Many advanced-economy countries are looking for ways to recycle their excess Special Drawing Rights (SDRs) to support more vulnerable countries whose economies are being buffeted by the economic aftermath of the COVID-19 pandemic and the Russian invasion of Ukraine. The G20 has pledged $100 billion of SDR recycling—much of that is going to the IMF, but about $40 billion has yet to find a destination.
A new proposal by the African Development Bank (AfDB) gives donors an excellent opportunity to recycle their SDRs, potentially having a much more significant impact than traditional recycling methods and making a bit of a profit too.
Here are the five reasons why countries should recycle at least some of their SDRs to the AfDB as hybrid capital:
- Every SDR100 million recycled to the AfDB will be multiplied to increase loans to vulnerable African countries by SDR200-400 million. The AfDB will leverage these SDRs as capital to mobilize more lending funds. The bank will then loan these funds to support a sustainable transition throughout the African continent. The AfDB has the regional expertise and connections to make these loans effective.
- The SDRs are never themselves spent. The AfDB will hold them as capital in its SDR account at the IMF. They would be pulled out of that account only if the loans they supported through leverage went bad, and as a last resort. And with the AfDB's sound financial management practices, the chances of that happening are virtually nil. The AfDB has a AAA rating and the ratings agencies have welcomed this new form of capital.
- There will not be any call on central banks' currency reserves through this kind of recycling. Some central banks worry that recycling SDRs could strain central bank reserve management. For example, if an advanced country were to recycle its SDRs directly to a vulnerable country, the vulnerable country would likely then exchange those SDRs for hard currency (dollars, euros, yen…) because it couldn’t buy things (like vaccines) with SDRs. That exchange would draw on the reserve currency of some central bank—perhaps even that of the country that recycled the SDRs. If volumes got large, this could strain the cash reserves of some countries. But there is no need for such worries with the AfDB scheme because the SDRs are held as capital at the IMF. They are not lent to vulnerable countries.
- The hybrid capital model preserves the SDRs’ reserve asset characteristic (RAC). In calling for $100 billion worth of SDR recycling, the G20 insisted that any recycling maintain the RAC—meaning that the SDRs can be redeemed on demand and are as close to risk-free as possible. The AfDB has designed its hybrid capital scheme with these characteristics in mind. While it is up to each lending country to interpret the RAC, the IMF staff has confirmed that SDRs invested in AfDB hybrid capital would count as reserves in the IMF’s official statistics.
- Countries recycling SDRs to the AfDB could make a small profit on their investment. Recycling SDRs is costly to advanced-economy countries because they must pay the SDR interest rate to the IMF (see blog here). But as part of the agreement to lend the AfDB their SDRs for hybrid capital, the AfDB will pay interest to them slightly above the SDR interest rate. So that more than covers the cost of recycling. The AfDB covers these costs with the interest they receive on their loan. The interest rate they charge will be between the SDR rate and the market rate. So everyone benefits: the SDR donor gets a slight premium on the SDR rate, and the borrowing country gets a loan from the AfDB at a slight discount from the market rate. And if the donor countries are generous, they could agree to forego the interest payments on the recycled SDRs and give the AfDB more financial flexibility.
While recycling SDRs through the IMF’s Poverty Reduction and Growth Trust or its Resilience and Sustainability Trust are essential avenues for a lot of the recycling, they don't utilize the power of the SDR as fully as the AfDB scheme: the leverage ratio is less than one, the SDRs are spent, countries trade them for hard currency, and there is no profit (but also no loss) for the donor country.
Countries that have yet to decide how to recycle SDRs should look very hard at the AfDB scheme and include AfDB hybrid capital as part of their SDR recycling portfolio.
CGD blog posts reflect the views of the authors, drawing on prior research and experience in their areas of expertise. CGD is a nonpartisan, independent organization and does not take institutional positions.
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