Chapter 2 Use of the Fund’s Resources
- International Monetary Fund
- Published Date:
- September 1962
The policies which guide the Fund on the use of its resources continue to be those outlined in previous Annual Reports. Members are given the overwhelming benefit of the doubt in relation to requests for transactions within the “gold tranche,” that is, for drawings which do not increase the Fund’s holdings of the currency beyond an amount equal to the member’s quota. The Fund’s attitude to requests for transactions within the “first credit tranche”—that is, transactions which bring the Fund’s holdings of a member’s currency above 100 per cent but not above 125 per cent of its quota—is a liberal one, provided that the member itself is making reasonable efforts to solve its problems. Requests for transactions beyond these limits require substantial justification. They are likely to be favorably received when the drawings or stand-by arrangements are intended to support a sound program aimed at establishing or maintaining the enduring stability of the member’s currency at a realistic rate of exchange. Any drawing exceeding 25 per cent of a member’s quota within any twelve months (except to the extent that the Fund holds less of the member’s currency than 75 per cent of its quota), or any drawing which would increase the Fund’s holdings of that currency to more than 200 per cent of the quota, requires the grant of a waiver in favor of the member, under Article V, Section 4. The first waiver of the former kind was granted in August 1953, and such waivers have since been granted frequently. No country has been granted a waiver for drawings that would increase the Fund’s holdings of its currency beyond the limit of 200 per cent of its quota. The largest amount of a member’s currency, in terms of a percentage of quota, which the Fund has ever held is 175 per cent for a number of countries, but the Fund has granted stand-by arrangements under which the Fund’s holdings of a currency could be increased to 200 per cent of quota.
A member’s drawing increases the Fund’s holdings of its currency. A member is expected to reduce the Fund’s holdings of its currency after a drawing when the problem for which it has used the Fund’s resources is solved, and in any event not later than three to five years after the drawing. Drawings made under stand-by arrangements are repayable in three years or less. The scale of charges for drawings recognizes the desirability of prompt repurchase by increasing the charges with the passage of time; under the present scale, in conjunction with Article V, Section 8(d) and the Fund’s established policies, the member considers and agrees with the Fund, not later than three years after a drawing, how to reduce the Fund’s holdings of the member’s currency. More is said below about the kinds of policy which members are encouraged to pursue in order to restore equilibrium in their balance of payments, rebuild their reserves, and repurchase their currencies from the Fund within the appropriate period.
Use of Resources to Finance Capital Transactions
When the Annual Report for 1961 was written, the Fund was engaged in a re-examination of the legal and policy aspects of the provisions in the Articles of Agreement respecting the use of the Fund’s resources to finance movements of capital. As far as the legal position is concerned, the Executive Board decided by way of clarification that a previous Decision1 did not preclude the use of the Fund’s resources for capital transfers in accordance with the provisions of the Articles, including Article VI.1
The basic improvement in the strength of the principal European currencies which led to the attainment of external convertibility in December 1958, followed by the acceptance in February 1961, by the countries concerned, of the obligations of Article VIII, has greatly facilitated the international movement of short-term capital in search of maximum interest yields, or for other reasons. Article VI precludes use of the Fund’s resources “to meet a large or sustained outflow of capital”; but it is, of course, clear that a temporary outflow of short-term capital can create difficulties indistinguishable from those arising from an adverse development of any other items in the balance of payments. Moreover, the precise cause of any particular drain on a country’s exchange reserves may be unknown in the short run; and the use of resources obtained from the Fund cannot be reserved to cover any individual source of weakness in the reserves to the exclusion of others. It is the Fund’s view that it should not be precluded from assisting a member because the latter’s difficulties are caused or accentuated by an outflow of short-term capital, which cannot be deemed large or sustained. If a country facing an outflow of capital were to turn to the Fund for assistance, the test to be applied by the Fund would be in accordance with its accepted principles, i.e., that appropriate measures were being taken so that equilibrium in the balance of payments would be restored, and that assistance provided by the Fund would be repaid within a maximum period of three to five years.
Increases in the Fund’s Resources by Borrowing
Early in 1961 the Executive Board began to give consideration to the question of increasing the Fund’s resources by means of borrowing under Article VII of the Fund Agreement. Convertibility of the main currencies had stimulated international trade and movements of capital; at the same time it made possible substantial shifts of funds from one country to another. To avoid any undesirable impact on the functioning of the international monetary system as a result of such developments, it had become imperative to strengthen the resources which might be made available, and so to enable countries which experience difficulties to pursue appropriate policies. Fortunately, most of the industrial countries already possess substantial reserves of their own. For its part, the International Monetary Fund has nearly $3 billion in its gold account and $6.5 billion in the currencies of the main industrial countries. At any given time, how-ever, some of these countries may be facing balance of payments difficulties, making it advisable that, temporarily, their currencies should not be drawn from the Fund. The considerations for the selection of currencies to be used in drawings on the Fund are discussed below (page 36). It will be seen that drawings should be made largely in the currencies of those countries that have strong balance of payments and reserve positions. The borrowing arrangements envisaged were designed to provide the Fund with additional resources of these latter currencies at times when they were needed to forestall or cope with an impairment of the international monetary system. In this way, both the liquidity of the Fund and the resilience of the monetary system would be enhanced, to the benefit of all members.
After extensive discussion, at the Annual Meeting in Vienna and subsequently, of the proper role and method of Fund borrowing in present circumstances, the Executive Board took, on January 5, 1962, a “Decision on General Arrangements to Borrow,” which is reproduced in Appendix XI. This decision sets out the terms and conditions under which the Fund would be able to borrow supplementary resources in order to fulfill more effectively its role in the international monetary system under conditions of convertibility, including greater freedom for short-term capital movements. Ten main industrial countries, after such authorizations have been obtained as may be necessary to enable them formally to adhere to the arrangements, will stand ready to lend their currencies to the Fund up to specified amounts when the Fund and these countries consider that supplementary resources are needed to forestall or to cope with an impairment of the international monetary system. The total of such supplementary resources amounted to the equivalent of $6.0 billion, composed as follows:
|(equivalent in million U.S. dollars)|
|Germany, Deutsche Bundesbank||1,000|
In an exchange of letters among themselves, the ten countries have set down the procedures that they will follow in making supplementary resources available to the Fund for the financing of a particular Fund transaction for which such resources are considered necessary. These procedures will enable the Fund to make practical use of the facilities envisaged in Article VII, by providing for the speedy mobilization of the additional resources.
The Fund decision provides that requests by participant countries for drawings for which supplementary resources are required will be dealt with according to the Fund’s established policies and practices with respect to the use of its resources. Repayment to the Fund of such assistance will have to be made when the country’s problem is solved, and in any event within three to five years. In its turn, when the Fund receives repayment, it will repay the countries that made supplementary resources available; in any event, the Fund will repay not later than five years after a borrowing. Rights to repayment are backed by all the assets of the Fund. Moreover, a country that has lent to the Fund can receive early repayment, should it request and need this because its own payments position has deteriorated. In this way, the claims of countries that have lent supplementary resources to the Fund have been guaranteed a highly liquid character.
Interest on the resources lent to the Fund will be based on a formula which at present yields a rate of 1½ per cent per annum; in addition, the Fund will pay a charge of ½ of 1 per cent on each borrowing transaction.
The borrowing arrangements will become effective when at least seven countries with commitments totaling the equivalent of $5.5 billion formally notify the Fund of their adherence to the arrangements. The arrangements will remain in effect for four years, with provisions for extension. The amounts included in the arrangement may be reviewed from time to time in the light of developing circumstances, and altered with the agreement of the Fund and all the participating countries.
Currencies to Be Drawn and to Be Used in Repurchases
The Executive Directors approved on July 20, 1962, the following statement and decided that it should be included in the Annual Report (see Appendix XI, page 245).
From the beginning of the Fund’s operations through 1957, drawings were overwhelmingly made in U.S. dollars. Starting in 1958, however, the Fund has increasingly encouraged drawings in other currencies, and this has been facilitated by the introduction of de facto convertibility for the currencies of the main industrial countries. Since the same currencies have become formally convertible under Article VIII in February 1961, repurchases have also begun to be made in these currencies.
Certain practices have been developed which take into account the new situation of the increasing number of currencies usable for the transactions of the Fund. These practices are still in a state of evolution as increased experience is being gained. The following paragraphs set out what may be regarded as appropriate practices to be followed for the time being.
When a substantial number of currencies other than the U.S. dollar became usable for drawings, the drawing countries began to discuss with the Managing Director what currencies might be drawn. It gradually became the practice that consultation should take place between the drawing country and the Managing Director about the currencies to be drawn, and this practice has now become established in connection with all stand-by arrangements and drawings. Before giving advice to the drawing country, the Managing Director has got into contact with countries whose currencies might be drawn, even in circumstances where speed in arranging the drawing was essential. These consultations and the contacts with the countries concerned have thus become an integral part of the procedure which has been evolved.
In addition, an attempt is being made to indicate from time to time the amounts likely to be drawn and what might be a proper distribution of drawings among different currencies. Since under stand-by arrangements even fairly large drawings may be made suddenly, such indications as will be given can only be tentative and informal but they can, even so, serve a useful purpose in contributing to the maintenance of close contact between the Managing Director and the countries whose currencies may be drawn.
It has been concluded that the Fund has the legal authority to specify the convertible currencies to be used in making repurchases in discharge of obligations to repurchase that do not arise under Article V, Section 7(b), and that, accordingly members are required to obtain the prior agreement of the Fund on the convertible currencies to be used in making such repurchases. Such repurchases must not increase the Fund’s holdings of a member’s currency beyond 75 per cent of that member’s quota or decrease the Fund’s holdings of the repurchasing member’s currency below 75 per cent of that member’s quota.
Until further notice, and in order to maintain conditions which foster repurchases and the revolving character of the Fund’s resources, the Fund will accept any convertible currency fulfilling the conditions set forth in the last sentence above, provided that the repurchasing member has consulted the Managing Director on the currencies, and the amounts of each, to be used by the member in making its repurchase. Before giving his advice, the Managing Director will consult with countries whose currencies could be used in repurchase, and he will also attempt to give advance indications comparable to those relating to the currencies to be drawn. In all of these consultations, the Managing Director’s recommendations will be guided by the principles regarding the currency composition of repurchases set out in Section II below.
The preceding paragraph shall apply to those repurchase obligations outside Article V, Section 7(b) that are entered into after July 20, 1962. Members that entered into such obligations before that date shall be invited to consult the Managing Director on the currencies to be used in discharging these obligations, and the Managing Director will follow the procedure and be guided by the considerations referred to in the preceding paragraph.
The Managing Director will notify the Executive Directors at least two business days before any repurchase under the preceding paragraphs is carried out.
Where consultations with a country are referred to in this document they will normally be conducted with the Executive Director appointed or elected by such country.
II. Criteria for the Selection of Currencies for Drawings and Repurchases
The experience of the Fund in recent years has made it possible to indicate the main considerations which govern the selection of currencies for drawings and repurchases.
With regard to the question of the selection of currencies for a particular drawing or for drawings in general, account has been taken of the balance of payments and reserve positions of the countries whose currencies are considered for drawing, as well as of the Fund’s holdings of these currencies.
It has been found in practice that weight has to be given to all these three considerations, with some differentiation according to specific circumstances, and perhaps most particularly according to the size of the transaction or transactions involved.
During periods when aggregate drawings were moderate in amount, little difficulty was experienced in distributing these drawings among countries with reasonably satisfactory balance of payments positions on the basis of the level of these countries’ reserves. When the volume of drawings has been large, it has been necessary to give more importance to the relative balance of payments positions of the countries to be drawn upon, so as to prevent excessive declines in their primary reserves as a result of Fund sales of their currencies. In connection with large drawings, in particular when they are associated with short-term capital movements, it is usually fairly easy to single out the countries whose reserves have benefited from an inflow of capital and to direct drawings more particularly toward the currencies of these countries.
By the attention thus given to the balance of payments position, the Fund has been able to arrange drawings in large measure to offset movements of funds in the exchange markets, and thus contribute to the strengthening of the international payments position. In considering a country’s balance of payments position, seasonal fluctuations have not been allowed great weight, and the Fund has avoided drawing prematurely the currency of a country which is in the process of building up reserves from a relatively low position.
In applying the third consideration, account has to be taken of prevailing circumstances. For example, when the Fund’s holdings of a particular currency have become very low, this has precluded substantial sales of that currency irrespective of the balance of payments and reserve position of the country concerned. In practice, the Fund has taken account of the level of its holdings of any currency well before the point of actual exhaustion, by gradually—rather than abruptly—reducing its sales of that currency on account of this factor.
Small drawings have normally been executed in one currency only, preferably the currency in which the drawing country holds the bulk of its reserves, even in circumstances where the payments position of the reserve center drawn upon has not been strong. Somewhat larger drawings have usually been distributed over more than one currency, but only exceptionally more than three to five currencies have been involved in a single drawing unless it has been a very large one. As far as possible, factors relevant to the particular drawing country, such as closeness of trade and payments relations, have been taken into account in the selection of the currencies to be drawn.
With regard to repurchases, the range of currencies is, as mentioned in Section I above, limited to currencies that are formally convertible and of which the Fund’s holdings are below 75 per cent of the quota. As a result, repurchases in currencies have, until early 1961, been made almost exclusively in U.S. dollars. The U.S. dollar was also, in recent years, a currency that was available in the exchange market at favorable rates which reflected the prevailing balance of payments position.
Increasingly, however, weight has been given, in suggesting the allocation of repurchases among the countries whose currencies can be received in repurchase, to the Fund’s holdings of these currencies compared to quotas. It would seem from the point of view of equity, and also with due regard to the liquidity position of the Fund, that great weight should be given to this criterion. But consideration should also be given, when appropriate, to the prevailing balance of payments position. In the case of relatively small repurchases it has been found practical that they be made in the currency in which a country holds its reserves, provided of course that such currency can be received by the Fund.
It has been the experience in the Fund that a country drawing one or more currencies, after consultation with the Managing Director, has often wanted to convert either the whole or part of the amount drawn in a particular currency into one or more other currencies depending upon the payments that country has to meet or the currencies it normally holds in its reserves. The conversions thus effected have made it possible for the drawing country to meet its payments obligations and to strengthen its reserves in the most effective manner.
In the case of drawings in dollars, sterling and moderate amounts of certain other currencies, there has been no difficulty in effecting conversion at the going rate by transactions in the exchange market. Since the currencies drawn have generally been strong currencies for which there is a demand in the market, such conversion has generally been carried out without any disturbance to the market. For several currencies, arrangements have often been made between central banks, i.e., between the central banks in the drawing country and in the country whose currency is drawn, which provide for direct conversion into the latter’s main reserve currency at the prevailing market rate without any commission being charged. In certain cases, however, especially when the amounts involved have been large, consideration has been given to the fact that conversion on the market would have affected exchange rates, and in some cases an allowance for this has been made. A preference has been indicated by two central banks for conversion at par, especially for large drawings.
In accordance with normal central banking procedure, whenever a country desires conversion of a currency it is drawing, it would get in touch with the central bank of the country drawn upon in order to reach an understanding on the most convenient way to arrange such conversion. When conversion has presented a country with difficulties, the assistance of the Managing Director has been sought in order to arrive at an appropriate solution.
The practices outlined above for drawings can, mutatis mutandis, be applied when a country needs to obtain a currency in order to make a repurchase from the Fund with that currency.
The Fund will keep the practices with respect to conversion as described above under study, and will re-examine them in the light of further experience.
The Fund’s Policies Regarding Financial Stability
From its inception, the Fund has cooperated with countries in the establishment and support of realistic exchange rates and in the maintenance of stability and confidence in monetary systems. In some respects, this is the part of the Fund’s work least understood by those not intimately associated with the Fund’s financial and technical assistance to members. It derives primarily from the implementation of the purposes outlined in the Fund’s Articles of Agreement, not the least of which is to contribute to the “promotion and maintenance of high levels of employment and real income and to the development of the productive resources of all members as primary objectives of economic policy.”1
The maintenance of high levels of employment, and the pursuit of the most rapid rates of economic growth consistent with orderly development and available resources, are now widely accepted as appropriate aims for national policies. One of the aims of the Bretton Woods Conference was to establish an institution which would provide international credit, so that short-term financial difficulties would not frustrate the achievement of these objectives. The Fund’s policies with regard to the use of its resources have been directed toward this end. The Fund’s advocacy of monetary stability is an expression of its views regarding the best way to achieve high levels of real income and employment, and, in particular, to encourage the development of productive resources. In some respects the problem of maintaining monetary stability is most acute in the less developed countries, where the resources available for investment are almost always smaller than would provide a rate of growth satisfying the aspirations of its citizens for better standards of living; and even with the assistance of development funds from abroad, economic progress tends to lag behind expectations. In these circumstances it is of the greatest importance that countries follow financial policies that will be conducive to economic growth.
The Fund recognizes that the process of economic growth itself is likely to create pressures on resources that may lead to price increases and that not all price increases are incompatible with sound development. However, experience shows that, if prices rise fast enough to initiate a wage-price spiral or to undermine confidence in the real value of assets denominated in money (e.g., savings deposits), economic growth will be discouraged. It is an inflation of this kind with which the following pages are concerned. In individual countries that have acted resolutely to stop such inflations, comparison of the conditions before and after that action show that monetary stability is a prerequisite for rapid economic expansion. A few examples of the results of stabilization are cited in the next section of this Report.
Insofar as inflation stimulates economic expansion, this expansion is often in areas that are not most conducive to a high and sustained rate of growth in the country concerned. It tends, rather, to take the form of ventures aimed, in particular, at the purchasing power of the minority of the population whose incomes rise faster than prices. There is commonly, also, an expansion of those activities (usually the production of nonessential goods) which obtain the greatest degree of protection from the import restrictions that the country may adopt to protect the balance of payments from the effects of inflation. Often these are not the most appropriate uses for the country’s resources. At the same time, exports suffer in competition with countries with stable currencies, and the production of price-controlled necessities is discouraged. Indeed, the disincentive to produce for export is one of the most damaging consequences of inflation.
These developments counter, and frequently outweigh, any advantages which may possibly be gained from “forced savings” by the private sector induced by inflation. In fact, experience suggests that these “forced savings” induced by government deficits are often used, not for investment, but to cover the current operating losses of government enterprises, or as subsidies to stabilize the cost of living in an attempt to offset some of the social injustice inherent in inflation. For these reasons there is, as the Fund observed in its Annual Report for 1959, “a growing awareness of the importance of monetary stability. Governments have intensified their efforts to impress the urgency of temporary austerity upon the public, who have now had a long experience of the disruptive effects of inflation, and these efforts have begun to yield positive results.…”1
A continuing inflation is likely to drain resources away from economic development even more directly. One of the most serious effects of inflation is to divert the community’s savings from home development into foreign investment. Once inflation gets under way and becomes an expected part of the community’s life, the view becomes prevalent that depreciation of the exchange rate is inevitable. One of the easiest ways to obtain protection against a depreciating rate is to acquire foreign assets. Certain aspects of this incentive to capital flight are discussed, in more detail, in the next chapter. Even if a country has exchange control, it may not be able to prevent the flight of capital (as is indicated by the experience of Spain discussed below), and the existence of controls may discourage the inflow of capital. Unless and until a capital flight is reversed, the inflating country loses resources which it can ill spare. A particularly unfortunate feature of the international financial scene in the last decade has been the large flow of private capital from those less developed countries which have tolerated inflation to countries, frequently wealthy, which have maintained monetary stability. This flight of domestic capital has significantly offset, and in some cases exceeded, the inflow of capital to the developing countries.
On the other hand, a country which shows itself determined to maintain stability is better able to attract capital from abroad than one with similar potential which does not maintain monetary stability. More important is the fact that, where reasonable stability of prices and wages can be expected, enterprise will be attracted to long-term ventures of the kind which are essential for sound economic development. Difficult as it may be to change the psychology of the community from the expectation of continuously rising prices to a belief that prices will remain stable, this adjustment is the first requisite for sustained economic growth.
However, it must be admitted that the early stages of stabilization are likely to be difficult; frequently, consumption and investment decline in the short run. But if a stabilization program had not been undertaken, the declines in investment and consumption would almost certainly have been greater. Inflation arises if countries attempt to absorb more real resources than they can produce or are able to borrow abroad. This results in a decline in their international reserves and an exhaustion of their available lines of foreign credit. If inflation is allowed to continue, some much less beneficial expedient, probably a rapidly depreciating exchange rate or further discriminatory and distorting exchange controls, will have to be accepted. Such attempts to offset the effects of inflation will accelerate capital outflow, make foreign credit less available, and force on the country a reduction in consumption and investment as inflation leads to still further distortion of the economy.
If the expectation of continuously rising prices gives way to a belief that they will remain stable, the patterns of investment outlay will be markedly changed from expenditure giving relatively little real benefit to expenditure with substantial real benefit. This realignment of the economy may have, as one of its first consequences, a temporary decline in investment. Investment is a time-consuming process. There is an inevitable lag between the decision to create physical capital and the actual consumption of resources in capital production. On the other hand, once the process of investment is started, it may frequently be cut off rather quickly. One effect of stabilization may well be a quick end to the development of those industries which would be unprofitable in a noninflationary world, and a decline in their demand for investment resources. Even if a stable environment makes alternative industries appear to be profitable fields for investment, it takes time for entrepreneurs to convert their investment intentions into orders for resources. Hence, the period immediately after stabilization may well be marked by a temporary diminution in the demand for investment resources, with a consequent decline in their production. As has been frequently observed, inflation induces an excessive accumulation of inventories. Consequently, at the time of stabilization, stocks of inventories may be expected to be unduly high. As a result, the stabilization period may also be marked by the working off of inventories, and this can result in a temporary reduction in output.
It should be emphasized that the decline in economic activity which may coincide with the halting of an active inflation is temporary. With a new set of expectations, investors are able to make plans for future capital creation, with a consequent rise in their demands for resources. The disinvestment in inventories is necessarily short-lived: after excess stocks of commodities are used, any consumption of the remaining stocks must be met by replacement.
The Fund has frequently discussed with member countries the kinds of policy which are appropriate, in order to “make possible more rapid and significant progress toward the achievement of the Fund’s objectives, which include the achievement of monetary stability, the adoption of realistic rates of exchange, the relaxation and removal of restrictions and discrimination, and the simplification of multiple currency practices.”1 Such a program may cover fiscal, credit, and exchange policies, all of which have a direct impact on the rate of growth that can be sustained. Fiscal reform aims at reducing or holding expenditure while taxation is increased, with any remaining budgetary gap financed either from noninflationary domestic borrowing or from the domestic currency proceeds of foreign grants or credit. Monetary reform is directed primarily at limiting bank credit to an order of magnitude that can be safely absorbed without inflation or chronic disequilibrium in the balance of payments. Reserve requirements may be increased, central bank credit to commercial banks curtailed, or credit ceilings imposed on commercial banks. New exchange systems may be established which are intended to permit wider scope for market forces in determining a realistic exchange rate and in allocating foreign exchange among different uses. The adoption of such policies is likely to bring direct beneficial results within the economy; also it has made it possible for many members to obtain foreign resources in addition to their drawings on the Fund. The acceptance by the Fund of a declaration of intent, and the granting of a stand-by arrangement, inspires confidence, in private investors in other countries and in governments, that the country concerned will halt inflation and experience more rapid economic development, and thus become a more promising area for investment.
The Fund’s experience, however, suggests that, essential as monetary stability is, it alone will not ensure well-balanced economic growth. Appropriate fiscal and other economic policies are also essential; without such policies, either the community will be discouraged from saving, or savings will be channeled into investments of little value to the community. It must also be recognized that for most countries rapid growth is possible only with the assistance of foreign capital. This capital will not be attracted to a country with development potential unless its policies are directed to the fulfillment of this potential. But sound policies alone cannot ensure rapid development. The best of policies can only speed the achievement of potential production; in the short run, development may be arrested by transitory set-backs in output possibilities or market demands.
Experience with Stand-By Arrangements
The experience of a number of countries which have taken steps to stabilize their economies, whether or not assisted by Fund stand-by arrangements, sheds practical light on the principles which have guided the Fund’s policies in this field. Mention might be made of the experience of the industrial countries which stabilized their economies in the immediate postwar period, of which the Belgian and Netherlands reforms were striking examples. Later stabilization operations assisted by the European Recovery Program (such as those in Germany and Italy) provided bases for subsequent large increases in economic activity. The stabilization of the French economy in 1958–59, with assistance from the Fund through a drawing and stand-by arrangement, is a further example.
The United Kingdom drawing and stand-by arrangement in August 1961, following the Government’s announcement of domestic measures to stem the decline in foreign reserves, was the most notable of the Fund’s stand-by operations associated with stabilization measures during the past fiscal year. The measures adopted by the United Kingdom, and the progress achieved after the middle of the year, are discussed below (pages 97–98); so also are contemporary developments in several primary producing countries (pages 106–10). The experience of the Fund and its members with stand-by arrangements over a somewhat longer period may be illustrated here, by considering three less industrialized countries, all of which took steps of varying intensity to end inflation, but which faced somewhat different problems.
Spain provides a notable example. During 1961 that country was able to terminate a stand-by arrangement which had formed part of a joint Fund-OEEC program to assist the implementation of a Spanish reform leading to the rehabilitation of the economy, inaugurated in 1959. In many respects, the problems facing Spain were similar to those of other countries which have decided to restore monetary equilibrium, and the success of this program provides an example of the results that may be expected from such operations. Prior to August 1959, prices in Spain were rising rapidly, there had been frequent exchange rate adjustments, foreign exchange reserves had dwindled to one fourth of their size at the end of 1955, being equal to less than one month’s imports, and output was growing only slowly.
To eliminate the primary cause of the inflation (the excessive investment expenditure of autonomous public agencies financed largely through advances from the Bank of Spain), higher taxes as well as measures to limit the total expenditure of the official sector were introduced and successfully implemented. In 1961, central government revenues were 45 per cent higher than in 1958, whereas the increase in expenditure was only a little more than 35 per cent, even though government investment expenditure had risen by over 50 per cent. Advances by the central bank and the foreign exchange institution to the official sector, which in 1958 amounted to more than 12 per cent of the total expenditure of the official sector, were sharply reduced in 1959 and totally eliminated thereafter. Moreover, financing of the government sector by the other banks was eliminated after 1958. The Bank of Spain also took a number of measures designed to restrict credit to the private sector. Consequently, the volume of money, after increasing by approximately one third in the two years ended December 1958, increased by only 4 per cent per annum in the following two years. One of the first steps taken to stabilize the economy in 1959 was the elimination of the complex multiple rate system and the adoption of a par value (which was significantly depreciated compared with many of the important rates which it replaced). Since then, the rate has been maintained within ¾ of 1 per cent of par.
The first results of these steps were visible in the rise in the country’s foreign exchange reserves. By December 1961, official foreign exchange holdings had increased more than thirteenfold, to the equivalent of almost a year’s imports, even though Spain had repaid, in advance of schedule, the equivalent of $50 million drawn from the Fund and $24 million borrowed from the OEEC. The improvement in the foreign exchange position was attributable mainly to a shift in capital transactions. Prior to the stabilization, there had been a considerable outflow of capital, mainly through the under-invoicing of exports and the retention of the excess proceeds abroad, and through the black market, which was largely fed by tourists’ sales of foreign exchange. Once expectations changed regarding the future course of Spanish prices and the exchange rate, exporters tended to convert the full proceeds of their sales into pesetas, the black market dried up and tourist exchange was converted through official channels, and there was a considerable repatriation of previously accumulated foreign balances. In addition, Spain continued to receive foreign aid. At the same time, the flow of private foreign capital to Spain, which had been quite small down to 1958, became important in 1959, and again expanded markedly in 1960.
As a result of all these measures, inflationary pressures were eased to a large extent. In the three years before 1959, the cost of living increased by approximately one third; the subsequent years have been marked by price stability. Immediately after the Government took steps to halt the inflation there was a decline in output, but by late in 1960 these hesitancies were overcome. Total output rose by 4 per cent in 1961, and it continued to rise at an accelerating rate in the early part of 1962. In 1961, the authorities considered it possible to ease their restrictive polities, and the growth in bank credit to the private sector returned to its prestabilization rate. The Spanish economy still faces many problems, but those arising from inflation have largely disappeared.
Peru took positive steps to end inflation in mid-1959 under exceptionally favorable conditions. In the first place, the Peruvian economy is basically one of the more stable of the less industrialized countries. It is one of the most diversified of the primary-product export economies. In the second place, conditions in 1959 were especially propitious. Foreign investment in copper production was reaching fruition. There was also an unusual expansion in fishery production; exports of fish products in 1961 were $50 million greater than in 1958.
In the two years before mid-1959, expansionary policies of the official sector, largely financed by credits from the Central Reserve Bank, had led to a depletion of the Bank’s exchange reserves, despite an exchange depreciation. By July 1959, Peru’s net international reserves were less than $5 million, equivalent to less than one week’s imports. Furthermore, this worsening of Peru’s international position was accompanied by a sharply reduced rate of economic growth. Whereas the real gross national product had increased between 1951 and 1956 at an annual rate of over 4.5 per cent, the expansionary financial policies in the two years ended December 1958 were associated with an annual rate of growth of less than one half of 1 per cent.
Faced with this deterioration of the country’s economy, the authorities undertook fiscal and monetary reforms. In the three years ended December 1961, government revenue increased by approximately 85 per cent while expenditure rose at a slower rate. The budget deficit in 1959 was reduced to less than 5 per cent of expenditure, from more than 10 per cent in 1957 and 1958. In 1960 there was a sizable cash surplus, and in 1961 a smaller surplus. As a consequence, government borrowing from the central bank was negligible. Starting late in 1958, central bank credit to the other banks was restricted. At the same time, measures were taken to enforce the legal reserve requirements of the banks more strictly, and these requirements were appreciably tightened in April 1960.
These fiscal, credit, and legal reserve policies, supported by annual stand-by arrangements with the Fund, contributed to notable economic and financial improvements. A leveling off in economic activity occurred in 1959, but an expansion of more than 11 per cent in real gross national product was attained in 1960, and the increases in domestic prices were considerably reduced. Growing public confidence also helped to encourage private investment, which rose by an estimated 10 per cent in 1960. The depreciation of the exchange rate was arrested; and after the exchange system was unified in May 1960, the rate appreciated slightly. The central bank’s net foreign reserves increased by $28 million in 1960. In 1961 output expanded by approximately 6 per cent and the net official international reserves rose by a further $37 million. While factors other than stabilization contributed to these changes in output and reserves, the slow economic progress and the balance of payments deficits prior to the stabilization program can be explained largely by the impact of inflation in that period. The current rate of progress, under conditions of stability, is among the highest in the world.
In Colombia, steps were taken toward monetary stabilization in 1957 under conditions less favorable than those prevailing in Peru. Whereas Peru benefited from external developments, the price of coffee, Colombia’s major export, which had started to decline in 1954, fell by more than one third in the three years subsequent to the inauguration of monetary stabilization. In spite of a substantial increase in volume, the foreign exchange value of coffee exports, which represented about 70 per cent of total exports, declined by about 18 per cent over that period. Yet Colombia attempted to overcome the difficulties which excessively expansionary policies had created by the middle of 1957. Following a period when credit expansion was unduly large, Colombia’s foreign exchange liabilities (mainly arrears of payment for imports) exceeded its foreign exchange assets by $285 million at the end of 1956. At the end of 1954, its foreign assets had been $125 million larger than its liabilities. In the three years ended December 1957, total credit to the private sector increased by approximately 75 per cent. The expansionary fiscal policies of the national government, financed mainly by central bank credit, gave rise to a fourfold increase in the net government indebtedness to the banking system, and real gross domestic product increased at an annual rate of approximately 3 per cent.
The stabilization policy was adopted in 1957, with the support of a stand-by arrangement with the Fund. Attempts were made to increase government revenues and to slow down the rise in government expenditure. The rediscount facilities of the banks were reduced, ordinary reserve requirements raised, marginal cash reserve requirements instituted, and advance import deposits increased. These policies have been pursued with varying degrees of intensity. There was a considerable depreciation of the exchange rate in 1957 and in subsequent years, but a rather complex multiple rate structure has been maintained. Throughout this period, considerable reliance has been placed on direct trade restrictions. The depreciation of the exchange rate, and the strict import restrictions, contributed to an improvement in Colombia’s balance of payments in 1958 and 1959.
In 1957 and 1958, some attempt was made to restrain bank credit. Legal reserve requirements were raised and credit from the central bank to the commercial banks was restricted. However, the Government’s policy of financing the purchases of coffee for stockpiling purposes, by advances from the central bank, offset the effects of these restrictions. Credit to the private sector, together with credit for financing coffee purchases, increased by about the same amount as in the immediately preceding years.
In 1959, unlike the two preceding years, the dollar value of exports was maintained on the basis of a larger volume of coffee exports. The central bank ceased to provide finance for coffee retention, and the National Coffee Federation repaid a sizable amount of the credit obtained in the previous year. The commercial banks also reduced their indebtedness to the central bank. These monetary restraints, aided by continued fiscal austerity, made it possible to stabilize the exchange rate through most of 1959 and, by about the middle of the year, to arrest the rise in prices. Following a slight decline in economic activity in 1957 and 1958, the rate of growth in real gross domestic product amounted to about 6 per cent in 1959, the highest rate since 1954.
The stabilization policies contributed to substantial balance of payments surpluses in 1957 and 1958, permitting the reduction by nearly $200 million of short-term liabilities arising from import arrears, and, in addition, a moderate increase in reserves. In 1959, there was a substantial increase in output and a further large balance of payments surplus. The country’s problems had not been solved when the authorities, influenced by the early improvement, relaxed their stabilization policies in 1960. The advance in output in that year (4 per cent) was less than in previous years, and there was some decline in the volume of exports and a marked worsening in the balance of payments. In 1961, central bank credit expanded at a much faster rate than in 1960, and the Government’s deficit, which had reappeared in 1960, increased. Also, in 1960 central bank financing of coffee stockpiling was resumed. These relaxations in the program led to price increases, government intervention to support the exchange rate, and rising imports, despite a further decline in exports.
The recent experience in these three countries provides some evidence that the policies of monetary stabilization and their effective implementation have contributed to economic growth. When the basic economic conditions are adverse, as in Colombia, the problems are inevitably difficult. When the nonmonetary conditions are favorable, as in Peru, the problems of maintaining monetary stability and encouraging economic growth are easier. Spain, in an intermediate position, shows even more clearly that economic progress may be expected to be more rapid after the initiation of policies designed to maintain financial equilibrium.
However, it should be emphasized that, while monetary stability is an essential prerequisite for rapid and well-balanced economic growth, stability alone is not enough. Continuous efforts must be exerted in other fields of economic policy, and radical changes may be required in basic fiscal policies and in the financial structure. Vigilance in the financial sphere may be relaxed only at a country’s peril. But as economies make progress, more attention needs to be directed to social developments within the limits of the available resources.
First Annual Meeting of the Board of Governors, Report of the Executive Directors and Summary Proceedings, September 27 to October 3, 1946, page 106.
See Appendix XI for text of the Decision.
Annual Report, 1959, pages 73–74.
Annual Report, 1951, pages 81–82.