The SDR interest rates calculations take place weekly. These rates act as the base for the derivation of other rates. In addition, SDR rates provide a foundation for evaluating rates to be used in the payment of interests on SDRs holdings, International Monetary Fund loans, levied charges on SDR allocations and quota subscriptions (Somanath, 2011). The remuneration rate is equivalent to the SDR interest rates. These rates are generated by the summation of multiplicative products in the valuation basket using SDR terms. The SDR rate on the 23rd November stood at 0.05% that is equivalent to 0.727 USD. The interest rate calculation is implemented with the combination of market interest rates on short-term debts. Weighted averages of rates in money markets for Japan, United Kingdom, Euro area and the United States of America are used. These rates are calculated each Friday using the prevailing rates on that specific day (Prowse, 2014). The interest rate generated takes effect on the next Monday and applies through up to the subsequent Sunday. For instance, Table 1 shows the interest rates generated on Friday, 20th November 2015. These rates took effect on Monday, 23rd November 2015 to Sunday, 29th November 2015.
Table 1. Interest rates for the week of November 23rd to November 29th the year 2015
Place New Order
|
CURRENCY |
CURRENCY AMOUNT UNDER RULE O-1 (A) |
EXCHANGE RATES AGAINST SDR (B) |
INTEREST RATES^2 (C) |
PRODUCT (A*B*C) |
|
EURO |
0.4230 |
0.77459 |
-0.325391 |
-0.1066 |
|
JAPANEESE YEN |
12.1000 |
0.00589498 |
-0.090000 |
-0.0064 |
|
U. K STERLING POUND |
0.1110 |
1.10681 |
0.480000 |
0.0590 |
|
U.S DOLLAR |
0.6600 |
0.724729 |
0.110000 |
0.0526 |
|
TOTAL |
-0.0014 |
|||
|
FLOOR FOR SDR INTEREST RATES |
0.050 |
|||
|
SDR INTEREST RATES ^3 |
0.050 |
Source: International Monetary Fund
The valuation method used in calculating the SDR interest rates is inclusive of financial instruments. The executive agrees on two criteria that should apply to the evaluation of the interest rates. The board argues that the financial instruments used should represent the financial instruments that are available to investors (Prowse, 2014). Along with that, the financial instruments used should possess such characteristics as the official standing of SDR. After every five years, the executive Board reviews the composition of the basket used in the valuation of the interest rates. The review makes certain that the importance of the currencies in the universal financial systems reflects in the calculation of the interest rates (Somanath, 2011). The last review took place in the year 2010 (Somanath, 2011), which sets the next review to take place late in the year 2015.
SDR Allocation to IMF Members
According to the Articles of Agreement, SDRs may be allocated to IMF members in proportion to their quotas. A costless asset is provided for each member. Interest is paid to members whose Special Drawing Rights holdings are above the stipulated allocations. On the other hand, a member pays interest on the loss for holding fewer Special Drawing Rights than those allocated to it. Interests are credited to the holdings accounts of the members while charges are debited to the holdings accounts (Prowse, 2014). The SDR Department has a mandate to pay interests to all the members who earned it even if the SDRs received are not sufficient to meet the payments. In fact, a delay in payments of SDRs leads to a temporary creation of additional SDRs.
The SDR Department of the IMF maintains the records of the SDR allocations and holdings given to members. Once allocated the SDRs, the members can hold or sell the allocations in the proportions they prefer (Somanath, 2011).They can also exchange the SDRs for usable currencies through a voluntary agreement or designation. In addition, the allocated SDRs can be used in transactions linked to IMF such as loan repayment, interest payments, and payment for future increase in quotas (Somanath, 2011). Holding SDRs incurs little operational costs estimated to being a fraction of one percent. The members of the IMF can obtain SDRs through two ways that are free exchange between members or designation by the International Monetary Fund to members with strong positions to buy from members who have weaker external positions.
Buying and Selling SDRs
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Members of the IMF often discharge their obligations to the International Monetary Fund by buying SDRs. Additionally, they adjust their reserve compositions by selling SDRs. The SDR market functions by free and voluntary trade harmony (IMF Fund, 2009). Therefore, the IMF acts as an intermediary that facilitates the free exchange of SDR holdings to usable currencies. With the increase in the allocations, the number of voluntary agreements has increased to guarantee uninterrupted liquidity in the SDR voluntary market. Including the nineteen new arrangements, the total numbers of voluntary arrangements stand at thirty-two since the SDR allocations disbursed in the year 2009 (Prowse, 2014). In the event of lesser buyers, the IMF designates the SDR holders with strong positions of the balance of payments to provide usable currency in exchange for SDRs. The mechanism is known as designation mechanism. This mechanism ensures that participants can use the Special Drawing Rights to obtain currency when the need arises. The need may arise due to its balance of payments, the reserve position it is in, and the developments taking place in its reserves. At the same time, the IMF also authorized the exchange of SDRs among members through donations, forward operations, swaps, loans, and pledges.
SDR Allocation
The allocation of Special Drawing Rights operated within the convenience of supplementing reserve assets in the long-run to satisfy the global needs. The allocation also revolves around its ability to avoid economic stagnation, deflation, inflation, and excess demand associated with goods and services. The global need implies that all members of the International Monetary Fund have adequate resources even in the absence of SDR supplementation. The SDR allocation focuses on fulfilling long-term needs of its participants rather than short-term needs. Before any proposal is made on the allocation of the Special Drawing Rights, the manager must consult the participants to ensure that they support the proposal.
Mainly, there are two types of allocations offered to the members of the International Monetary Fund, namely the general and the special allocations. The International Monetary Fund can be unrestricted liquidity via general SDR allocation (IMF Fund, 2009). However, its allocations are limited to participants in the SDR Department. In fact, the IMF is not allowed to distribute SDRs to itself or other possessors that it prescribes. The total SDRs allocated in the year 2009 cumulatively added up to a total of two hundred and four billion and one million (Prowse, 2014). Members with excess holding establish net claims on the SDRs, but members with holdings lesser than their allocations result to a net obligation on the SDR termed as an asset to the SDR department.
General Allocations of SDRs
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The function of general allocations of SDRs is to attain the long-term universal needs of supplementing the reserve assets in existence. In addition, the SDR general allocations aim at attaining the purposes of IMF as well as avoiding deflation, inflation, excess demand and economic stagnation (Herrmann & Terhechte, 2012). There are two steps that are involved in the general allocation of Special Drawing Rights. First, the projection of demand to hold reserve must be ascertained, then a decision is made concerning how the level, to which the demand should be met. The demand is met through the allocation of the Special Drawing Rights. The financial committee supports quick approval of SDRs worth two hundred and fifty billion dollars to the IMF members through general allocations. Up to date, general SDR allocations are rare and have only been made thrice: in the years 1970_1972, 1979-1981 and 2009. During the first allocation, three billion four hundred and fourteen million was allocated. For the next two consecutive years, two billion nine hundred and forty-nine million and two billion nine hundred and fifty-two billion were allocated respectively (Wilkie, 2012). On the date 7th August 2009, one hundred sixty-one billion two hundred million was approved and issued on the 28th August. These allocations increased the SDR holdings and allocations by about seventy-four percent of the quotas. A part of the allocation is given to the industrialized countries; some went to the developing countries and emerging markets while some went to low income countries (Herrmann & Terhechte, 2012).
Special Allocations of SDRs
IMFs Board of Governors approved the Special SDR Allocation also known as the Fourth Amendment on September the year 1997. The Special SDR allocation was to provide an equal platform for all members to participate in the Special Drawing Rights. It became operational on the 10th August 2009 after the IMF certified acceptance by eighty-five percent total voting powers of the IMF members. The implementation of Special Allocations of the SDR took place on the 9th September 2009 (Prowse, 2014). The members of SDRs increased cumulatively by twenty-one billion one million through the use of a common benchmark. The fourth amendment states that upon joining the International Monetary Fund, a new member will be entitled to collect SDR special allocation. However, the member must obtain the SDR Department membership within three months of joining the IMF to be able to enjoy these benefits. Currently, the special SDRs allocations are equal to about three hundred and seventeen billion.