Africa’s Chronic Liquidity Challenges and the Role of Special Drawing Right Allocations

Published: May 28, 2024

Overlapping global shocks faced by African countries have caused severe liquidity challenges in recent years. Many countries are currently experiencing low real gross domestic product (GDP) growth, higher inflation, exchange rate instability, balance of payments crisis and a high risk of debt distress. The most critical is the increasing disruption that climate change risks pose to the macroeconomy, including worsening conditions of conflict and instability. Africa is at a significant historic moment to resolve its development finance challenges to ensure a transition to a low-carbon economy while achieving the targets set in the United Nations 2030 Sustainable Development Goals (SDGs).

In 2021, the International Monetary Fund (IMF) approved $650 billion worth of Special Drawing Rights (SDRs), the Fund’s reserve asset. Following this allocation, debates emerged on the possibility of using SDR allocations for development, though the mechanism for re-channeling SDRs for this purpose remains elusive.

In a new working paper published by the African Economic Research Consortium, Kevin P. Gallagher and Abebe Shimeles explored the value proposition for enhanced Special Drawing Right (SDR) allocations for African countries, the institutional barriers and conditionalities presenting constraints to African countries, and options for SDR facilities to leverage productive investment and increase domestic resource mobilization. Based on their analysis, the authors present six policy recommendations.

Policy recommendations:
  • Make new allocations of SDRs: The analysis shows that new SDR allocations bring new and liquid reserve assets without increasing the debt burden of a country and grant a country the highest degree of policy autonomy.
  • Provide built-in incentives for re-channelling SDRs: During this wave of crises, developing countries have had to rely on pledges of re-channelled SDRs. SDR allocations should have built-in re-channelling mechanisms so stakeholders can deliberate about where and how, not whether, SDRs can be re-channelled based on global circumstances.
  • Reform the SDR interest rate policy: The current interest rate structure provides disincentives to deploy SDRs. The SDR rate should be brought to zero while increasing the floor rate and levies where appropriate, moving towards a single SDR holding rate.
  • Channel SDRs to multilateral development banks (MDBs) through hybrid capital arrangements: The African Development Bank (AfDB) proposal is a strong model for maintaining the reserve asset qualities of SDRs while expanding the balance sheets of MDBs so they can provide more development finance to countries in need. SDR-backed bond issuances should also be considered.
  • Reform IMF instruments and policy: IMF programs that can utilize SDRs such as the Poverty Reduction and Growth Trust (PRGT) and the Resilience and Sustainability Trust (RST) need strong subsidy accounts to bring down the cost of these instruments and broaden the eligibility requirements. Most importantly, requiring investment-led recoveries, rather than conditioning access on fiscal consolidation programs, would make these programs more attractive, achieve better growth and stability outcomes, and improve creditworthiness.
  • Flexibility in SDR use: African countries could be granted more flexibility in how they use their allocated SDRs. For example, they could be allowed to use SDRs to finance development projects, invest in infrastructure or address social needs, in addition to supporting macroeconomic stability. This may extend to leveraging SDRs for inclusive finance where private entities such as small- and mid-sized enterprises are poised to benefit from SDR-backed hybrid capital arrangements.

In addition to these policies, the authors call for a comprehensive reform of the international financial architecture that considers how the climate crisis will impact the continent. They emphasize that access to concessional funding at scale needs to come forth to accelerate Africa’s progress towards the SDGs.