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Pegging to the SDR: The experience of four Middle Eastern states is discussed

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
March 1976
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Andreas S. Gerakis

Since the introduction of generalized floating in March 1973, there have been substantial fluctuations in world currency markets. In particular, the U. S. dollar, the pound sterling, and the French franc registered wide movements against each other and the rest of the major currencies. The value of the U. S. dollar, for example, has gone up or down seven times in relation to the European snake, varying by 10 per cent or more; at one time, between July 1973 and January 1974, the appreciation of the dollar in terms of the deutsche mark was about 20 per cent.

In this period of turbulent conditions for the world economy, these fluctuations have created problems for the majority of Fund members that have been linking their exchange rates to particular currencies. Some of the countries experiencing balance of payments deficits and certain others subject to strong inflationary pressures have been particularly affected. The former have tended to make their situation worse by pegging to appreciating currencies and the latter by tying their exchange rates to depreciating ones.

Various options are available to deal with the disadvantages of a single-currency peg. One can continue the peg and devalue or revalue against the intervention currency either in one large step or in several discrete steps, based perhaps on a formula taking into account price, balance of payments, and other developments. Alternatively, one can abandon the link to a single currency, in which case two different courses of action are open—to float independently or to peg to a basket of currencies. The merits and demerits of these alternative policies have been comprehensively covered elsewhere and need not be discussed here.

Pegging to a basket of currencies

The majority of countries now pegged to a basket are using their own composite reflecting the pattern of their trade with the outside world. However, the procedures applied in this type of a peg are quite complicated. Inter alia, they involve the selection of currencies to be included in the composite and the weights to be attached to each currency. In addition, the country concerned must have a formula to compute the changes in exchange rates which will stabilize the value of its currency in terms of its basket.

Pegging to the SDR is a much simpler matter. It involves two essential elements: to determine a parity With the SDR, and to ensure that the available margins of up to 2.25 per cent on each side of parity are not violated, given the rates set for individual foreign currencies. A numerical example will serve to illustrate these points. Suppose that country A decides to apply a parity of SDR 1 = 5 units of its domestic currency (DC). If so, the margins within which the DC must be maintained are SDR 1 = DC 5.1125 (the upper margin for the SDR and lower margin for the DC) and SDR 1 = DC 4.8875 (the lower margin for the SDR and the upper margin for the DC). Let us now suppose that on a given date the SDR/dollar rate computed by the Fund is SDR 1 = US$1.25. Then the spot rates for the dollar must be in the range of US$1 = DC 4.09 (obtained by dividing 5.1125 by 1.25) and US$1 = DC 3.91 (= 4.8875÷1.25).

What are the considerations on the basis of which a country should choose between a peg to its own composite and a peg to the SDR? The main argument for the former arrangement is that it is better suited to the country’s individual circumstances. On the other hand, as the latter alternative is simple, it is easier to administer. Another important advantage of an SDR peg is that it offers certainty and creates confidence in the exchange system, particularly so if compared with a basket of undisclosed composition. Moreover, a peg to the SDR is superior from the international standpoint in that it would in principle, assure constancy between the cross rates of the pegging countries.

Experience of four countries

So far up to September 1975 (the cutoff date for this article) seven Fund members are, or have been, pegged to the SDR. Burma initiated its peg in January 1975; Iran, Jordan, Qatar, and Saudi Arabia followed in February and March; Malawi in June; and Guinea in July. However, since September 9, 1975 Saudi Arabia has not been maintaining the margins of 2.25 per cent and its currency is now technically classified as floating for the purposes of the Fund’s guidelines. The following paragraphs are a study of the experience of Iran, Jordan, Qatar, and Saudi Arabia.

In order to understand the reasoning which led these four countries to give up their peg to the U. S. dollar and link themselves to the SDR, it should be recalled that all of them have been plagued by a serious problem: inflationary pressures generated by their efforts to accelerate economic development and raise living standards as well as by sharp, concurrent increases in import prices. Consequently, they were disturbed by the depreciation of the U. S. dollar which started in the last quarter of 1974 and continued during the first two months of 1975. Furthermore, these particular countries had no reason to fear the balance of payments repercussions of any appreciation of their currencies resulting from an abandonment of their link to the dollar. All four have substantial surpluses in their external accounts; Iran, Qatar, and Saudi Arabia have benefited from the increase in oil prices, particularly since the beginning of 1974, while Jordan has been on the receiving end of sizable transfers and capital inflow from some of the oil exporting nations. It is ironic that since the four countries acted to offset the downward movement of the U. S. dollar that currency has reversed its direction. From a low of SDR 1 = US$1.26132 on February 27, 1975 the dollar has been rising, slowly at first but faster more recently; it reached a level of SDR 1 = US$1.18288 on September 15,1975.

Jordan pegged to the SDR in mid-February 1975, at a rate of JD 1 = SDR 2.57895; in this and the other cases discussed here the new parity was the same as the existing par value. The Jordanians, like the Iranians, Qataris, and Saudi Arabians, continued to avail themselves of the wider margins of 2.25 per cent, so that the upper and lower limits of the dinar in terms of the SDR are JD 1 = SDR 2.63698 and JD 1 = SDR 2.52092, respectively. In setting their exchange rate against the U. S. dollar, on any given date, the Jordanian authorities appear to be applying the following formula: they probably multiply the SDR rate in terms of the dollar for the previous day, say $1.25 (which they receive by telex from the Fund), by the parity of the dinar, that is, SDR 2.57895. However, they may also be making minor adjustments to the figures thus computed on the basis of certain secondary considerations. The evidence in Table 1 seems to confirm that this has been the procedure used. The table shows for selected dates between February 10 and September 15, 1975, the representative rate for the Jordanian dinar, i.e., the midpoint between the central bank’s buying and selling rates for the U.S. dollar, and the rate for the SDR calculated by multiplying the representative rate by the SDR/dollar rate for the previous day (with the Friday rate being used for Saturdays, Sundays, and Mondays). As indicated by the data, there have often been deviations from the parity rate for the SDR, but these have usually been small; the largest one was on March 1, and it amounted to 1.1 per cent.

Table 1Jordan and Qatar: rates for U. S. dollar and rates for SDR on selected dates in 1975
Representative rateRate for SDRRate for U.S. dollar2Rate for SDR2
Dates1(In U.S. dollar per Jordan dinar 1)(In SDRs per Jordan dinar 1)(In Qatar riyals)
(1)(2)(3)(4)
February103.17462.5723
113.19492.5826
March13.21542.5511
183.21542.56523.94744.9479
193.21542.56013.79094.7613
April163.17462.56413.84664.7624
June253.19492.56963.85454.7925
303.19492.57583.82554.7444
July243.11532.59633.96874.7620
303.07692.57703.98764.7612
313.05812.55763.98264.7621
August73.07692.57993.99304.7622
143.05812.57814.01424.7616
213.07692.57993.99384.7633
283.06752.58204.00194.7544
Sept.43.05812.57994.00784.7621
153.05812.58244.01744.7574

Includes dates on which maximum deviations from SDR parity were observed.

Qatar’s intervention currency is the pound sterling and the Qatar Monetary Agency quotes buying and selling rates only for that currency. The midpoint of these rates multiplied by the sterling/SDR rate of the previous day (Friday rate for Saturdays, Sundays, and Mondays) gives the riyal/SDR rate shown In col. (4). The rate for the U.S. dollar shown In col. (3) has been obtained by dividing col. (4) by the corresponding dollar/SDR rates of the previous day (Friday rate for Saturdays, Sundays, and Mondays).

Note: The parity rate of the Jordan dinar in terms of the SDR is JD 1 = SDR 2.57895 and the upper and lower margins (or the dinar are JD 1 = SDR 2.63698 end JD 1 = SDR 2.52092, respectively. The parity for the Qatar riyal in terms of the SDR is SDR 1 = QR 4.7619; the upper and lower margins for the riyal are SDR 1 = QR 4.65476 and SDR 1 = QR 4.86904, respectively.

Includes dates on which maximum deviations from SDR parity were observed.

Qatar’s intervention currency is the pound sterling and the Qatar Monetary Agency quotes buying and selling rates only for that currency. The midpoint of these rates multiplied by the sterling/SDR rate of the previous day (Friday rate for Saturdays, Sundays, and Mondays) gives the riyal/SDR rate shown In col. (4). The rate for the U.S. dollar shown In col. (3) has been obtained by dividing col. (4) by the corresponding dollar/SDR rates of the previous day (Friday rate for Saturdays, Sundays, and Mondays).

Note: The parity rate of the Jordan dinar in terms of the SDR is JD 1 = SDR 2.57895 and the upper and lower margins (or the dinar are JD 1 = SDR 2.63698 end JD 1 = SDR 2.52092, respectively. The parity for the Qatar riyal in terms of the SDR is SDR 1 = QR 4.7619; the upper and lower margins for the riyal are SDR 1 = QR 4.65476 and SDR 1 = QR 4.86904, respectively.

The Qatari authorities initiated their peg to the SDR on March 19, 1975 at a parity rate of SDR 1 = QR 4.7619. On the same date, the Qatar riyal was appreciated by 4.1 per cent against the U. S. dollar; this may be viewed as a necessary realignment since the U. S. dollar/riyal rate had fallen out of line with the parity for the SDR. The subsequent policy of the authorities was very much like that of the Jordanians. Specifically, the riyal was maintained close to the parity level (see Table 1). In point of fact, its deviations from parity have been even smaller than the dinar’s, the maximum difference on June 25 being equal to about 0.6 per cent. This result was achieved by making frequent, almost daily, changes in the buying and selling rates for Qatar’s intervention currency, which was the pound sterling.

On February 12, 1975 the Iranian authorities linked the rial to the SDR at a rate of SDR 1 = Rls 82.2425 and announced that they would adjust their buying and selling rates for the U.S. dollar, the only currency quoted officially, whenever the implied rial/SDR rate fell outside the relevant margins for five consecutive business days. On the above date, the representative rate for the U.S. dollar was US$1=Rls 67.625 (Table 2) and the corresponding rate for the SDR was SDR 1 = Rls 83.6577, close to the lower margin for the rial of SDR 1 = Rls 84.0929. The buying and selling rates were US$1 = Rls 67.500 and US$1 = Rls 67.750, as the spread between them has always been equal to Rls 0.250 over the period discussed. In the next five business days the selling rate for the U.S. dollar converted at the corresponding SDR/U. S. dollar rate fell outside the lower margin. Accordingly, the buying and selling rates were adjusted and the representative rate became US$1 = Rls 66.641. The new rates were kept unchanged for about five months and, due to the appreciation of the dollar, the rial moved to its upper margin of SDR 1 = Rls 80.39210. From July 23 the Iranian authorities depreciated their dollar rates five times, to levels slightly below those on February 12. These changes did not prevent deviations above the rial’s upper margin, but all such deviations lasted less than five business days.

Table 2Iran and Saudi Arabia: representative rates for U. S. dollar and rates for SDR on selected dates in 1975

(In Iranian rials and Saudi Arabian riyals)

IranSaudi Arabia
DatesRepresentative rateRate for SDRRepresentative rateRate for SDR
February1167.62583.6587
1267.62563.8739
2066.64183.0466
March1466.64183.41713.5504.4437
1566.64183.45523.4704.3455
April3066.64182.73083.4904.3246
May3166.64183.08923.4904.3514
June3066.64182.64753,4904.3283
July1766.64180.74563.5004.2408
2366.89180.68123.5004.2216
2466.89180.01053.5104.2116
2867.37580.86703.5104.2126
3067.37580.44643.5204.2029
August267.37580.00833.5204.1917
467.72580.50013.5204.1917
967.87580.59823.5204.1798
1067.87580.59823.5304.1917
1268.02580.63483.5354.1903
1368.02580.72263.5304.1889
2168.02581.13073.5204.1982
2668.02580.79603.5304.1927
Sept.268.02580.66543.5354.1987
468.02580.82663.5304.1943
868.02580.74303.5304.1900
1568.02580.5552
Note: The parity rate for the Iranian rial In terms of the SDR is SDR 1 = Rls 82.2425 and the upper and lower margins for the rial are SDR 1 = Rls 80.3921 and SDR 1 = Rls 84.09296, respectively. While the Saudi Arabian riyal was pegged to the SDR its parity rate was SDR 1 = SRIs 4.28255 and its upper and lower margins were, respectively, SDR 1 = SRIs 4.1862 and SDR 1 = SRIs 4.3789.
Note: The parity rate for the Iranian rial In terms of the SDR is SDR 1 = Rls 82.2425 and the upper and lower margins for the rial are SDR 1 = Rls 80.3921 and SDR 1 = Rls 84.09296, respectively. While the Saudi Arabian riyal was pegged to the SDR its parity rate was SDR 1 = SRIs 4.28255 and its upper and lower margins were, respectively, SDR 1 = SRIs 4.1862 and SDR 1 = SRIs 4.3789.

Saudi Arabia’s link to the SDR became effective on March 15, 1975 at a parity of SDR 1 = SRls 4.28255. Simultaneously, the buying and selling rates for the U. S. dollar were appreciated by a little more than 2 per cent, to bring them within the lower margin for the riyal in terms of the SDR (see Table 2). Subsequently, the policy of the Saudi Arabian authorities was similar to that of the Iranians; there was only one change in these rates until the middle of July, with the result that the riyal appreciated to its upper margin vis-à-vis the SDR. In the next two months the dollar rates were lowered seven times, but there were also three small increases on occasions when the authorities felt they had some elbow room. Despite these changes, the upper margin for the riyal was exceeded on several occasions. Saudi Arabia has recently informed the Fund that, as from September 9, the riyal would be maintained within margins somewhat wider than 2.25 per cent from the existing parity but not exceeding 7.25 per cent. On September 15, 1975 the actual deviation of the representative rate from parity was equal to about 2.4 per cent.

There have probably been two reasons which prompted the Saudi Arabian authorities to terminate their peg to the SDR. One could have been that they wished to reduce the frequency of changes in the riyal/dollar rate. More importantly, they were concerned that the depreciation of the riyal vis-à-vis the dollar, necessitated by efforts to keep within the relevant margin, was contributing to inflation. This depreciation against one foreign currency was being offset, and perhaps more than offset, by an appreciation in terms of the currencies of Saudi Arabia’s other trading partners. Nevertheless, given the monopolistic organization of the import trade in Saudi Arabia, as in other developing countries, exchange rate developments probably have asymmetrical effects on the price level. Domestic prices of goods imported from the United States are likely to be increased in step with a decline in the value of the riyal compared with the dollar, while prices of imports from countries against whose currencies the riyal is rising may remain unchanged: Furthermore, the rate for the dollar may be of special psychological importance to the Saudi Arabian business community.

Exchange structure

On the basis of the data in Table 3 it is possible to make a number of general observations regarding the principal effects of an SDR peg on the actual structure of exchange rates. In the first place, as shown in the table, the changes in the effective exchange rates of the Iranian rial, the Jordan dinar, the Qatar riyal, and the Saudi Arabian riyal, computed on the basis of import weights, were quite close to the corresponding changes in their rates against the SDR—remarkably close considering that the period covered was one with substantial swings in the major currencies. Thus the SDR alternative gave these countries a degree of effective appreciation or depreciation as well as a level of exchange rates very similar to those which would have resulted from a link to an import weighted basket—on the assumption, of course, that comparable policies with respect to margins would have been followed in both instances. Incidentally, in view of the argument made earlier regarding the choice between alternative pegs, this similarity of results suggests that the four countries made the right decision in linking their currencies to the SDR rather than to their own composites.

Table 3Changes in four currencies in terms of composites and major world currencies 1

(In per cent)

Change inChange In terms of
Effective exchange rate (1)Rate for SDR (2)U. S. dollar (3)Pound sterling (4)Deutsche mark (5)Japanese yen (6)
Actual exchange rates
Jordan dinar0.20.0–4.38.55.9–2.6
Qatar riyal0.80.1–5.77.95.1–2.0
Iranian rial5.43.9–0.612.39.91.1
Saudi Arabian riyal3.04.0–1.712.29.31.9
Hypothetical exchange rates assuming peg to U.S. dollar
Jordan dinar4.74.50.013.310.61.7
Qatar riyal6.55.80.014.211.13.6
Iranian rial6.04.40.013.310.61.7
Saudi Arabian riyal4.75.80.014.211.13.6

For Jordan dinar and Iranian rial, changes between February 12 and September 8; for Qatar riyal and Saudi Arabian riyal, changes between March 12 and September 8.

Note: The percentages shown in columns (4), (5), and (6) in the lower part of the table cannot be obtained by adding the percentages of depreciation against the dollar and the percentage changes In terms of the other currencies shown in the upper part. They are derived as In the following example: Say, that one Saudi Arabian riyal was equal to $0.2882 and £0.1196 on the base date and to $0.2833 and £0.1342 on the terminal date for the calculation. Then14.2=(0.28820.28330×0.13420.1196)1(withdueallowanceforrounding).

For Jordan dinar and Iranian rial, changes between February 12 and September 8; for Qatar riyal and Saudi Arabian riyal, changes between March 12 and September 8.

Note: The percentages shown in columns (4), (5), and (6) in the lower part of the table cannot be obtained by adding the percentages of depreciation against the dollar and the percentage changes In terms of the other currencies shown in the upper part. They are derived as In the following example: Say, that one Saudi Arabian riyal was equal to $0.2882 and £0.1196 on the base date and to $0.2833 and £0.1342 on the terminal date for the calculation. Then14.2=(0.28820.28330×0.13420.1196)1(withdueallowanceforrounding).

In contrast, the exchange rates determined by the SDR peg were quite different from those which would have resulted from a, continuation of the policy to link to the U. S. dollar. Had these four Middle Eastern countries maintained their rate against the dollar, their currencies would have appreciated by 13.3–14.2 per cent against the pound sterling (depending on the initial and terminal dates of the period covered in Table 3 for each of the four countries), by 10.6–11.1 per cent against the deutsche mark, and by 1.7–3.6 per cent against the Japanese yen. Furthermore, the overall appreciation in their effective exchange rates would have been of the order of 4.7–6.5 per cent. In fact, by pegging to the SDR, they depreciated in terms of the dollar and appreciated less against the other currencies—the Jordan dinar and the Qatar riyal depreciated slightly in terms of the yen. Their appreciation in effective terms was considerably smaller than it would have been under a dollar peg.

As indicated earlier, Jordan, Qatar, Iran, and Saudi Arabia followed two different policies. Whereas the former two stayed close to their respective parities, the latter permitted their currencies to move up from the lower to the upper margins of the bands around the SDR and then pegged them to those upper margins. As a result, Iran and Saudi Arabia depreciated less than Jordan and Qatar in terms of the U. S. dollar, while appreciating more against other currencies and in effective terms. By way of evaluation, one should say that the Jordanian/Qatari approach was more in the nature of an unqualified SDR peg. However, the policy of Iran and Saudi Arabia served better their original objective of arresting inflationary pressures.

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