interest payments. Hence, usage of SDRs is like a perpetual loan.

One criticism that has been repeatedly levied at the IMF’s SDR system is that it disproportionately benefits advanced economies. Critics often question why advanced economies need SDRs in the first place. This is a fair criticism. SDRs are allocated according to a country’s quota share in the IMF’’s General Resources Account (GRA). This means the largest recipient of a new SDR allocation will be the US, which has received about 16% of all allocations. However, SDRs can be very instrumental for small economies. For some smaller economies, such as the Central African Republic or Libya, the SDR allocation is 6% and 10% of their respective gross domestic product (GDP).

For Bangladesh, the latest SDR allocation was a meagre 0.4% of GDP, which edged up its cumulative SDR allocation to about 0.8% of GDP. However, while small, these shares are actually large when compared with the resources that Bangladesh has used from other IMF programmes. To bring some perspective, Bangladesh’s total SDR allocation is six times what it borrowed from the GRA. From a policymaker’s view, SDRs are an important resource for Bangladesh, especially when one looks into how Bangladesh has used other IMF programmes in the past.

Why has Bangladesh chosen to hold rather than use SDR?

There are good reasons why Bangladeshi policymakers have chosen not to draw the full amount from the country’s IMF-created SDR allocation. The first reason is that Bangladesh’s central bank is actively engaged in the spot forex market, in order to stabilise the exchange rate between the local currency, the Taka and the USD. Bangladesh receives strong constant remittance and other capital inflows. These inflows lead to upward pressure on the exchange rate. In fact, in 2021 the country’s balance of payments account saw a surplus of USD 9.2 billion. This has expanded forex reserves to a sizeable USD 46.4 billion!

A second reason is that forex reserves are usually used to help finance imports, especially of food and raw materials. According to a recent IMF assessment, a safe threshold for Bangladesh is 5.7 months of import cover. Yet, during the strong forex inflow time of 2021, this import cover reached 7 months.

Third, forex reserves are a useful safeguard against any unforeseen developments. The 2022 war in Ukraine, for example, has already led to a highly unexpected worldwide increase in the price of wheat and fertiliser. It has also disturbed existing trading patterns, leading to forex reserve erosion in many countries. Given the countless sources of uncertainty, Bangladesh’s policy of holding a higher level of reserves certainly provides reassurance.

SDRs for public investment

As discussed, there are sure merits of a highly cautious approach in using the new SDR allocation. But there are also alternative approaches to using SDRs. One option is to use SDR holdings to enhance public investment in Bangladesh. Bangladesh has already announced the creation of its Bangladesh Infrastructure Development Fund (BIDF), to finance mega-infrastructure projects. The BIDF has been capitalised using USD 2 billion from the strong forex inflow experienced since 2020. The new SDR allocation could be funnelled to increase the capital base of the BIDF.

Birds eye view of the Padma Bridge, the biggest self-financed infrastructure and the largest bridge in the country, Dhaka, Bangladesh, May 2022 | Photo by Nashirul Islam.

One option is to use SDR holdings to enhance public investment in Bangladesh.

SDRs have a comparatively very low interest rate, determined as the weighted average interest rate of the short-term government debt of the SDR’s basket currencies. Given the low interest rate on SDR borrowing, policymakers have the option to invest this cheap source of funds in a whole array of social impact investment areas. Another angle could be to exclusively earmark the usage of SDR holdings for investment in the future effects of climate change. This is particularly relevant for Bangladesh, which is among the world’s top climate-vulnerable countries.

Some projections estimate that Bangladesh stands to lose up to 11% of its land area as a result of rising sea levels by 2050, meaning about 15% of the population is in danger of displacement. The low-interest nature of SDR borrowing makes it an ideal instrument to undertake investments that will prepare Bangladesh for this ‘climate’ eventuality.

SDRs to refinance government debt

A quick-benefit way to use Special Drawing Rights (SDR) is to retire existing government debt. The SDR interest rate is substantially lower than the interest rate that Bangladesh pays on its Treasury Bonds. As of April 2022, Bangladesh owes about USD 34 billion in Treasury Bonds, USD 5.5 billion of which have an annual interest rate in excess of 10% per annum.[2]

The blended non-maturity adjusted average interest rate of this USD 5.5 billion debt is 11.6% per annum. That means Bangladesh currently faces about USD 600 million in annual interest expenses on this debt. By contrast, the SDR interest rate is just 0.56% per annum.[3] Bangladesh can reap massive gains if it uses its SDR allocation for an early repayment on these Treasury Bonds. This can be done either through the secondary market or by triggering an early payment clause in the bond contract.

In fact, using SDR borrowing to retire Treasury Bonds with a tenor of more than 10 outstanding years would essentially pay for itself over the next decade.[4] This means that, were Bangladesh to use USD 1 billion of its SDR allocation to retire Treasury Bonds, it could save more than USD 1 billion in interest payments over the next 10 years. This amount under discussion is some 0.3% of GDP, which is quite significant.

Mitigating SDR-induced risks

Using SDRs for debt refinancing poses renewed interest and exchange rates. The period of historically low interest rates that key advanced economies like the US and the EU have experienced over the past 15 years is coming to an end. With rising interest rates in key advanced economies, the SDR interest rates are also set to increase.[5]

If Bangladesh were to use its entire stock of SDR holdings and if the exchange rate of the Taka against key currencies depreciates, Bangladesh’s effective debt burden will grow.

In addition, using SDRs for debt financing means replacing domestic-denominated debt with debt in a foreign currency denomination. Any repayment of SDR holdings must be made either in SDR holdings or in one of the basket currencies. If Bangladesh were to use its entire stock of SDR holdings and if the exchange rate of the Taka against key currencies depreciates, Bangladesh’s effective debt burden will grow. This situation must be avoided.

Luckily, there are a number of strategies to minimise interest rate and exchange rate risks. For one, Bangladesh can assess if it has any foreign currency debt with an interest rate above 10% per annum. In this case, it would make sense to repay this debt. It would be a likewise swap but with the added benefit of lower rates.

Another option is for Bangladesh to draw a threshold line at half of its total SDR holdings. In case of a big change in any exchange or interest rate, this remaining portion of SDR holdings could be used as a new and cheaper source of funding. According to the latest IMF data, from April 2022, Bangladesh still holds over USD 2.7 billion in SDR holdings. This means it could easily use USD 1 billion for an early debt repayment on Treasury Bonds, without much risk.

A last option for Bangladesh is to simply change the composition of its forex reserves. This will mean holding a larger portion of the reserve in SDRs rather than other assets. With this strategy, Bangladesh can keep its SDR holdings unused because other types of forex reserves will be put to use repaying existing debt. In other words, rather than using USD 1 billion of SDR holdings, Bangladesh could sell USD 1 billion of other forex holdings to refinance existing debt.

Rather than using USD 1 billion of SDR holdings, Bangladesh could sell USD 1 billion of other forex holdings to refinance existing debt.

This would minimise future interest rate and exchange rate risks. However, it would also lead to some pressure on the exchange rate as well as foregone interest income on the forex assets. In addition, this strategy will create less flexibility in a future crisis situation, primarily because usage of SDRs is slower and more cumbersome than for most forex reserves.

Conclusion

Bangladesh has shown a great deal of caution in pursuing different lending facilities from the IMF. Bangladeshi policymakers can note one point: there is also such a thing as too much caution. This seems to be true for the country’s policy in using the IMF’s Special Drawing Rights allocation. Given Bangladesh’s vast need for infrastructure investment, as well as large interest repayments on Treasury Bonds, Bangladesh could opt to adopt a better strategy to use the SDR system.

If done on a reasonable scale, this will give Bangladesh access to a cheaper source of financing. The net benefits: freeing up budgetary space and strategic investment to prepare for what is sure to be a volatile and difficult future.

 

[1] Unless noted otherwise, all amounts are at current exchange rates.

[2] These come in 147 different bond issues.

[3] The SDR interest rate has increased from a historical low level of 0.05% per annum in 2021 to 0.56% per annum in May 2022.

[4] Because the interest differential is currently in excess of 10% per annum.

[5] Consequently, the interest rate differential, which determines the amount of actual interest rate savings, will decline over the next few years. This is because Bangladeshi Treasury Bonds have a fixed interest rate while the SDR interest rate is variable. As the SDR interest rate increases, the differential decreases.

 

Cover ©️ IMF/Cory Hancock

Photo ©️ Mahmud Hossain Opu

Tobias Pforr
Tobias Pforr is Research Fellow at the Robert Schuman Centre for Advanced Studies at the European University Institute. He is an economist. He specialises in monetary theory, financial instruments and climate change adaptation. He was a research and teaching fellow at the University of Reading and the University of Warwick. He was a consultant at the UN World Food Programme, the International Federation of Red Cross and Red Crescent Societies and the Overseas Development Institute. He pursued his doctoral studies at the University of Warwick and LUISS Guido Carli.