SDR allocation a positive step but won’t end debt woes - Capital Economics
Emerging Markets Economics

SDR allocation a positive step but won’t end debt woes

Emerging Markets Economics Update
Written by William Jackson

The mooted $650bn allocation of IMF Special Drawing Rights (SDRs) that looks close to being signed off would provide welcome relief to some smaller frontier markets such as Ghana and Kenya that still face very high foreign borrowing costs. But it won’t solve the underlying problems in those EMs where debt dynamics look unsustainable, including Ethiopia and Argentina.

  • The mooted $650bn allocation of IMF Special Drawing Rights (SDRs) that looks close to being signed off would provide welcome relief to some smaller frontier markets such as Ghana and Kenya that still face very high foreign borrowing costs. But it won’t solve the underlying problems in those EMs where debt dynamics look unsustainable, including Ethiopia and Argentina.
  • An SDR allocation was first suggested at the peak of the market turmoil in March last year. Opposition from the US meant that the plan didn’t proceed, but the Biden administration is on board with the proposal and media reports today suggest that a G20 draft communique endorses a $650bn allocation.
  • These SDRs would be allocated according to countries’ IMF quotas, which are largely based on the size of GDP. In terms of how the allocation works, IMF members’ central banks receive an asset (an SDR) which they can exchange for usable currencies (mainly US dollars, yen, and euros) with other IMF members. Because IMF members commit to hold and exchange SDRs, they have a status as a reserve asset. The allocation therefore increases central banks’ gross international reserves.
  • The allocation also results in a long-term foreign liability, so the central bank’s net foreign currency position is unchanged. But the key point is that the asset is highly liquid, allowing the central bank to provide foreign currency to residents. And the liability is a soft one in that it doesn’t need to be repaid at a scheduled point.
  • One common criticism of SDR allocations is that a large share will go to developed economies and richer emerging markets with ample foreign exchange reserves such as China; the economies most in need receive fewer resources. (See Chart 1.) There has been some talk of a ‘reallocation mechanism’ to mitigate this, although we’re not convinced that this would be workable. It would involve complex (and highly political) judgements about which countries need the SDRs and which do not (and on what conditions).
  • In any case, in relative terms, the poorest and most debt-distressed EMs will receive the greatest uplift increase in gross international reserves. A $650bn allocation would more than double Zambia’s gross international reserves and it would raise reserves by more than 10% in Argentina, Ethiopia, Ecuador, Kenya, Ghana and Sri Lanka, all of whom face very high borrowing costs on global capital markets. (See Chart 2.) China’s gross international reserves would, in contrast, rise by just over 1%.
  • This increase in reserves would give central banks more scope to provide foreign currency liquidity to residents, allowing for higher imports and/or facilitating external debt repayments. In turn, that would open the door to a stronger recovery in demand and provide a cushion in the current environment of tightening external financing conditions.
  • While clearly a positive step, there are two points worth stressing at this stage. The first is that it would have been much more beneficial to do this a year ago at the height of the market stress. The second is that this increase in foreign currency liquidity won’t prevent the need for debt restructuring in countries where debt trajectories are on unsustainable paths (e.g. Ethiopia and, ultimately, Argentina and Ecuador too).

Chart 1: Impact of $650bn SDR Allocation on Gross
Intl. Reserves ($bn)

Chart 2: Impact of $650bn SDR Allocation on Gross International Reserves (% of Current Reserves)

Sources: Refinitiv, IMF, Capital Economics

Sources: Refinitiv, IMF, Capital Economics


William Jackson, Chief Emerging Markets Economist, william.jackson@capitaleconomics.com