Chapter 3 Exchange Rates and Payments Restrictions
- International Monetary Fund
- Published Date:
- September 1962
During the 12 months ended April 30, 1962, the Fund concurred in changes in the established par values of the currencies of four member countries. These countries, and the dates upon which the changes took place, were Ecuador (July 14, 1961), Iceland (August 4, 1961), Costa Rica (September 3, 1961), and Israel (February 9, 1962). Each change involved a devaluation required to correct a fundamental disequilibrium. In Costa Rica, Ecuador, and Israel, the changes were also associated with the reduction or virtual elimination of multiple exchange rates. Since the end of the fiscal year the Fund has also concurred in a new par value for the Canadian dollar.
The Fund also agreed to initial par values proposed by New Zealand (October 27, 1961) and Portugal (June 1, 1962) in accordance with the Membership Resolutions for these members. The values established did not involve any change in the effective exchange rate for the New Zealand pound or the escudo. On June 30, 1962, initial par values had been agreed between the Fund and all but the following 13 of its 76 members: Afghanistan, China, Cyprus, Indonesia, Korea, Laos, Liberia, Malaya, Nepal, Nigeria, Thailand, Tunisia, and Viet-Nam (Appendix X).
A number of Fund members continue to use exchange rates which differ from their par values as established under the Articles of Agreement; some of them have fluctuating rates. From October 1950 to June 1961, the Canadian exchange rate was permitted to fluctuate freely, being determined by market forces and with a minimum of official intervention; the maximum variation in Canadian reserves within any calendar year in that period was approximately $125 million. In his budget speech on June 20, 1961, the Minister of Finance announced that, henceforth, the Exchange Fund would “be prepared, as and when necessary, to add substantial amounts to its holdings of United States dollars through purchases in the exchange market.” He stated, “No one can say today what the appropriate level of our exchange rate would be when our balance of payments is in a position better suited to our present economic circumstances. But the rate will certainly be lower than it has been of late, and it may well be appropriate for it to move to a significant discount.” At the beginning of June 1961, the Canadian dollar was quoted at US$1,015; by June 20, it was approximately equal in value to the U.S. dollar; by the end of June, it was worth US$0.966. Between May and October, official reserves rose by more than $150 million; but during November and December, they declined by about $50 million. From the end of June 1961 until early in 1962, the exchange rate remained fairly stable, falling to an equivalent of US$0.95 in February. This represented a depreciation by about 11 per cent from the peak rate, attained in October 1959. During the first four months of 1962, the exchange rate was supported by sales of about $465 million of foreign exchange by the Exchange Fund. These arrangements were terminated by the adoption on May 2, 1962 of a new par value, as noted above.
Several other countries, particularly in Latin America, have exchange rates which are nominally fluctuating but are in fact fixed by the authorities and changed only occasionally. In many countries these rates showed a high degree of stability during the 12 months reviewed. The problems created by fluctuating exchange rates are further discussed below.
Multiple Currency Practices
Reliance upon multiple currency practices continued to decline during the year under review. As mentioned above, Costa Rica, Ecuador, and Israel adopted new and virtually unified exchange rate systems. In Costa Rica, the change involved the abolition of a dual rate system with some mixing rates on the export side; in its place, the new par value was applied to all transactions, except for certain transitional arrangements, most of which have since expired. In Ecuador, a complex multiple rate system was replaced by a single par value applying to most transactions; only a minor free market with a fluctuating rate was retained for some transactions in invisibles and unregistered capital. In Israel, a complex system of exchange rates was replaced by a unitary rate based upon the new par value, the only exception being that a small free market has been retained for certain capital transactions.
In January 1962, the Philippines substantially simplified its multiple exchange rate system and at the same time removed almost all restrictions on payments. A freely fluctuating rate is now applied to all exchange payments and to all receipts other than 20 per cent of the proceeds of merchandise exports, to which the official par value of ₱2 = $1 is applicable. In Jordan the last traces of a multiple currency system were removed when the official exchange rate was extended to all transactions, including those with neighboring countries. In Brazil, several changes made in the exchange system during the period under review brought that country substantially closer to its goal of a unified exchange rate. By the end of 1961, most exchange transactions there were taking place at the free market rate, which was pegged; however, in a number of instances, various other requirements affected the cost of exchange transactions. In the period under review, the United Arab Republic simplified its exchange system by consolidating the different premiums on foreign exchange applied to various receipts and payments into a single premium applicable to most exchange transactions. In May 1962, the U.A.R. adopted a rate of LE 1 = $2.30, applicable to all but a few categories of transactions. The U.A.R. is following a policy designed to extend the application of the rate to all transactions in the near future.
There were a few exceptions to the general trend away from multiple rates: Chile reintroduced a dual rate system in January 1962, and Korea re-established exchange subsidies for private exports. At the end of the period under review, 12 member countries continued to employ multiple exchange systems; of these, 6 countries had systems consisting essentially of only two effective exchange rates.
Fund Policy Regarding Fluctuating Exchange Rates
The Fund’s position with regard to fluctuating exchange rates was defined in 1951 in the following terms:1 “In previous Annual Reports the Fund has discussed the par value system that was agreed at Bretton Woods, noting particularly that the system is one of stability of rates rather than rigidity. The governments that negotiated the Fund Agreement concluded that the exchange rate system best calculated to promote the Fund’s purposes is a system of fixed par values agreed with the Fund and subject to occasional adjustment—in accordance with orderly procedures—for the purpose of correcting any fundamental disequilibrium that may develop in the economic relationships of the member countries.
“From time to time, in the public press and in both technical and non-technical discussions of foreign exchange policy, this par value system has come under critical review. There has been some advocacy not only of fluctuating exchange rates to suit particular circumstances facing a given country but even of a large number of rates fluctuating at the same time. One important argument offered in favor of this system is the idea that exchange rates should be left to find their own level, in the belief that market forces can best determine appropriate valuations for currencies. A fluctuating rate is sometimes advocated as a procedure better designed than changes in par values to facilitate frequent changes in the rate of exchange when such changes are made necessary by unstable foreign or domestic conditions. Those who favor a ‘fluctuating rate system’ also argue that each rate of exchange should move so as to protect the domestic economy from pressures arising abroad, and, under other circumstances, that the exchange rate should protect the balance of payments against pressures arising out of domestic economic policies.
“The continuing interest in alternative foreign exchange arrangements calls for a brief review of the par value system and of the objectives that it serves. The system is not a wise one merely because it was written into the Articles of Agreement. But it is correct to state that it was written into the Articles of Agreement because it emerged from the experience of the world over a period of many years. No one would deny that the maintenance of a given exchange rate is sometimes made very difficult either by a set of internal policies or by the external economic forces with which countries must deal. In the main, these difficulties arise from the fact that changing economic forces operate with unequal effects on various countries. Nevertheless, it is a striking fact that the maintenance of stable rates of exchange is virtually the invariable objective of all countries at all times; even those countries that have embarked on a policy of fluctuating rates have in practice generally stabilized their rates within narrow limits over long periods of time.
“Those who advocate allowing rates to find their ‘natural’ level, permitting market forces to determine a rate of exchange that will be stabilized, seek to provide a simple solution for a very complex problem. There is no such thing as a ‘natural’ level for the rate of exchange of a currency. The proper rate will, in each case, depend upon the economic, financial and monetary policies followed by the country concerned and by other countries with whom it has important economic relationships. If the economy of a country is to adapt itself to a given exchange rate, there must be time for the producers, sellers and buyers of goods and services to respond to the new set of price and cost relationships to which the rate gives rise. This means that in the short run changes in the exchange rate are either no test or a very poor test of basic economic inter-relationships. It also means that whether a given exchange rate is at the ‘correct’ level can be determined only after there has been time to observe the course of the balance of payments in response to that rate. Moreover, past experience with fluctuating rates of exchange has proved that movements in the rate are significantly affected by large speculative transfers of capital. Consequently countries prefer to make adjustments in their rates of exchange in a manner that will minimize distortions through speculation. Parenthetically it may be mentioned that generally implicit in the arguments for fluctuating rates is the assumption that some major currency will remain stable as a point against which to operate the fluctuating rates.
“When a rate of exchange becomes inappropriate because of fundamental changes in a country’s balance of payments, arising from forces either external or internal, it should be adjusted to the new situation. The Fund Articles are sufficiently broad to permit any necessary and justifiable changes in par values, and if changes are made by the orderly procedure provided by the Articles, sufficient weight will be given to the interests of all members of the international community. In the present circumstances it is essential that the cooperative endeavor represented by the Fund be extended and improved, rather than undermined. By establishing the Fund, its members recognized that each had a responsibility toward all the others; that the action of each had effects on all the others; and that only by working together could they mitigate the evils of economic nationalism and secure the benefits of expanded trade. The course of events since the meeting at Bretton Woods has shown that their judgment was sound.
“For these reasons a system of fluctuating exchange rates is not a satisfactory alternative to the par value system. But there may be occasional and exceptional cases where a country concludes that it cannot maintain any par value for a limited period of time, or where it is exceedingly reluctant to take the risks of a decision respecting a par value, particularly when important uncertainties are considered to exist. Even under such circumstances, however, members of the Fund must recognize that should any one of them be moved by these considerations to allow its rate of exchange to fluctuate, other members of the Fund will be affected. For a country whose position in international trade is comparatively unimportant, this consideration may not be as significant as the benefit it expects to derive for its own economy. But there is always the danger of the psychological impact of such action on expectations in other countries that might force these countries to follow the same course. When such a situation is examined with respect to a country with an important position in international trade, particularly if its currency is one of the major trading currencies, the implications for other countries are far more important than the results that it might seek to achieve for its own economy. Moreover, if a substantial number of exchange rates were allowed to fluctuate, complex problems would be created for all countries and a chaotic situation might easily develop.
“What should be the Fund’s attitude toward these exceptional cases which, from time to time, have been presented to the Fund and may be again presented in the future? A member of the Fund cannot, within the terms of the Articles of Agreement, abandon a par value that has been agreed with the Fund except by concurrently proposing to the Fund the establishment of a new par value. What a country can do under the circumstances described above is to inform the Fund that it finds itself unable to maintain rates of exchange within the margins of its par value prescribed by the Fund Agreement, and, accordingly, that it is temporarily unable to carry out its obligations under Sections 3 and 4(b) of Article IV.
“The circumstances that have led the member to conclude that it is unable both to maintain the par value and immediately select a new one can be examined; and if the Fund finds that the arguments of the member are persuasive it may say so, although it cannot give its approval to the action. The Fund would have to emphasize that the withdrawal of support from the par value, or the delay in the proposal of a new par value that could be supported, would have to be temporary, and that it would be essential for the member to remain in close consultation with the Fund respecting exchange arrangements during the interim period and looking toward the early establishment of a par value agreed with the Fund. No other steps would be required so long as the Fund considered the member’s case to be persuasive, but at any time that the Fund concluded that the justification for the action of the member was no longer sustainable, it would be the duty of the Fund so to state and to decide whether any action under the Fund Agreement would be necessary or desirable.
“The essence of this whole analysis may be very simply expressed. The par value system is based on lessons learned from experience. There is ample evidence that it continues to be supported by the members of the Fund. Exceptions to it can be justified only under special circumstances and for temporary periods. The economic and financial judgment of the Fund in such cases must be tempered by recognition of its responsibilities in the wider field of international relations.”
Postwar Experience with Fluctuating Rates
Experience since 1951 has confirmed the views expressed at that time. Except when adopted temporarily, as part of a comprehensive program of exchange reform, “a system of fluctuating exchange rates is not a satisfactory alternative to the par value system.” Furthermore, a fixed exchange rate subject to frequent changes, or a temporarily pegged fluctuating rate, is likely to encourage destabilizing speculation which will create even more serious problems than those which arise under a system of freely fluctuating rates.
In specific cases, a short period of fluctuation may be a means of reaching a rate which can subsequently be maintained. Many of the stabilization programs with which the Fund has been associated have included a fluctuating exchange rate as one of the instruments to be used in attaining monetary equilibrium. At the time of stabilization after a period of inflation, the existing trade and exchange controls, particularly in a multiple currency system, make it difficult to state what exchange rate is actually in effect. Even if there has hitherto been only a single rate, the preceding inflation is likely to have made this inconsistent with the existing price structure; and the adjustment required to eliminate the distortions in the economy are likely to make it virtually impossible to estimate in advance the required degree of over-all price change. In such circumstances, it may be impossible to calculate a new rate which would be appropriate after the measures of monetary reform had taken effect. Hence, at the time of stabilization, the choice may often lie between the free determination of the rate in the market and a continuing distortion of the economy by exchange restrictions.
In exceptional circumstances, such as the large capital inflow into Canada in the early 1950’s and into Peru for brief periods, the fluctuating rate may have an upward tendency. The experience of the postwar period, however, suggests that if a country does not clearly and quickly adopt a monetary policy aimed at stability, the movements of its fluctuating rate are likely to be oscillations not around a stable value but around a declining trend. It is an illusion to expect the fluctuating rate to ease the problems facing the monetary authorities. On the contrary, by eliminating the rallying point of the defense of a fixed par value, a fluctuating rate makes it necessary for the authorities to exercise greater caution in determining monetary policy.
When fluctuations in the rate become of significant amplitude, these fluctuations may themselves contribute to the forces leading to depreciation. If, as in most countries at present, wages are not equally flexible in both directions, fluctuations in the exchange rate may create inflationary pressures. Any circumstance leading to a temporary depreciation of the rate will raise the domestic currency cost of imports and will directly and indirectly lead to price increases. These increases will encourage demands for higher money wages, at least some of which may be met. Hence, depreciations are likely to encourage increases in domestic costs. By contrast, institutional rigidities limit reductions in money wages, so that exchange appreciations are unlikely to lead to significant decreases in domestic costs. Therefore, a fluctuating rate may be expected to encourage a rising trend in domestic costs. In turn, increases in costs exert a downward pressure on the rate. Thus, if an exchange rate fluctuates widely, it may be expected to depreciate over time. The movements of exchange rates and prices over the last ten years in six countries that had fluctuating rates show, on the whole, a persistent tendency in that direction (Chart 2).
Chart 2.Selected Countries: Exchange Rates and Purchasing Power of Money, First Quarter 1951-First Quarter 1962
1For Argentina and Indonesia, implicit export rate; Brazil, implicit export rate excluding coffee; Peru, principal exchange rate, which does not differ markedly from the implicit export rate and the implicit import rate; Uruguay, principal export rate.
2For Argentina, Brazil, and Chile, implicit import rate; Indonesia, “other” import rate; Uruguay, free rate.
Suggestions that a fluctuating rate serves to maintain an equilibrium relation between an economy following an inflationary policy and the rest of the world are based on the belief that any variations in the rate will be fairly closely associated with changes in the relation between domestic and foreign prices. In practice, however, countries that have sought protection by adopting a fluctuating rate have often pegged the rate rather quickly, even though internal stability and external equilibrium were not assured. Consequently, if the rate was an appropriate one initially, it soon became inappropriate. Recent experience covers quite a few cases where “fluctuating rates” were kept pegged in the face of large losses in reserves and sharp increases in domestic prices. In these circumstances, the fall in reserves convinced importers, exporters, and foreign and domestic holders of liquid assets that a depreciation was inevitable. The demand for imports rose and exports were held back, while capital flight was fostered. All the basic pressures on the rate were aggravated. If the rate had been left to fluctuate freely, its immediate depreciation would have reduced the possible gains to be obtained by capital flight, discouraged imports, and encouraged exports. The pegging of a fluctuating rate, however, while the underlying domestic developments are such that a depreciation is probable, is apt to compound the disadvantages of instability. As a result, the countries concerned suffer many of the hardships created by the uncertainty of exchange rate fluctuations, without obtaining any of the benefits which such a system might produce.
Experience has also shown that when the pegged rate could no longer be held the depreciation of the exchange rate sometimes proceeded more rapidly than the accompanying or ensuing price increases. Depreciation, which is rightly regarded as a symptom of inflation, then became a cause of inflation. As pointed out earlier in this Report, one of the more serious consequences of an inflation is the encouragement of capital flight. Hence, the market forces determining a fluctuating rate reflect not only transactions arising from exports and imports of goods and services, and transfers of investment capital, but also the flight of capital. A rate so determined will rapidly depreciate. Temporarily, the depreciation may be postponed by exchange and trade controls; but even if these controls had no adverse effects in themselves, they could not prevent eventual depreciation.
Recent experience with fluctuating rates, which has been commented on here, suggests that the countries using this device have not, on the whole, been able to protect thereby their economies from pressures arising from abroad, nor to protect their reserves from expansionary domestic economic policies. In particular, a fluctuating exchange rate tends to aggravate the pressures on the balance of payments arising out of domestic economic policies. The continuance of an inflation, to which a fluctuating rate tends to contribute, both by stimulating wage increases and by removing the danger signal of pressures on exchange reserves, tends in the longer run to drive the rate down.
The use of fluctuating rates in the last decade has been limited to a relatively small number of countries, of which only one, Canada, accounts for a substantial proportion of world trade; and Canada, which introduced a fluctuating rate in 1950, adopted, with the approval of the Fund, a new par value after the end of the period with which this Report deals.
It is important to bear in mind, therefore, that the postwar experience with fluctuating rates in a limited number of countries has occurred within the framework of fixed parities, in terms of each other and in terms of gold, for the currencies of well-nigh all the industrial countries. Such changes in the values of the latter currencies as have been made have followed the approval procedure laid down in the Articles of Agreement of the Fund, which is designed to ensure that exchange rates are determined with full consideration of their impact on other countries.
Recent Changes in Payments Restrictions
Developments with respect to restrictions on international payments during the twelve months ended December 31, 1961, and to some extent during the first quarter of 1962, have been described in the Thirteenth Annual Report on Exchange Restrictions. The net gain noted there in the liberalization of current payments was the result of divergent experiences of different groups of countries. In general, the industrial countries were able to continue to liberalize their restrictions on imports and import payments; in the process, some of them reduced or eliminated elements of discrimination. On the other hand, some primary producing countries either intensified their import restrictions or made only minor progress toward further import liberalization. The industrial and primary producing countries likewise differed in respect to liberalization of transactions in invisibles, although the general trend toward such liberalization continued.
Spain, in July 1961, issued regulations providing for nonresident accounts in convertible pesetas and thus created a basis for establishing the external convertibility of its currency. Cyprus, France, Italy, and Japan substantially eliminated dollar discrimination in their import licensing policies. Discrimination against imports from Japan was further reduced by some countries, and eliminated by Finland and Spain. Finland, Jordan, and Turkey further liberalized the availability of exchange for transactions in invisibles; however, Iran found it necessary to place limitations on the exchange provided for certain types of payment.
The use of advance deposit requirements as a prerequisite to obtaining import or exchange licenses or to clearing goods through customs showed no clear trend during the period, although there were a number of changes in individual countries. Two countries (Morocco and Tunisia) introduced this device for the first time, but several other countries made changes that reduced its importance. In some countries, the advance deposit requirements were being applied in a discriminatory manner, thus raising the possibility that they would lead to distortion of trade patterns and uneconomic use of resources.
Bilateral payments agreements involving Fund members continued to decline in both number and importance. Seventeen such agreements, to which both parties were Fund members, were terminated, while six new ones were initiated. Of special significance was the reduction in the reliance upon bilateralism among Latin American countries; following the termination of the three important agreements between Argentina and Chile, Argentina and Brazil, and Brazil and Uruguay, as well as some others of lesser importance, bilateral payments arrangements ceased to have any major effect upon the flow of trade and payments within the area. Countries which terminated three or more of their bilateral payments agreements with other members during the period include Brazil, Chile, Norway, and Turkey.
A number of Fund members continue to maintain bilateral payments agreements with countries that are not members of the Fund, mostly the state-trading countries of Eastern Europe; these agreements now constitute by far the most numerous part of the remaining bilateral payments agreements. At the end of 1961, there were in existence 156 agreements with nonmembers, compared with 46 between members. A few new agreements with non-members were entered into during the period under review. On the other hand, in the renegotiation of several agreements with non-members, increased provision was made for settlement of balances (in excess of the swing limits) in convertible currencies, thus reducing the strictly bilateral aspect of the arrangements. Some other countries (e.g., the United Arab Republic) have taken steps in their trade policy to reduce or eliminate the discrimination in favor of their bilateral partners.
Changes in restrictions over capital payments during the period under review were only minor, except in South Africa, where restrictions were introduced in June 1961 to check a substantial outward flow of capital. As the country’s balance of payments improved, it was possible, in March 1962, for the original restrictions to be relaxed somewhat.
Annual Report, 1951, pages 36–41.