How does IMF give loan to its Members?
The International Reconstruction and Development Bank (IBRD) and The International Monetary Fund (IMF) and were established in July 1944 in the Conference of 44 countries held in Bretton Woods, New Hampshire, USA. India is the founding member of the IMF.
About Special Drawing Rights
The main motive of the International Monetary Fund (IMF) is to provide economic assistance to member countries for eliminating the adverse Balance of Payment (BOP). To solve the problem of international liquidity it started the concept of Paper Gold I.E. Special Drawing Rights (SDR) in 1971.
Currently the total quota of SDR is 477 billion (US$692 billion). The IMF has allocated a total of 204 billion SDR (some $296 billion) to its member countries.
The value of SDR is determined by the basket of 5 currencies i.e. Euro, US Dollar, Yen, Chinese Yuan, Pound Sterling. Chinese Yuan was introduced as the 5th currency in the SDR basket in Oct. 2016.
US dollar has highest weightage (41.73%) in deciding the value of SDR followed by the Euro (30.93%).
SDR is the unit of International Accounting and Payment. The SDR is neither an International Currency nor an international credit facility.
SDR is the reserve currency by which the member country of the IMF discharges its loans or repayments obligations by receiving foreign currencies in exchange of its SDR quota.
The member countries which are given the rights of the SDR can receive foreign currency from other member countries.
The basic purpose behind the creation of SDR is to provide more resources to all members of the IMF so that the member countries can arrange the money for foreign exchange without putting additional pressure on the resources of the IMF and to solve the problem of international liquidity.
How IMF lends to member countries;
SDRs are used as an international reserve asset. A country's share of SDR allocations is established in proportion to its quota. The SDR quota determines a member's voting power in IMF's decisions. Currently India's quota in the IMF is 2.76% (vote share). USA has biggest quota of 17.46% followed by the Japan (6.48%), China (6.41%).
The country which requires the international currency for an international transaction or foreign exchange at the cheaper rate can apply for loan in the IMF. In this situation the member country is allocated SDR in proportion of its quota in the IMF.
After receiving the request for the loan; the IMF forwards this request to a member that has positive Balance of Payment and abundant reserve with the IMF. This country is called an authorized country.
The applicant country can take the SDR up to twice of its maximum limit of SDR. In this lending process the SDR of applicant country reduces while authorized country’s SDR increases in the accounting book of the IMF.
So in this way the authorised country repays the debt of the applicant country. Thus the applicant country can meet its exchange requirements through the SDR.
Keep in mind that the applicant countries have to pay simple interest on the amount of issue of the SDR. This interest rate is very low around 2%.
As a summary, it can be said that SDR has eliminated the problem of liquidity at the international level and it has also replaced the gold for the international transaction.
It is expected that after reading this article, you may have clearly understood how the IMF gives loans to its member countries with the help of SDR.