How do SDRs help maintain balance of payments?

News:  In July-September 2021, India received $31.2 billion foreign exchange reserves. Out of this, $17.86 billion was by way of Special Drawing Rights (SDR) support received from the International Monetary Fund.

SDRs being one of the components of foreign exchange reserves (FER) of a country, an increase in its holdings is reflected in the BOP.

What is SDR? Read here: Special Drawing Rights

What are the key components of BOP?

BOP: It divides transactions of a country with the rest of the world into two accounts: the current account and the capital account.

Current account: it consists of net trade of exports and imports of products and services, net earnings on cross-border investments, and net transfer payments.

Capital account: constitutes a country’s transactions in financial instruments i.e., assets and liabilities constituting of direct investment, portfolio investment, loans, banking capital, and other capital.

International reserves and IMF transactions: IMF transactions are also a key component of the BOP.

What does the SDR support signify?

The present support of $17.86 billion in August 2021 by way of SDR indicates two things,

One, the domestic business environment is failing to attract foreign direct investment.

Two, FPIs move away from host countries such as India due to US Federal Reserve’s plans to increase interest rates.

Is dependence on SDR a matter of concern?

A BOP dependent on an SDR-dependent capital account surplus to cushion the country’s widening current account deficit is a matter of concern.

Because IMF support comes with conditions. For instance, in 1991, the support came with the condition that India has to initiate big-ticket economic reforms. It impacts India’s sovereign rights to design its policy strategy.

What has been India’s BOP position in recent years?

In the January-March quarter of FY20, the country’s current account had recorded a surplus on the back of a higher decline in imports.

However, In the July-September 2021 quarter, India’s current account slipped into a deficit of $9.58 billion as against a surplus of $6.57 billion in the April-June 2021

Source: This post is based on the article “Surplus liquidity in the system: How it came and how it may go” published in Live Mint on 17^th Jan 2022.