Last year, the International Monetary Fund (IMF) celebrated the largest allocation of Special Drawing Rights (SDRs) in its history. This extraordinary act of money creation was worth approximately $650 billion and provided all IMF members with additional access to hard currency.
Contrary to the general practice of the IMF and the World Bank of conditioning aid on political, fiduciary, and economic management parameters to ensure funds are spent as intended, there are virtually no restrictions on how IMF members can use SDRs.
We recently warned that the immediate negative consequences of the latest SDR allocation outweighed its hypothetical benefits, and that the World Bank’s International Development Association was a better vehicle for channeling aid to the world’s poorest countries. This case has only grown stronger in recent months, given the lack of evidence that rich countries and the IMF are delivering on promises of Reallocations of SDRs to poor countries that they used to justify the attribution in the first place.
Today, Russia’s brazen invasion of Ukraine brought to light one of the worst results of SDR allocation.
The Trump Administration opposed to an allocation of SDRs because it should be distributed to all IMF members in proportion to their membership in the IMF, rather than targeted according to need. Thanks to this formula, Russia received SDRs worth about 17 billion dollars, or roughly the same share like all low-income countries combined. The complicit Belarusian government also received around $1 billion.
SDR supporters such as the United States and the European Union (EU) now face the question of how to deal with the SDRs they helped hand over to Russia (and other rogue regimes) just a few months ago.
Admittedly, the new DTS represent only a small part of the more than 600 billion dollars in the reserves. Corn growing pressure on the Russian economy requires vigilance with respect to all potential Russian financial resources, including SDRs.
Using SDRs requires finding an IMF member counterparty with whom to trade. Fortunately, Russia would probably have a hard time finding a quid pro quo due to the severe sanctions against the Central Bank of Russia announced by the United States and the EU. Even though there is no formal ban on Russian and Belarusian trade, the global backlash and outrage in the aftermath of the invasion is likely to have a chilling effect.
But the United States still needs to work to secure a formal agreement at the IMF that all member countries will refuse to exchange Russia’s or Belarus’ SDRs for hard currency or engage in any other financial transactions related to their SDRs.
As the conflict enters a protracted phase, there will be sanctions fatigue on both sides. Russia will seek to evade sanctions and eliminate financial restrictions. As a preventive measure, it is essential to establish a default rule at the IMF according to which Russia and Belarus cannot use their SDRs without ending their aggression. Statements in the background about the Treasury Department’s intention to prevent Russia from using its SDRs are helpful, but the United States should leverage international outrage over Russia’s behavior to formally establish such a ban at the IMF.
Additionally, the IMF should commit to immediate transparency regarding Russian or Belarusian SDR trading, even if an IMF member like China refuses to comply with a transfer ban. The IMF must also ensure that the Ukrainian government continues to have access funding available under its current IMF program.
Likewise, the World Bank needs to decide how to engage with Ukraine. So far he has offered strong rhetorical support for the Ukrainian people. Still, tough questions lie ahead if Russia’s goal of overthrowing the Ukrainian government succeeds, given the billion-dollar loans currently outstanding. The World Bank’s private sector lending arm, the International Finance Corporation (IFC), provides about half of its investments to financial intermediaries, the on-lending of which could potentially provide financing to Russian-owned or affiliated entities. The IFC must not allow this to happen, and it should also divert investment from all Russian companies.
Congress played an important role to ensure accountability, given the generosity with which American taxpayers have supported these multilateral institutions for the past 75 years. Following the bipartisan consensus on the need to respond to Russian aggression with economic pressure, Congress, led by Rep. French Hill (R-Ark.) and Sen. Bill Hagerty (R-Tenn.)rightly demands accountability from the Secretary of the Treasury Janet YellenJanet YellenWhite House to sanction Putin over Ukraine invasion DC lobby firms cut ties with Russian banks VTB, Sberbank Live coverage: Ukrainian president says Russia will ‘attack’ Kyiv tonight MORE how the Biden administration plans to work with the IMF to ensure that Russia cannot benefit from its SDRs.
Congressional progressives should give up their misguided push that the IMF allocates an additional 2.1 trillion dollars in SDRs. More importantly, Congress should review the Special Drawing Rights Act and consider whether to require Congressional approval for all SDR allocations in light of these latest developments. The law was last amended in 1983 and needs to be reviewed, given the dramatic expansion in the use of SDRs since the Financial crisis of 2007-08.
In the longer term, the problems associated with SDRs revealed by Russia’s assault on Ukraine should serve as a warning against future calls for SDR allocation. Outside of acute balance of payments crises, the SDR is a solution in search of a problem.
DJ Nordquist served as U.S. Executive Director of the World Bank from 2019 to 2021, and is a Fellow of the University of Virginia’s Darden School of Business and a nonresident Senior Advisor to the Center for Strategic and International Studies. Follow her on Twitter @DJNordquist.
Dan Katz served as a senior adviser to the Treasury Department from 2019 to 2021, and is a co-founder and portfolio manager at Amberwave Partners, an investment manager focused on jobs, security and growth in the United States. Follow Amberwave on Twitter @Amberwave.