Interbank System

The participants in an interbank market are commercial banks and, in some instances, foreign exchange dealers (if these are licensed for the purpose). Individuals and firms are permitted to bid through the commercial banks or dealers acting as their agents. Of the developing countries that have adopted an interbank system, most already had a sufficient number of commercial banks and foreign exchange dealers operating in the economy to ensure a competitive environment. In other instances, major considerations in the choice of an interbank system were the absence of sufficient manpower and expertise at the official level to conduct auction arrangements and the belief that, with sufficient freedom of entry into the newly created market, the necessary institutions would develop quickly.

Under this system, the exchange rate is determined in negotiations between banks and their clients and in transactions between the banks. The exchange rate is free to vary from hour to hour and day to day. However, to ensure the competitive operation of the market, in all instances except the Philippines and Uruguay there are maximum or minimum limits imposed on commercial bank holdings of foreign exchange. The purpose of such regulations is twofold: first, to prevent major dealers from cornering the market or from using inside information to speculate on their foreign exchange operations; second, to prevent imprudently large exposure of banks to exchange risk. Such limits on stocks may be important particularly in the initial stages of the market when a minimum volume of trading is necessary to establish confidence. The size of the limits may be established initially by reference to the previous behavior of commercial banks’ working balances, and then adjusted in the light of experience with the market. Such limits may also be seen as assisting the responsibility of the central bank for managing accumulation of international reserves from the low initial levels generally prevailing in these countries. A second type of regulation on the market would involve an upper limit on the volume of foreign exchange surrendered to each commercial bank, to prevent any bank from cornering the market in a flow sense. Such a limit, as introduced in Sierra Leone, could be necessary in countries where the foreign exchange receipts of the economy accrue to one or a few major transactors who could then direct all of their foreign exchange earnings to one exchange dealer. If constrained by the stock or flow limits, banks must either buy or sell from other banks or, if other banks were also at their limits, transact with the central bank.

Another important form of official involvement in the interbank market is the periodic fixing session, at which the central bank has representatives present, who may also transact.⁹ At the rate-fixing sessions, held at least once a week, the commercial banks trade in foreign exchange, and an exchange rate is fixed taking into account the outcome of the previous fixing and subsequent transactions between banks and their customers during the week. The fixing exchange rate is usually set at a level which allows the largest volume of purchase orders to be transacted, and in the course of the fixing session commercial banks trade short and long positions according to their needs at this rate; a minimum volume of transactions may be specified by the central bank. Except for customs valuation and other official statistical purposes, the fixing rate normally does not apply to transactions other than in the fixing session; it is immediately superseded by rates in the interbank market. Particularly in economies marked by a relatively small number of transactors, or by other political or institutional tendencies toward collusion, the fixing session is an important means of providing the authorities with a view into the operation of the system, and thus preventing abuses. In countries where there are inadequately defined budgets for foreign exchange expenditures by the government itself, there may also be rules concerning the entry of the government or government enterprises into the interbank market, either in the course of the week or at the time of the fixing. Such rules may be especially relevant where the floating arrangements are introduced ahead of fiscal adjustment measures.

In most instances, there are official requirements for surrender of exchange to the official market. All countries in this group, except Lebanon and Uruguay, have surrender requirements for foreign exchange. In Nigeria, the Philippines, and Sierra Leone, all receipts from exports of goods and services are required to be surrendered to commercial banks (except oil receipts in Nigeria, which are surrendered to the central bank). Receipts of the marketing board in The Gambia and receipts of mining companies and oil companies in Zaïre are required to be surrendered to the central bank. In the Dominican Republic, foreign exchange earnings of traditional exports of goods and services previously subject to an exchange surcharge (sugar, cocoa, coffee, tobacco, most metals and minerals, and services other than tourism) are required to be surrendered to the central bank. The significance of the surrender requirement to government authorities is that, although the government uses the exchange rate determined in the market, it may seek to guarantee the provision of foreign exchange for certain purposes. The surrender requirements are therefore a consequence of official intervention in the allocation of foreign exchange by nonprice methods, for example, import licenses or exchange restrictions.

In some cases, portions of the supply and demand of foreign exchange are allocated outside the market, although at the same exchange rate. Such extra-market transactions occur when the central authorities retain exchange surrendered to them for their own use or when private sector exchange earners are granted retention privileges to use or sell the retained amounts outside the market. This results in less information on transactions being channeled through the market, and a consequent loss of efficiency in the floating arrangements. As will be seen below, this has led on occasion to severe instability of the exchange rate, especially when the information is ultimately made available to market transactors, and expectations are corrected suddenly.

Demand for foreign exchange by the public sector, including public enterprises, is met at the prevailing exchange rates either through the commercial banks or through the central bank. In Nigeria and Uruguay the central bank acts as an agent when it is requested by the government to purchase on its behalf foreign exchange from commercial banks (or at the auction also in the case of Nigeria). In the Dominican Republic, the central bank sells foreign exchange to the government from receipts surrendered to it. In The Gambia and Zaïre, debt service obligations of the public sector are paid from exchange surrendered to the central bank. However, the government may obtain foreign exchange from commercial banks for other purposes. In most countries severe shortages of foreign exchange for building up depleted reserves and meeting external debt service obligations, including the elimination of arrears, make it very difficult for the central bank to become a net seller to the interbank market. On the other hand, excessive purchases by government would tend to overdepreciate the domestic currency, leading to political and social difficulties. Intervention will therefore usually be limited to very short-run smoothing or seasonal operations and to purchases for gradual reconstitution of international reserves.

For the efficient and competitive operation of the interbank market, it is important that exchange rates determined in these transactions be widely and openly published so that the possibility of collusive practices by commercial banks is reduced and that the regulations set specific requirements to this effect. The central bank may in addition set maximum commissions or spreads between buying and selling rates that may be charged by commercial banks. Purchasers of foreign exchange may also be required to provide documentation that the purchase is for transactions in accordance with prevailing exchange and trade controls and income tax regulations.

An important question in setting up a competitive market is the degree of freedom of access to the market. In several countries, exchange transactions are limited to certain groups. In Zaïre, foreign exchange dealing licenses are granted only to commercial banks and hotels. There is no specific information on the network of informal foreign exchange dealers, but it is thought to be small and scattered. In the Dominican Republic, the foreign exchange market is a very broad one owing to the openness of the economy and the prior existence of a secondary market in which some 16 commercial banks and more than 90 foreign exchange houses participated. Nigeria also has a large number of commercial banks (over 40), and other dealerships may be licensed. At the other end of the spectrum is the market in The Gambia, in which only 3 commercial banks participate, and nonbank foreign exchange dealers are not permitted to participate in the fixing session. Generally speaking, the easier are entry requirements into the market, the more competitive and stable it will be.

Auction Markets

The role of the authorities in an auction system (as conducted by Bolivia, Ghana, Guinea, Jamaica, Uganda, and Zambia) is a more central one than in an interbank market. Receipts from specified exports and services are surrendered to the central bank at the prevailing exchange rate and are auctioned by the authorities on a regular basis. The central bank decides the amount of exchange to be auctioned and the minimum reserve price below which it will not accept bids. The minimum amount of the sales may be predetermined as part of a macroeconomic program. The central bank may decide to auction foreign exchange in minimum amounts (say, US$50,000), allowing banks to bid on behalf of their customers. Where licensing requirements are retained, all bidders with a valid import license are required to lodge an advance deposit, either partial or equivalent to 100 percent of the foreign exchange they intend to purchase, before the submission of bids. The bids submitted to the auction are then examined, and all bids in excess of the highest bid which fully exhausts the available supply of foreign exchange (i.e., the market-clearing price) are accepted, providing they exceed any reserve price established by the central bank. The market-clearing marginal rate (the average exchange rate in Bolivia) becomes the market exchange rate. After the auction, the market exchange rate, the total number of bids received, and the number of successful bidders are announced. The auction-determined exchange rate applies until the next auction date to all exchange transactions, including surrenders for the next auction and any transactions that may not be required to be channeled through the auction market (e.g., transactions of the government).¹⁰ Advance deposits lodged by unsuccessful or partly successful bidders are returned in whole or in part, respectively, but bids are normally not permitted to be withdrawn. If a successful bidder fails to make full payment for his foreign exchange within a specified period, he may be subject to a fine that may be collected from the deposit he has lodged. Spreads between buying and selling rates of individual commercial banks and any limits on commercial bank foreign exchange positions are closely monitored by the central bank to ensure that collusive practices are not involved and that they reflect reasonable profit margins.

Perhaps the basic differences between interbank and auction system arrangements are the treatment of the supply of foreign exchange to the market and the frequency or continuity of adjustment of the rate. An essential feature of an auction market arrangement is that it requires the surrender of foreign exchange to a centralized unit, which to date has been the central bank of the country organizing the market. In contrast, in an interbank arrangement the ownership of foreign exchange may remain diffused in the private sector. In some auction arrangements (as with the interbank arrangements described above) the surrender requirement is less than complete, and retention allowances have been kept for certain export or other foreign exchange earners. Similarly, the supply by the central bank of foreign exchange it has collected may be less than complete, as the central bank retains a certain portion of foreign exchange from the market for the use of government.

In Bolivia, Ghana, Jamaica, and Uganda, all export proceeds are required to be surrendered to the central bank. In Guinea, joint ventures in the mining sector pay a special export tax in foreign exchange, and partial surrender requirements apply to other major exports. In these five countries, all sellers of foreign exchange to the central bank are entitled to receive local currency at the auction market exchange rate for all foreign exchange surrendered. In Bolivia, in order to stimulate surrender, those surrendering foreign exchange were for a short time able to obtain an exchange reimbursement certificate in an amount equivalent to 10 percent of the foreign exchange surrendered. In Zambia, the authorities have accepted, on a transitional basis, retention privileges for the mining company and exporters of nontraditional products, reflecting concerns about the availability of foreign exchange. For example, in the latter case, about 50 percent of total export proceeds are estimated to be retained by exporters. However, the Zambian and the Ugandan authorities have introduced policies whereby the source of foreign exchange earnings is no longer subject to declaration, in order to encourage capital inflows into the system.

Once the central bank obtains the foreign exchange, it may put some portion aside for its own uses— reduction of external arrears, accumulation of reserves, and payments of external debt obligations. In Guinea, Jamaica, Ghana, Uganda, and Zambia, payments for official imports, such as petroleum and some other payments, are made by the central bank from the surrendered foreign exchange, and the other available foreign exchange is auctioned. The foreign exchange requirements of public enterprises may also be provided at the official exchange rate, or the enterprises may be required to purchase foreign exchange in the auction market (Bolivia, Ghana, Jamaica, and Uganda). Most of these requirements are, in practice, met outside the auction in Jamaica. The net effect of these arrangements under which government needs are met outside the auction at the market rate is to limit severely the proportion of overall foreign exchange earnings that is channeled through the auction market.¹¹ In Uganda and Zambia, the amount supplied to the market has been largely prespecified in absolute terms, although subject to some variation according to the balance of payments performance. In Jamaica, the amount supplied to the market has been larger and has naturally fluctuated with overall balance of payments developments. The retention and sequestering of exchange for official purposes, although undertaken to ensure availability, has often created problems both for the flow of information to the auction market and for the provision of sufficient exchange for the orderly discharge of current demands, by reducing confidence in the operation of the market and thus sales to it.

The other aspect of the supply side of the market, namely the exchange rate applying to sales to the central bank, in part for the auction, also marks an important difference from the interbank market system. Under the interbank system the exchange rate may be determined directly and may vary continuously during business hours by negotiation between buyers and sellers, but under the auction system, which functions discretely, surrender occurs in practice at the exchange rate determined in the preceding auction. This may create uncertainty for market participants, and a risk of exchange loss in the interim for participants engaged in both purchases and sales in the market. Of course, the more frequently the auctions are conducted, the less inefficiency in the market-clearing process will result from this source. In addition to adding to exchange risk, infrequent auctions could also cause delays in the availability of exchange. Further delays will result if participants’ difficulties in assessing the clearing price cause them to make one or two unsuccessful bids before finally obtaining exchange. Auctions take place daily in Bolivia, twice a week in Jamaica, and weekly in Ghana, Guinea, Nigeria, Uganda, and Zambia.

Eligibility for participating in the auction on the demand side of the market is basically determined by the restrictive system of the particular country (see next section). In addition, there may be technical requirements that must be satisfied in order to establish the ability of a participant to make the local currency payment and to otherwise consummate a successful bid. Bids in the Ghanaian auctions must be accompanied by a deposit equivalent to 100 percent of the bid amount. In Bolivia, any individual or legal institution that wishes to obtain foreign exchange is permitted to submit a bid in the auction, although each bid must have a minimum value of US$5,000 and must be accompanied by a banker’s check in domestic currency equivalent to the bid. In Jamaica, private participants in the market comprise all bona fide importers with valid due or outstanding payments and other nonbank applicants holding foreign exchange approvals of the central bank. Bids for transactions below US$50,000 are aggregated and presented by Jamaican commercial banks (US$500 for Ghanaian banks) on behalf of their clients. In Bolivia, all public sector institutions must also validate their participation by producing a banker’s check. In Guinea, all transactions of the public sector are conducted at present in the primary exchange market (first window) which handles, inter alia, external debt service obligations and official petroleum imports. Transactions of the mining companies are also conducted at this window, while all other trade transactions are conducted at the second market window. Authorized Nigerian foreign exchange dealers are free to participate in that country’s auction for a portion of foreign exchange receipts, without provision of documentation regarding end-use of exchange; for the purpose of capital controls they act as agents of the government in their sales in the interbank market. In the initial stage of operation of the Ugandan market, bids for foreign exchange were limited to imports (excluding oil and essential spare parts and capital goods), to invoices made out by foreign airlines for transportation, and to private sector service and transfer payments. In Zambia, all public enterprises, except the mining enterprise, must bid for their foreign exchange requirements in the auction. Advance deposits, amounting to 30 percent of the kwacha offered at the auction have been required of all participants since November 1986; in effect this has constituted a restriction on access to the auction.

Some of these countries have penalties for the successful bidder who fails to take the bid within a certain period, even though he has deposited with his commercial banks checks against the full local currency value of his foreign exchange application. In Zambia, for example, a penalty not exceeding 10 percent of the amount of the bid will be imposed on the bidder if the Foreign Exchange Committee finds a blatant abuse of the foreign exchange arrangements. A bidder found persistently abusing the arrangements may be placed by the Committee on a black list for up to 12 months, during which time the individual is disqualified from participation in the market. In countries with floating systems that have retained import or capital controls, pre-existing legal penalties for contravention of these regulations may also continue to apply.

Another aspect of auctions is the choice of arrangements for determination of the exchange rate between a “Dutch auction” and a “marginal pricing” approach. Under the Dutch auction system, each bidder whose bid is accepted must pay his bid price for foreign exchange. This system has been applied recently by Bolivia, Ghana, Jamaica, and Zambia. Participants in this type of auction may pay a price for foreign exchange that is significantly higher than the market-clearing price if they assess demand conditions in the market incorrectly but their bid is successful. Guinea, Nigeria, and Uganda operate marginal price auctions. Under the marginal price system, a single rate—the most appreciated bid price at which the available foreign exchange is exhausted, which is the market-clearing price—is applied to all successful bidders. Bidders who have offered rates more depreciated than the market-clearing rate will receive all the foreign exchange they have bid for at the clearing rate. Those who have offered a rate more appreciated than the clearing rate will not receive foreign exchange and those who have offered the marginal rate will receive only part of what they have bid for, on the basis of an allocative rule. In Jamaica and Zambia, the authorities switched to a Dutch auction from a marginal pricing auction mainly because they were concerned that speculators would act on the belief that the local currency would depreciate sharply against foreign currencies and that these speculators should pay the full price of their bid. In practice, however, participants in the Jamaican auction have been able to obtain sufficient information regarding each other’s bids for the spread between buying and selling rates to remain very narrow. Similarly, in Bolivia, following a settling down period of a month or so after introduction of the Dutch auction, the successful bids in the auction also converged within a narrow (less than 2 percent) range. Bids in the recently constituted Ghanaian auctions have been converging, and as of November 1986 were in the 6-7 percent range, but convergence has not been observed to date in Zambia.

A possible difficulty with the Dutch auction system is that it may inhibit entry to the market by participants who fear having to pay a price significantly higher than the clearing price for exchange if their bid is successful, leading to continuous existence of a black market and collusion before auctions. The risk would be increased if significant spreads actually do emerge between successful bids. For example, an importer could be left with overpriced goods on his hands relative to those held by others bidding in the market. However, the experience of the Jamaican and Bolivian Dutch auction systems to date has been that the spreads in the market have been very small, in part in Bolivia because the parallel market provides a guide. A more basic criticism of the Dutch auction system is that it involves price discrimination, and constitutes an additional incentive for collusion, to ensure that the consumer surplus is not appropriated by those administering the auction. The marginal approach to auction pricing is the best approximation to normal private markets, in which the consumer surplus is not appropriated. Under a marginal pricing approach, rates of return are free to vary and thus to direct foreign exchange to the most valued uses.

The Dutch auction approach raises questions as to which exchange rate will be relevant to extra-auction market transactions (e.g., government transactions). In Bolivia, the exchange rate struck and announced for this purpose is the weighted average of successful bids,¹² while in Jamaica it is the lowest price at which exchange was bought and sold in the auction—that is, the marginal price.¹³ Another aspect of the Dutch auction system is that, to the extent that it gives rise to exchange rate spreads of more than 2 percent between the buying and selling rates as a result of official action, a multiple currency practice arises. In countries maintaining the Dutch auction system, the Fund approved the resulting multiple currency practice on a temporary basis.

Another consideration in the setting of exchange rates is the use of a reserve price for foreign exchange, that is, the most appreciated exchange rate at which the central bank will undertake to supply exchange. In general, a reserve price has not been set and should not be necessary, as countries adopting these systems have normally been in a situation of overall excess demand for foreign exchange. Where the market is subject to sporadic supply, including strong seasonality, the experience with floating exchange markets having sufficient freedom of entry is that even relatively rudimentary markets effectively discount such seasonality. For example, in Somalia a secondary free market in which the sole commercial bank does not participate has been marked by relatively small two-way variability of the exchange rate. Where the arrangements have not been in place sufficiently long to ensure adequate confidence in the free operation of the system, a reserve price may be used to ensure against untoward appreciation of the currency with respect to a level that the authorities regard as an equilibrium (Ghana).

Issues that Have Arisen in the Choice and Implementation of Floating Arrangements

The basic objective of auction and interbank market systems is to establish an exchange rate that will move flexibly to equilibrate the supply of and demand for foreign exchange and thus to reduce dependence on exchange and trade restrictions. The choice between the two forms of arrangement must take into account the institutional and economic structure of the country concerned. Where a sufficient number of capable commercial banks exists or there is a pre-existing network of operators dealing in the parallel market, the interbank arrangement is likely to be the more efficient, and will require less resources at an official level to ensure its success. However, one question that may be considered open is whether provision for freedom of entry into a floating interbank market, even when the number of capable banks is initially small, will result quickly in sufficient institutional depth. The existence of experienced brokers in often extensive legal and illegal parallel markets suggests that this will normally be the case. The recent experience with the institutionally limited market in Somalia, noted above, and also the market in The Gambia, in which only three commercial banks participate, has also provided evidence of the general applicability of interbank or other arrangements centered on the private sector. One further consideration in the choice of the form of floating arrangement is the extent to which collusion among participants may be expected. As discussed above, there are ways of ensuring that one or several operators do not corner the market, but in a country that has had a history of commercial domination by a small group, central bank organization of an auction market may be preferable to an interbank arrangement, at least until wider participation in foreign transactions becomes established. On the other hand, where a primary consideration of the authorities in choosing floating is their desire to distance themselves from responsibility for the setting of the exchange rate, the administration of the auction by the central bank may run counter to that objective.

In Guinea, an interbank market was considered inappropriate by the authorities because there are only three commercial banks operating in the country and because the public sector is the main source of foreign exchange earnings. Likewise in Uganda, an interbank market was considered unworkable by the authorities because of the limited number of commercial banks and the danger of collusion. In addition, since coffee was the main source of foreign exchange earnings, and since it was exported by the Government, it was thought that an interbank market would not be efficient. Further, profits that the central bank would earn from foreign exchange auctions were seen as a source of budget revenue that could not be captured by an interbank market, although they gave rise to an allocative inefficiency because such profits also represented taxes on exchange transactions. Commercial banks have been the only legally recognized foreign exchange dealers in Uganda.

On the other hand, the authorities in The Gambia chose an interbank arrangement, although there were only four banks operating in the country at the time. The reasons for this were first, that the central bank did not have enough foreign exchange and manpower to conduct the auction; second, that the banks were trusted by the authorities to take a role in allocating foreign exchange efficiently to institutions, including small private traders; and third, that operation of the system was envisaged to be simple but comprehensive. In practice there were some initial difficulties in ensuring the competitive operation of this market, but these have since been overcome.

Owing to the wide dispersion of commercial banks throughout the Philippines, it has not been considered necessary to legalize foreign exchange dealerships other than commercial banks, but there are many unauthorized dealers specializing in workers’ remittances and other small flows. Similarly, the establishment of a market in Zaïre was facilitated by the existence of a well-established commercial banking system with 10 banks. Foreign exchange dealer licenses are granted only to commercial banks and hotels. There is no specific information on the network of foreign exchange dealers either before or after the float, but it is thought to be small and scattered. In the Dominican Republic, the existence before the float of a free secondary market in which 16 commercial banks and more than 90 foreign exchange houses and hotels participated meant that the foreign exchange market was already a relatively broad one.

In the implementation of some floating arrangements, the effects of pre-existing external payments arrears have created difficulties. In Jamaica, the overhang of arrears in the early operation of the market was so large that it adversely affected confidence in the auction market by causing an almost complete cessation of new imports. For this reason, the backlog of arrears was removed from the market and subjected to a phased repayment. In principle, this could have been accomplished through purchases from the auction, but actually a certain portion of the proceeds of surrender before the auction was set aside. Provision was made for all applications relating to previous due dates to be registered with the central bank for rescheduling. The applications were required to be accompanied by an affidavit from the foreign creditor to the effect that the amounts remained due and payable. Once verified, the foreign exchange for the arrears would not be permitted through the market; instead, a fixed sum would be set aside on a regular basis by the central bank for the rescheduled payments. An exchange rate guarantee was not provided, and supplementary local currency deposits were required at the rate on the day of actual payment. Modalities for the rescheduling might include cash payment of foreign exchange over a period of years, or investment of the local currency counterpart domestically; in the latter case, liquidation or repatriation of the investment might be permitted only at the end of a fixed period. Provision would be made for blocked counterpart deposits against all the arrears. An important aspect of the handling of the arrears “overhang” problem has been early contacts with creditors to ensure the best possible environment for the start-up of the market.

Questions of the adequacy of international reserves and techniques of foreign exchange “cash flow management” have also been raised in countries considering floating arrangements and other flexible arrangements for the exchange rate. To assist in providing as stable an environment as possible for the introduction of a floating rate system, and with the aim of minimizing the initial depreciation of the exchange rate after floating, arrangements have been made in several instances for “bridging” finance from official or commercial bank sources ahead of drawings under a Fund stand-by arrangement and rescheduling of existing external obligations. The discussions with the World Bank and other donors and creditors have been important at this stage in underpinning confidence in the new market by providing reasonable assurance that balance of payments financing would be forthcoming. The positive effect on the capital account of the floating arrangement itself in promoting a slowing or a return of capital flight, as examined in Section IV below, may also be expected to assist in stabilizing the exchange market.

For example, in the period preceding the establishment of an auction market in Bolivia, the authorities were concerned that, because of the thriving unofficial market, the supply of foreign exchange to the auction would be limited. They saw this problem as being exacerbated by the lack of an effective institutional apparatus to ensure that export proceeds flowed through the official channels. The authorities therefore considered using official reserves and borrowing from official sources abroad to supply the foreign exchange market in the initial stages. In the event, this proved unnecessary. The demand for foreign currency in the official market initially fell below supply, reflecting in part the high reserve price as well as the relatively low demand because of a lack of experience with the market mechanism. As a result, the authorities built up official foreign exchange reserves in the start-up period.

Beyond the start-up period for the floating market, the management of foreign exchange to accommodate seasonal or other identifiable reversible factors also plays an important role, given the generally low level of international reserves in this group of countries. A problem that might have been foreseen in the market established in The Gambia was the potential instability of both the volume of transactions and the exchange rate. Tourist receipts fluctuate widely from season to season, and exports of groundnuts also have strong seasonality. It is important for the market to absorb this instability, and accumulation of adequate reserves either by the central bank or in the banking system for use during the lean season is an aim of the arrangement. Tourism receipts are also highly variable in Uruguay. In both instances, the arrangements have been successfully implemented, and seasonal variability in the exchange rate has not been a significant factor.

In Guinea, all banks transacting business on behalf of customers credit the central bank with the entire counterpart of any transaction within three working days. Residents must also obtain permission to open convertible foreign currency accounts in order to auction funds through authorized banks; with liberal authorization of these accounts as at present, the auction market could become an important additional source of foreign exchange, but without it, supply could be curtailed.

Certain difficulties have marked the operation of the auction system in Jamaica from time to time. First, owing to political sensitivities there have been tendencies for large importers at times to restrain their demand for foreign exchange. Second, importers were for a time in 1984 not permitted to bid in the auction market for foreign exchange with which to repay letters of credit, and banks would not open letters of credit unless the importer had on deposit the foreign exchange. However, as most letters of credit were required by creditors to be on a prepaid basis (owing to Jamaica’s arrears), this documentation requirement effectively meant that market access was denied to importers. This vicious circle was addressed for a time by having importers present exchange control documentation following the auction, and by the institution of penalties should proper documentation not be presented. As the market settled down, banks have resumed opening letters of credit on a more normal basis. Third, importers who had no evidence of income tax clearance were for a period of months banned from the auction. Delays in obtaining this clearance were long enough to influence strongly the total demand of the auction, and the exchange rate was virtually fixed while this requirement was in effect. Fourth, sizable official foreign exchange operations outside of the auction have contributed from time to time to the instability of the exchange rate. This instability has occurred when supply to the market has been increased for a short time because of the incurrence of arrears, an unsustainable level of short-term credits by the public sector, or sales of government assets abroad. Subsequently, demand for foreign exchange increased, and the rate depreciated sharply. Since October 1985, although the market arrangements themselves have remained flexible in form, intervention by the central bank in the auction has in practice resulted in a virtually fixed exchange rate of the Jamaica dollar against the U.S. dollar.

The initial difficulty with the operation of the Philippine system was an unexpected rigidity of the exchange rate in terms of the U.S. dollar for some periods of time, which resulted in an initial appreciation of the real effective exchange rate that hindered export growth. In general, this outcome was explained by tight monetary policies reflecting the authorities’ intention to constrain inflation, accompanied by large short-term capital inflows; it was therefore not a necessary consequence of the exchange rate arrangements themselves. During other periods, most recently during the first quarter of 1986, flexibility in the exchange rate played an important role in limiting the re-emergence of a black market, in drawing back flight capital, and in protecting the balance of payments during periods of considerable financial uncertainty.

In Uganda, there were several problems during the implementation of the auction arrangements; the auction system was discontinued in November 1985. First, participation in the auction was subjected to various forms of government intervention such as import license requirements and tax payments certificates. Issuance of import licenses was for a time speeded up, but the issuance continued to be on an ad hoc and discretionary basis. Second, participation in the auction was on occasion confined to a limited group of influential importers. Third, it was not possible for participants to verify whether the announced rate was in fact the market-clearing exchange rate based on the actual bids submitted. Fourth, although import licenses and other supporting documents were required of participants in the auction, the use of foreign exchange was not closely monitored (e.g., the arrival of imports was not closely checked), so that the foreign exchange said to have been purchased for import payments may well have been used for illegal capital transactions. Fifth, initially the auction system required partial counterpart deposits against submitted bids; later, the commercial banks decided how much cash and credit were required to back a bid, depending on the credit-worthiness of the client.

The major problem in the institution of the market in Zaïre was an initial reluctance on the part of commercial banks to release foreign exchange to the market. To free up supply, the net foreign exchange position of each commercial bank was further limited to a certain proportion of its own resources, and the central bank also supplied foreign exchange to the market.

In the period preceding the establishment of Zambia’s auction market, the authorities were concerned with the possible effects of a completely free exchange market on the exchange rate and other macroeconomic variables, given the limited supply of convertible foreign currencies. Initially, therefore, the exchange rate was determined on the basis of an auction that involved only a selected group of foreign exchange users. Those excluded from the auction included the commercial banks, the government and government-owned enterprises, and the mining company. Importers not excluded had to show documentary evidence to the commercial banks of their import licenses and pro forma invoices for imports. Also in the initial stages of the auction, a number of bidders were unsuccessful in obtaining foreign exchange if their bid price was judged by the authorities to be too high, or if they had recently obtained foreign exchange through the auction market. The authorities have recently expanded the coverage of the auction to include the importers who were formerly excluded from obtaining foreign exchange in the auction market, and import licenses are now issued for a fee without restriction.