Chapter 4. Foreign Exchange Policies in Less Developed Countries

International Monetary Fund
Published Date:
September 1967
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Over the past two decades, and especially since the latter part of the 1950’s, the Fund has been closely associated with the less developed countries in connection both with the provision of resources to meet balance of payments difficulties and with periodic reviews and appraisals of policies and developments in their economies. From this association the Fund has gained considerable experience and insight in the search for solutions to the problems of these countries. The present chapter is based on this experience and deals with problems and policies in the foreign exchange field. Although this chapter does not deal with problems of the more developed countries, many of the observations made here are applicable to all countries.

Foreign exchange policies and practices of Fund members are regularly surveyed in the Annual Report on Exchange Restrictions. These annual reports clearly point to the substantial progress made by members, particularly in the past ten years or so, toward the establishment and maintenance of a sound international payments system. The less developed countries have shared in this progress; a large number have consistently pursued realistic foreign exchange policies and have succeeded in maintaining currency stability and a payments system which is wholly or largely free of exchange restrictions. Of the 31 members that have so far accepted the obligations of Article VIII, Sections 2, 3, and 4, about one half are less developed countries.

There are, however, many less developed countries where the balance of payments has been under serious and continuing pressure and dependence on direct restrictions or multiple currency practices has remained substantial. This chapter is devoted largely to discussing the problems of countries in such prolonged imbalance and reviewing the effectiveness of alternative policies to rectify it.

The Fund believes that policies aimed at achieving an enduring stability of the exchange rate at a realistic level—that is, a rate that provides adequate incentives for exports while facilitating the maintenance of a liberal payments system—are essential to sound economic growth. An exchange rate that is seriously out of line with the developments in the economy and abroad will result in distortions in the allocation of resources. These distortions will increase as the overvaluation of the currency increases over time, complicating the adjustment of the balance of payments and creating impediments to further growth. Consequently, in this analysis and review of situations typical of countries in persistent imbalance, attention is focused primarily on the economic costs of currency overvaluation and stress is placed on the advantages of prompt and decisive action to correct the situation.

The foreign exchange problems that have confronted less developed countries are, to some extent, of external origin. Continued weakness or instability in foreign demand and the existence of tariff and nontariff barriers to trade maintained by developed countries have been obstacles to a sustained expansion of export earnings of less developed countries. The contribution of appropriate foreign exchange policies toward the strengthening of their balance of payments will be more important if efforts to remove these obstacles succeed.

Payments Problems and Policy Responses

The types of balance of payments difficulties that have led members to adopt programs of stabilization were described in the 1966 Annual Report.1 In countries that are predominantly exporters of primary products, the difficulties have arisen to some extent from short-run fluctuations in export earnings as a result of natural or other conditions affecting supply or foreign demand conditions. Although the price behavior of primary products has not followed a uniform pattern and has affected countries differently, the short-term export fluctuations have at times placed considerable strains on the ability of these countries to maintain their development efforts. The Fund’s compensatory drawing facility, as revised and improved in September 1966, is designed, in conjunction with its normal drawing facilities, to assist countries to cope with difficulties in this area.2

Many of the payments difficulties of less developed countries can be attributed to the tendency for domestic expenditures to outstrip available resources as countries attempt to provide desirable public services to their growing populations and to increase the rate of economic growth. It has been difficult to restrain the growth in public current expenditures, particularly for defense and welfare purposes; in many instances, substantial and continuing budgetary support has been necessary to meet the operating losses of public enterprises. Moreover, not infrequently development plans have called for a considerable acceleration in investment expenditures. The mobilization of additional resources through taxation or other means for financing the rising levels of both current and investment expenditures has often proved difficult. Low levels of income have created social resistance to policies aimed at reducing the growth of private consumption. The absence of appropriate institutions for mobilizing and channeling private savings has also been a constraining factor. In these circumstances recourse to inflationary financing has been substantial, and one of the consequences has been a weakening of the balance of payments. In some countries the process of inflation has tended to become entrenched, aggravating the balance of payments difficulties.

Payments imbalance has at times been more directly associated with particular investment decisions made by a country. If investments are directed to activities which are not well suited to the country’s potential, they will fail to yield adequate economic returns, and will tend to weaken the balance of payments. The determination of an optimum investment pattern is, however, not an easy task. It is not always possible, for example, to identify precisely the areas where the country’s latent advantage in production lies. There may also be errors in estimating the costs of the projects or the period necessary before the investments can bring full results. The time horizon chosen for the selection of investments is, moreover, an important consideration; projects which yield higher returns in the short run may not be the more productive ones when a longer period is taken as the reference. While these basic difficulties may understandably give rise to pressures on resources and create payments difficulties, more frequently problems have arisen because allocation of investments was not based upon productivity considerations. This has been particularly evident when the saving of foreign exchange through the replacement of imports has been made the overriding criterion in the selection of new industries. In many small countries, for instance, the manufacturing sector consists mainly of the final stage of the assembly of consumer goods. The import content of the products of these industries has remained high, and, in view of the limited size of the market, they have only infrequently reached economic dimensions.

When, with the onset of balance of payments difficulties, action has been taken through speedy adjustments in financial and other internal policies, it has been possible, often with Fund support, to bring the payments position under control. With such action, the stability of the currency and confidence in the foreign exchange system of the country are not impaired and the undesirable effects arising from expectations of a change in the exchange rate or in trade and payments policies are avoided. In the absence of corrective action, the cost-price structure over a period of time will suffer serious distortions. The resulting overvaluation of the currency leads to a rise in imports, a tendency for exports to be discouraged, and, with growing expectations of a devaluation, an inducement for capital to move abroad. The adjustment of the balance of payments in these cases of serious imbalance requires changes in the pattern of production through a shift of resources from the domestic to the external sector. Experience shows that the reallocation of resources can best be achieved by creating appropriate market incentives through a change in relative prices.

A policy of deflation alone may achieve this but, in situations of serious imbalance, the required reduction of domestic expenditure will have undesirable consequences on the level of economic activity and the process of economic growth. Under these circumstances an exchange rate adjustment accompanied by monetary and fiscal policies aimed at eliminating excess demand will permit the desired shifts of resources to take place without being as disruptive of economic growth. These policies act in a complementary fashion to facilitate the adjustment; the increase in prices in domestic currency in the external sector, consequent on devaluation, creates new incentives while the reduction in domestic outlay releases resources for reabsorption. In practice, however, the restoration of internal and external balance takes time during which there may be difficult problems of adjustment. The speed with which the economy can respond to the changes in demand and supply conditions depends largely on the extent to which existing resources can be transferred between different uses and on the volume of additional resources that can be mobilized. If the structural or institutional characteristics of the economy inhibit the necessary mobility of resources, the ability of the country to attract foreign resources may be crucial. Moreover, the relative growth of the export sector depends on the rate of expansion of foreign demand for the country’s products and the extent to which producers are able to realize gains in productivity and reorient production to the characteristics of foreign demand.

Although the benefits of an exchange rate adjustment may take time to be fully realized, there are many ways in which the balance of payments may show an immediate favorable response. An increase in the exportable supply of some commodities, particularly through reduced domestic consumption as a result of higher prices, as well as the reappearance of exports withheld by traders in anticipation of a rate change, may yield quick results. Some immediate decrease in pressures on imports is also likely with the adjustment in prices of imports and a reduction in inventories of imported goods accumulated because of continuing inflation or uncertainties in import policy. Moreover, to the extent that confidence is restored, there is likely to be a favorable movement of capital.

It is, however, unlikely that the deficit in the balance of payments will be fully eliminated immediately after a devaluation. In order to reap the maximum advantage from the exchange rate adjustment, it may thus be necessary to have available adequate foreign financing to facilitate the avoidance or elimination of restrictions and to bolster confidence in the currency. The Fund has been an important source of such financing. Often its own assistance has been paralleled by resources from other sources, including long-term resources for investments necessary to foster output in those sectors where profitability has been improved by the rate adjustment.

Countries have sometimes delayed an overt adjustment of the exchange rate for various reasons, including domestic political resistance to a reduction in the external value of the currency and the fact that such action is virtually irreversible. The immediate effects of the adjustment on the prices of imported goods have weighed heavily on the judgment of their authorities, especially where such goods form an important component of the cost of living. More generally, the transfer of real incomes from consumers to producers of international goods, which would result from the change in relative prices of domestic and international goods, has generated resistance. There has also been a strong apprehension that a devaluation would seriously worsen terms of trade, particularly where the country is an important supplier to world markets.

Many less developed countries have, therefore, responded to continuing balance of payments difficulties by resort to a mixture of measures. These include exchange rationing, import licensing, reliance on bilateral payments or barter arrangements, export subsidies and import surcharges, and introduction of multiple rates, which have seemed to be preferable to the sometimes politically more difficult course of adopting a unified and realistic exchange rate. These measures have also seemed more suitable because they have permitted a differentiation in treatment between classes of foreign transactions. However, besides being objectionable from an international point of view, they have made the restrictive system increasingly complex and the effects generally have not been favorable to economic growth.

Effects of Restrictions on Allocation of Resources

Prolonged use of restrictions creates serious distortions in the allocation of resources, which tend to be drawn into the production of goods that cannot be imported or can be imported only in severely restricted quantities. At the same time, the increasing overvaluation of the currency strongly discourages the expansion of exports. In fact, the relative profitability of the new manufacturing industries tends to divert resources from existing export industries or from primary production, without encouraging exports by those new industries. Moreover, until recently, agricultural expansion did not receive adequate emphasis in many development plans; this together with the relatively liberal treatment usually accorded to imports of food and raw materials has weakened efforts to increase the domestic supply of food and agricultural raw materials, notwithstanding the increased need for food in response to growth in population and income. Preferential treatment of imports of capital goods has tended to result in an overexpansion of capacity. To provide foreign exchange for imports required for the establishment and operation of the new industrial enterprises, as well as for other essential imports, a fresh round of restrictions to compress the remaining imports sooner or later proves unavoidable. This process can in theory continue until domestic production has been so diversified that it can be maintained with a small volume of imports; in practice, however, the growing rigidity in the structure of imports means that after some point a reduction in their volume can only be achieved by restricting imports essential to the maintenance of domestic production. It is not an uncommon phenomenon for some industries in less developed countries to operate at levels much below capacity for lack of imported materials, fuel, and components.

Even when a country has a policy of stimulating production selectively, attempts to cope with a deteriorating payments situation by continued resort to restrictions make effective implementation of the policy very difficult. As restrictions embrace a wider range of products, it becomes difficult or even impossible to limit inducements to particular industries. Restrictions imposed more broadly for payments purposes lead to increases in prices in other sectors, often making it profitable to divert resources from the initially protected industries. Moreover, with continuing balance of payments difficulties, these industries can no longer count upon the uninterrupted supply of imported machinery and raw materials needed for the production process. The tendency in consequence is that the allocation of resources comes to be increasingly influenced by measures taken in response to the exigencies of the balance of payments situation and may differ substantially from an allocation based on the requirements of a well-conceived development approach.

The Fund has not objected, under certain conditions, to the adoption of multiple currency practices by members and, at times, has even made its resources available for an exchange reform that had certain multiple currency features. This support has, however, always been based on pragmatic considerations with an understanding that use of such practices would be temporary. Assistance has been given when the existing exchange rate was so out of line that the adoption of multiple currency practices could be considered an improvement. There are, however, serious disadvantages associated with the use of multiple currency practices. On the import side a multiple rate system discriminates in favor of “essential” goods and against “nonessentials.” This raises the same policy and practical issues as direct restrictions; it distorts the allocation of resources and involves exceedingly difficult determinations as to the “essentiality” of classes of imports. On the export side the rate applying to some exports has often continued to overvalue the currency, thus discouraging the growth of production of goods in which the country may have the greatest comparative advantage. Moreover, uncertainties and instability inherent in the multiple rate system have militated against new investment initiatives and rationalization of export production. As the balance of payments position has continued to weaken, frequent changes have been made in the scope and number of effective rates. The effect of these changes has been to depreciate the rate structure but on a basis that has inevitably become increasingly arbitrary as the complexity of the system has increased. Frequently, it has been necessary to combine multiple rate systems with complicated exchange controls and import licensing in order to limit the demand for exchange to the available supply.

When currency overvaluation persists for a long time, the machinery of exchange and trade control developed to mitigate the balance of payments pressures gradually tends to embrace nearly all areas of external transactions. The complexity and the discretionary aspect of the system makes it difficult to administer effectively. In such situations the scarcity of foreign exchange produces opportunities for exceptional gains for traders able to obtain import or exchange licenses. Moreover, with the increasing displacement of the market mechanism by detailed regulations, a disproportionate segment of the administrative apparatus becomes tied up in the interpretation and implementation of the regulations. Not only do foreign exchange allocation and management become wasteful but the making and implementation of sound policies in other spheres suffer.

With growing complexity of the exchange system, confidence in the currency is likely to be seriously eroded, leading to substantial outflows of domestic capital. If there are legal impediments, outflows may occur through various devices such as understating of receipts and overstating of payments requirements as well as export of banknotes and securities. At the same time, controls on current transfers, the general uncertainty about future policies, and the expectation of an eventual devaluation discourage the inflow of foreign capital.

Experience with Exchange Reform

The heavy costs of currency overvaluation emphasize the importance of early action in adjusting the exchange rate; undue delay in taking this action leads to allocative distortions in the economy which become more widespread over time. The correction of these distortions may in such situations call for a substantial adjustment of the exchange rate. Several countries have been able to accomplish the needed adjustment in one step. Others have chosen a gradual course and have made only a partial or selective devaluation in the initial stage. It has also not always proved feasible, in connection with a reform of the exchange system, to modify financial policies so as to eliminate inflation altogether. Thus the immediate objectives of some of the reforms have been limited to bringing about some liberalization of imports and encouragement of exports and slowing down the rise in prices, thereby preparing the ground for subsequent action.

Despite the initial problems of adjustment, the immediate establishment of a realistic rate, together with the adoption of policies aimed at the control of inflation, has important advantages. If the devaluation is adequate and is supported by financial and other measures of a comprehensive character, it will foster confidence in the stability of the currency and the new price relationships. Given this confidence, producers and traders can be expected to make the desired adjustments in production, investment, and marketing. If a gradual approach to the control of inflation or the reform of the exchange system is followed in order to ease the immediate problems of adjustment, action in the initial stage will be less far-reaching and there will be expectations of further changes. In view of the uncertainties, the response to the policy adjustments may well be less than expected. Any gradual approach carries with it the danger that evolving social or political pressures or the appearance of new economic difficulties may weaken the resolve to make further moves toward a realistic rate. This is not to say that a program of financial and exchange reform spread out over several years will be unsuccessful. But it has to be concluded that it is an exceedingly difficult operation, requiring sustained and resolute efforts to attain the objectives of the program.

In many less developed countries one problem that has arisen in association with a devaluation concerns the difference between the costs of production of traditional export goods and of other goods, especially manufactures. These countries generally have a comparative advantage in primary products but many of them understandably feel that in the longer run the best opportunity for improvement in the balance of payments lies in the diversification of exports, mainly in the field of manufacturing. A devaluation of the degree required to facilitate the diversification of exports may generate substantial windfall profits in the export sector for primary products. When the existing tax machinery of the country does not respond promptly to the increased income in this sector there is a case for levying taxes on exports of primary products, both to provide an additional source of financing for the budget and to encourage the diversification of production and exports. Moreover, when a country is an important world supplier of the goods in question, taxation would prevent an undesirable lowering of the foreign price inviting retaliatory action by competing suppliers. At the same time, however, in setting the tax rates it must be recognized that the placing of an undue burden on primary exports may have adverse effects on production. Failure to expand the supply of primary products for export at competitive prices may deprive the country of the opportunity of expanding exports as world demand increases, and may invite attempts at substitution in the importing countries. As the cost and price differentials resulting from the devaluation are narrowed by shifts in resources and production, the taxes may and often should be reduced and eventually eliminated. In general, it must not be assumed that the traditional export sector will take care of itself and can always stand heavy taxation.

On the import side a devaluation normally permits a relaxation of restrictions, thus increasing the influence of the price mechanism and competition from abroad in the allocation of resources. It thus affords the occasion for rationalizing import policy through the selection of industries to be stimulated and setting more clearly the degree of protection for such industries by an adjustment of the tariff structure. The general relaxation of restrictions on imports improves the relative attractiveness of the protected sector as well as the export sector. In many cases, however, retention of administrative restrictions on some imports has been considered necessary in order to ensure that import demand is kept sufficiently restricted. Import surcharges have also been used for this purpose; they have had the additional advantage of providing revenues and restraining import demand through the price mechanism, especially when the immediate impact of demand pent up during the previous period could not be clearly ascertained. It has been expected that, as exports responded to the new incentives and as production increased owing to a more rational allocation of resources, a basis would be created for the removal of the remaining restrictions. Import subsidies have occasionally been granted on a temporary basis in order to cushion the impact of devaluation on the cost of living, especially in situations where a considerable degree of devaluation was called for.

The establishment of a realistic rate of exchange has not always involved the immediate adoption of a fixed rate; not infrequently countries instead have adopted a fluctuating rate of exchange as a means of finding the level at which the rate can subsequently be maintained. At the time of stabilization after a prolonged period of inflation, there is often uncertainty whether the measures undertaken will be fully effective in eliminating inflation, or what the degree of overall price change will be when these measures have taken effect. In these circumstances it is difficult to determine the appropriate level of the exchange rate. This difficulty is sometimes even greater when a complex multiple rate system has existed and has, moreover, been combined with quantitative restrictions.

A fluctuating exchange rate adopted in these circumstances carries with it the understanding that the rate will be allowed to move in accordance with market forces and that the authorities will intervene only to maintain orderly market conditions. It is to be expected that rate changes will tend to diminish as the supporting financial policies exercise their effect; thus, the level of the rate after these policies become fully effective should provide a clearer indication of where it could be stabilized. In countries which have quickly implemented financial policies aimed at internal monetary stability, the movements in the rate in practice have been confined within a small range after the initial period. This has helped to establish confidence in the currency and enabled the authorities to stabilize the exchange rate in a relatively short time.

In other cases the immediate difficulties of terminating an acute and prolonged inflation or of adjusting a highly restrictive and complex exchange system have been considered so great that countries have chosen to undertake the reform in successive stages. Several countries, for example, have adopted programs aimed at a reduction of the degree, rather than the elimination, of inflation in order to let the economy adjust gradually to a slower pace in the rise in prices. With continuing domestic inflation, the beneficial effects of a single exchange rate adjustment are likely to be rapidly wiped out. Consequently, in these cases exchange rate policy ordinarily has involved some degree of rate flexibility conforming broadly to basic market trends, thereby helping to prevent undesirable shifts of resources from the external to the domestic sector of the economy and to maintain the country’s import capacity and access to foreign investment.

Even when the need for rate flexibility is recognized, the authorities often find it difficult to maintain a flexible rate; in the absence of clear criteria for exchange rate action, the tendency is to peg the rate at a level which soon becomes out of line with developments in the economy. Accordingly, in some countries where a flexible rate policy is considered essential because of continuing inflation, a “test” is set up as a means of assuring that a rate will be maintained which conforms to the basic market trends. Such a test usually consists of a prescribed minimum level at which the foreign exchange reserves of the country are to be maintained during a stated period, with exchange rate action taken whenever that level is threatened.

Some countries have chosen a gradual correction of the distortions caused by prolonged recourse to restrictions, even when there was a reasonable prospect of bringing inflation under control. The initial adjustments have taken various forms. When the currency has been devalued only partially, it has not been possible to achieve a substantial relaxation of restrictions. The further adjustments necessary to establish a realistic exchange rate have awaited an improvement in the balance of payments position. More frequently, exchange reform has consisted initially in different degrees of depreciation affecting different transactions, giving rise to two or three effective rates; such a system has provided another form of transitional reform of complex multiple rate systems.

Two broad types of simple multiple rate arrangements can be distinguished:

(1) One in which a fixed rate is applied to traditional exports, “essential” imports, and other “essential” payments and receipts, and a free rate is applied to all other transactions. Generally, transactions are gradually moved from the fixed rate to the free market and, when the free market covers all or nearly all transactions and acquires stability, a fixed unitary exchange rate is established.

(2) A more frequently used arrangement that differentiates between trade and nontrade transactions by applying a fixed rate to trade transactions while creating a free market for capital and invisibles. This has often been adopted when an outflow of capital has been a destabilizing factor and is not amenable to administrative controls. Isolating capital transactions in a separate market in which the rate is more depreciated enables the authorities to reduce the outflow while attracting capital from abroad; at the same time the pressure on external reserves is reduced. As confidence in the currency is strengthened, the spread between the two markets narrows, thus improving the prospects for unification. When the free market rate, however, has tended to suffer continuous depreciation, this deterioration has often been taken as an indication of basic maladjustments and the need to change the rate for trade transactions. In this situation it has been easier for the monetary authorities to gain political support for a devaluation.

Benefits of an Appropriate Exchange Rate

The Fund has endeavored to take account of the difficulties which have confronted many less developed countries in making necessary exchange rate adjustments. While the Fund has always favored full and adequate action, it has supported less than ideal adjustments when there was a clear indication that they represented a distinct improvement over the previous situation and when, moreover, it could be expected that they would be followed by further moves to establish a realistic exchange rate. In every case, the Fund considers the program of stabilization as a whole, in both its domestic and its external aspects. The Fund will continue this approach and will support phased programs of action aimed at several years of adjustment when countries do not find it possible to take immediate and decisive action to adjust a seriously unbalanced situation. In some instances, the early stages may involve multiple rates as strictly transitional devices.

The argument for the continuing application of multiple rates to trade transactions, as has been explained on preceding pages, is based on the idea that exchange rates can be geared to the differing conditions of production of various export commodities and to the need for selective and differential restriction of imports of goods that compete with domestic production and of those considered nonessential. In practice, it is difficult to devise a system where the exchange rates can perform these various functions and the attempt to do so leads to a complex differentiation of the rate structure.

Multiple rate arrangements, since they provide no unified single foreign value of the currency that the authorities seek to support by their domestic policies, tend to raise doubts about the stability of the currency. Moreover, multiple rates do not engender the discipline that a fixed unitary rate does; if, for example, inflationary pressures cause strains in the balance of payments, the policy response tends to make the rate system more complex in the hope of mitigating the strains, rather than to make adjustments in financial policies. As the number or scope of multiple rates is altered for balance of payments reasons, the initial objective of stimulating production selectively is impaired.

Furthermore, since exchange rates established for different transactions frequently can be altered by executive action, producers and traders tend to exercise strong and continuing pressures on the authorities for a more favorable rate treatment; efforts to modify the rate structure to their advantage appear to be an easier way to increase profits than the promotion of efficiency would be. In the past two decades many countries have resorted to multiple currency practices for the purpose of encouraging the expansion of manufactured exports. In general, however, multiple rates have not achieved this purpose. The rate for manufactured exports cannot be chosen in isolation from other rates. A small spread between the rates for traditional and manufactured exports may not be adequate to stimulate the production and export of manufactures. On the other hand, maintenance of a large spread proves difficult as continuous pressures are exercised by exporters of traditional products to obtain a rate similar to that applying to manufactured exports.

Taxes levied directly on exports and imports, on the other hand, are generally established by legislative bodies; adjustments in their levels also tend to be more carefully considered and reviewed. A realistic exchange rate with appropriate taxes thus provides a framework in which producers and traders are more likely to direct their energies to improving the efficiency of their operations in order to maintain and develop markets abroad and at home.

There are strong reasons to believe that a unitary exchange rate which is supported without undue recourse to restrictions can provide an active and dynamic link between the growth of the economy and that of the world at large. It influences the allocation of resources in ways that would help a country to increase its participation in the international division of labor and thereby creates a basis for furthering its development. A higher yield is secured from investments through both concentration on the production of goods in which a developing country has an existing or a potential comparative advantage and more intensive exploitation of the economies of scale as the size of the market widens. Full use of these opportunities is particularly important in a period when world trade has been expanding rapidly.

The experience of a number of less developed countries which have over the past 15 or 20 years maintained realistic exchange rate policies lends strength to this view. It is also reinforced by the experience of a considerable number of other countries, including some nonindustrial countries of Europe, that during the last 10 years or so, and especially in the latter part of the 1950’s, undertook exchange reforms in order to unify multiple exchange rate structures and liberalize trade and payments. In most cases the reform was introduced as part of a comprehensive stabilization program supported with resources from the Fund.

The establishment and maintenance of a realistic exchange rate, linked to appropriate domestic fiscal and monetary policies, have contributed importantly to the ability of both groups of countries to attain, on the whole, a satisfactory rate of economic growth. In some countries whose exports consist of products for which world demand has been buoyant, the export sector has led the growth process. In others, foreign exchange earnings have expanded sufficiently, along with the inflow of foreign capital, to meet the rising import needs of the economy. The increased earnings have resulted not only from a rise in traditional exports but also in many cases from a sizable expansion in exports of manufactured products, and in receipts from tourism. Many of these countries have had successive stand-by arrangements with the Fund in support of programs aimed at restoring or maintaining domestic stability, and avoiding the introduction or intensification of restrictions in the foreign exchange field.

Foreign Demand and Wider Access to Markets

While the Fund believes that growth in export earnings of the less developed countries is of strategic importance for their economic growth and that appropriate exchange policies are essential for export promotion, it recognizes that, in the face of persistent weakness in world prices for its exports, a country may find its efforts in this direction thwarted. It therefore welcomes efforts aimed at dealing with problems associated with the instability of commodity prices.

Although there has been a trend toward reducing import restrictions in industrial countries, the restrictions that remain bear heavily on many of the manufactures that less developed countries seek to export. Some of the highest tariffs are levied by industrial countries on products of light industries, which are relatively labor intensive, employ a simple technology, and in which the less developed countries have an existing or a potential comparative advantage. The restrictive effect of tariffs on manufactures is severe, since rates tend to be higher on manufactures than on semimanufactures and lowest on raw materials. For certain tropical products exclusively produced in the less developed areas, the widening of markets abroad is hindered by high internal taxes in a number of importing countries. The Fund firmly believes that one of the most important contributions that the industrial countries can make to the growth of the less developed countries would be to remove the existing barriers to the importation of goods from these countries. The removal of these barriers would be more beneficial if more of the less developed countries were pursuing realistic exchange rate policies; such policies would enable them to respond to any new opportunities which would be created by the removal of such barriers.

Efforts are being made by the less developed countries to promote various forms of cooperation among themselves as a means of expanding their markets, e.g., trade liberalization, coordination of investment programs, and regional integration of national markets. If the political problems in implementing such cooperative arrangements can be resolved, they can be of advantage, particularly to small countries, as access to a larger market will permit fuller utilization of the economies of scale and greater specialization. These benefits, however, can be reaped only if there is continuing implementation of coordinated financial and exchange rate policies.

1Chapter 3, pages 21-23.
2See below, pages 131-32.

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