“SDRs for climate finance still a long way from reality”

Mark Plant, chief operating officer of Center for Global Development, Europe, tells CarbonCopy about the obstacles that lie for developing countries on this alternate route to obtaining much-needed climate finance

On November 1, 2021, from the stage of COP26, the Prime Minister of Barbados, Mia Mottley expressed the dire need of international finance for climate vulnerable countries to adapt to climate change and mitigate further emissions. She proposed the mobilisation of climate financing from regular distributions of the International Monetary Fund’s (IMF) Special Drawing Rights (SDR). She proposed an annual issuance of $500 billion for 20 years that can be applied towards climate finance.

While we explain SDRs later on in detail, succinctly, the SDR is an international reserve asset created by the IMF to supplement the official foreign reserves of IMF member countries. They are neither a currency nor a claim on the IMF. Rather, it is a potential claim on the freely usable currencies of IMF members. SDRs can be exchanged for these currencies. IMF member countries receive SDRs in proportion to their quotas: due to their quotas, about 8 developed countries receive 60% of any allocation; low-income countries receive only 3.23%.

SDRs have been issued by the IMF to member countries only three times since their inception in 1969. The issuance of SDRs equivalent to $650 billion on August 2, 2021, to boost global liquidity in the aftermath of COVID-19 is the most recent example. It was the largest-ever distribution of SDRs. 

To start a similar issuance of SDRs for climate finance–that too annually as suggested in the Barbados proposal–several obstacles will have to be overcome. For example, the US will have to be on-board since it enjoys the largest vote share to veto any board decision by the IMF. 

To understand these intricacies better, CarbonCopy interviewed Mark Plant, chief operating officer of Center for Global Development, Europe. His appointment to CGD follows a long career at the International Monetary Fund. He is an expert on development financing, low-income country macroeconomics, and African economics.

What are SDRs? 

SDR is an international reserve asset created by the IMF to supplement the official foreign reserves of IMF member countries. SDRs are generally held by a country’s central bank. SDR is not a currency and cannot be used to buy anything. But SDR holdings can be converted to freely usable currencies, such as the US dollar, the euro, the yuan, the yen and pound sterling. 1 SDR is worth about US$1.4. 

[For more details go here.] 

Are they issued through voting, what are the minimum required votes?

The IMF’s executive board can authorise an issuance of SDRs upon recommendation of IMF management. It requires 85% of the board’s votes to be authorised. Important to note, countries’ voting power at the IMF is roughly proportionate to the size of each country’s economy. The biggest voting share is the United States at 16.5%. India’s voting share is 2.63%.

[For more details go here.]

Are there historical examples of SDR issuance? What are the learnings?

SDRs were originally issued to all IMF member countries in the 1970s. In response to the Great Financial Crisis of 2008, there was an issuance of SDR161.2 billion in August 2009. And in response to the economic crisis brought about by the COVID-19 pandemic, the IMF issued another SDR 456.5 billion in August 2021. The total number of SDRs now in existence stands at SDR 660.7 billion with an approximate value of just under US$1 trillion. 

What is the process of a country accessing them? Is there a difference between developed and developing world?

Whenever the IMF makes a new SDR allocation, every member country receives a portion of the total allocation determined by its quota, a measure closely related to its voting share. Thus, using the example above, the United States receives 17.4% of any allocation and India receives 2.75% of any allocation. [For quotas and voting power for every IMF member country, go here.] 

How can the use of SDRs for climate finance be brought under UNFCCC procedure? Is it important for this to be under the UNFCCC umbrella? What actions would be required to make it happen? 

SDRs belong to the member countries of the IMF, not to the IMF itself. In theory, member countries can dispose of SDRs in any manner they see fit. To date, countries have been hesitant to let SDRs be used outside of central banks as they are an asset and liability on central bank balance sheets. There are only 15 non-central-bank institutions that are allowed to hold SDRs. Another complication is that SDRs are not a currency and cannot be spent on climate activities or other goods or services. So to finance expenditure, SDRs need to be exchanged for usable currencies (see above). To date, this conversion has been facilitated by the IMF. Countries could choose to use other means, but the institution receiving the SDRs in exchange for usable currency would have to be a prescribed holder of SDRs. To have another institution hold SDRs would require an 85% vote of the IMF Executive Board.

Can a developed country use its SDRs to fulfil its climate finance obligation considering the lack of international finance? Some say that this process is less likely to be influenced by the ‘accounting tricks’ that developed countries are accused of indulging in? 

SDR is not a currency and thus cannot be used directly to discharge any obligation. In theory, a developed country could donate its SDRs to a developing country with some proviso that they be used for climate finance, but the terms of this agreement (grant or loan) would be between the two countries and the receiving country would have to eventually convert SDRs to usable currency. And it is important to realise that using SDRs has a cost—when a country’s SDR holdings are less than its allocation, the country must pay interest at the IMF-determined SDR rate—now at 0.092%, but subject to fluctuation with global interest rates. 

The US strongly opposes any new distributions of SDRs. Why is that? 

The US has said that it does not think a further SDR allocation is needed at this time. Critics of SDR allocations point to the fact that it is used to provide reserve assets to countries. The need for even higher global reserves is not clear, they argue, as reserves have increased during the pandemic. Some critics in the US Congress also point to the fact that SDR allocations benefit all countries, including some that the international community has sanctions against.  

As noted above, the US has 16.5% of the vote at the IMF, enough to block any new allocation. 

It should also be noted that there are IMF Articles of Agreement (by-laws) that restrict the frequency of SDR allocations to once every five years [also known as Basic Period]. However, this restriction could be changed by an 85% vote of the membership. 

The last ‘basic period’ (the eleventh) ended in December 2021 and the twelfth basic period began in January 2022. So another such distribution is possible this year?

This is correct. But there are calls by some for an annual allocation, which would require an amendment to the Articles of Agreement. [For which an 85% vote of the membership would be required.]

For the US to come on board, does it need Congressional approval? Because the US legislature’s record in committing to climate action and finance is uncertain at best. 

For allocations below roughly $650 billion, the Treasury needs to only inform Congress of its intent to vote in favour of the allocation—Congressional approval is not needed.  Many voices in the current Congress opposed the 2021 allocation, although since a vote was not required, their opposition did not affect the US’ action. For any SDR allocations above $650 billion, Congressional approval would be required. 

To ensure that the resources generated through SDRs are used by nations only for climate actions, the Barbados PM proposed creating a new ‘Climate Mitigation and Adaptation Trust’. Countries can voluntarily lend their SDRs to the Trust. Why is it important? Is there a precedent?

This could only happen if the trust was made a prescribed holder of SDRs. This would require an 85% vote of the IMF Executive Board. In addition, countries would have to be satisfied that the Trust was structured in such a way as to preserve the reserve asset characteristic of the SDR, which is not easy. 

The advantage of establishing such a trust is that the SDRs could be targeted toward countries that were confronting a substantial balance of payment difficulties because of climate change or their efforts to mitigate or adapt to climate change.  

There is no precedent for using SDRs for such a trust outside the IMF, although there are a plethora of climate funds and facilities that now exist.  

Is the IMF’s Poverty Reduction and Growth Trust [PRGT] to support low-income countries (LICs) in debt distress not a precedent? Barbados backed their idea to establish a climate trust citing PRGT’s example. 

The PRGT is a separate trust, but one that is administered by the IMF on behalf of the contributors to the trust. Being “within” the IMF gives it two advantages—the IMF makes loans for balance of payments purposes and thus helps preserve the reserve asset characteristics of the SDR and it is a designated holder of SDRs. Also the PRGT has two accounts—the reserve account and the subsidy account—that ensure that if repayments from PRGT borrowers are delayed, the lenders are repaid on a timely basis. It also allows low-income country borrowers from the PRGT to pay a concessional rate of interest on the loans—the current PRGT interest rate is 0%. 

The lessons from the PRGT for a trust outside the IMF are that great care must be taken to ensure that lenders into such a trust can reclaim their SDRs on demand. It also teaches us that a climate or other special purpose trust should have a governance structure that allows donors assurances that the assets they lend are safe, go to the purposes they intend, and will be repaid in due course. [More details on the PRGT and its workings can be found here]. 

To apply SDRs for climate action, for example to pay for the costs of decommissioning a coal-fired plant, a country will have to convert its SDRs to hard currency. What are the ways to do that? Does it involve convincing and negotiations with countries?

Under current arrangements, countries wishing to exchange their SDRs for so-called hard currencies have two choices—they can negotiate an agreement with another country or institution directly or they can approach the IMF who will arrange such a transfer using pre-negotiated voluntary trading arrangements. The creation of a separate trust would help only insofar as the trust could make the arrangements on behalf of many countries, rather than having the countries do so piecemeal.  

If it comes to negotiations, or convincing developed countries, can they impose unilateral conditions such as Net Zero, as has been seen in the GCF?

Developed countries are free to lend SDRs to other countries as they see fit, with whatever conditions they see fit. If they were to lend SDRs to a trust, the trust would impose conditions consistent with the purposes of the trust. For example, currently, disbursements from the IMF’s PRGT usually have macroeconomic conditions attached to the loans. 

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