5 Foreign Exchange Operations, Markets, and Reserve Management

International Monetary Fund
Published Date:
May 1997
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Dimitri Menchikov

Over the last four years, the transition countries have, on the whole, moved substantially toward more market-based exchange rate arrangements, with a view to promoting both greater economic efficiency and more effective macroeconomic stabilization.

Recent Trends

During 1995, foreign exchange reform and further development of central banks’ exchange operations and reserve management functions have shown significant, if uneven, progress (Table 12). A few countries, however, have slowed down and even reversed the exchange liberalization process.

Table 12.Developments in the Foreign Exchange Area in the Transition Countries in 1995
Exchange Rate Arrangements Policy1Market StructureRegulatory FrameworkCentral Bank Operations
ArmeniaArrangement: independently floating.

Policy in practice: dram has been stable against the dollar since January 1995, with reserve increasing by $25.5 million from the end of 1994 to the end of September 1995. The last semester of 1995 is still preliminary.
Exchange rate unified and cash/noncash spread (almost) eliminated (around 1% now).

Interbank trading permitted (but not developed); but the foreign exchange auction system dominates. although authorities intend to progressively withdraw from this. Frequency of auctions increased to 9 a week.

Bureau market has some 1,400 registered bureaux (down from over 2,000).
Not yet Article VIII status; a few restrictions remain, though many removed during 1995.

Surrender requirements abolished; 100% repatriation requirements.

No capital account restrictions.

Open position limits 40%.
Foreign exchange intervention has been through the auction system.

Coordination with monetary policy.

Reserves management: an investment committee set up, weekly reports developed. Progress in developing strategy and guidelines has been made.

Internal controls and administration: Foreign exchange department adequately organized; national bank’s foreign exchange accounts with local banks closed.
AzerbaijanArrangement: independently floating.

Policy in practice: exchange rate broadly stable against the dollar since late 1994, with reserves increasing to 2.4 months of imports.

A slight tendency to appreciate since the beginning of 1996.
Exchange rate unified.

Interbank trading is prohibited.

All trading occurs at the auctions, which are held 3 times a week.

Cash exchange takes place through bureaux.
Intending to move to Article VIII status.

Surrender requirements to the government abolished.

Export proceeds must be repatriated; 50% of proceeds must be sold at auction.

Some capital account restrictions remain.

Open position limits.
Foreign exchange intervention has been solely through the auction system.

Exchange intervention not undertaken for monetary policy.

Reserves management: national bank made responsible for managing foreign exchange reserves, and the “United Foreign Exchange Fund” was abolished.

Little progress in developing a sound reserves management strategy and implementation guidelines has been made.
BelarusArrangement: other managed floating.

Policy in practice: exchange rate has been stable against the dollar since April 1995. Exchange rate band (Rbl11,300–13,100 to $11 introduced in early 1996, but was ineffective Reserves have declined in recent months.
Exchange unified and cash/noncash spread and restrictions on banks’ cash transactions eliminated.

Interbank trading in noncash foreign exchange at freely negotiated rates was temporarily liberalized, but restricted again in late 1995. Foreign exchange auctions are held daily.

Exchange bureaus serve as a major channel for retail foreign exchange transactions.
Not yet Article VIII status; although some restrictions have been eliminated, others were reintroduced in late 1995, and arrears reemerged.

Surrender requirements: 100% sale of most export proceeds to the auction have been introduced in early 1996.

Repatriation requirements of 100%.

Capital account flows are strictly regulated by the national bank.

There are open position limits for banks.
Foreign exchange intervention has been solely through the auction system.

Foreign exchange intervention and monetary policy needs improvement.

Reserve management centralized at the central banks, and the Foreign Exchange Fund has been abolished. Satisfactory guidelines in respect of currency distribution, acceptable instruments, and limits have been established.

Internal controls and administration: technical preconditions for foreign exchange trading have been met.
EstoniaArrangement: pegged to the deutsche mark.

Policy in practice: currency board arrangement has been successfully maintained, and the exchange rate has been stable. Reserves have increased.
Central bank previously also undertook forward foreign exchange transactions, but these have now ceased.
GeorgiaArrangement: other managed floating.

Policy in practice: exchange rate stable against U.S. dollar since early 1995 with new currency introduced September 1995. Reserves increased to 2.5 months of imports over 1995.
Exchange rate unified.

Interbank trading permitted.

Foreign exchange auction: daily.

Bureaus: Active in cash transactions
Not yet Article VIII status, although current restrictions and multiple currency practices eliminated. Arrears exist, although agreements reached with some creditors.

Surrender requirements eliminated, however, repatriation requirements are retained.

Capital account restrictions also eliminated.

Open position limits are applied but have not been strictly enforced.
Foreign exchange intervention in the foreign exchange auction.

Foreign exchange intervention has been one of the main instruments of monetary management.

Reserves management guidelines have been developed; an investment committee has been established.

Internal controls and administration are being developed.
KazakstanArrangement: independently floating.

Policy in practice: exchange rate has been more stable against the dollar since mid-1995, while net international reserves have built up significantly to several months of imports.
Exchange rate unified, and bureaux rates close to the auction rate; the buy-sell spread is fairly narrow.

Interbank trading is permitted and new accounts for around 30% of daily turnover. The foreign exchange auction system remains with auctions held daily.

Bureaus market is fairly significant, with some 2,000 bureaux.
Authorities intend to accept Article VIII status in the first half of 1996 and intend to eliminate certain remaining restrictions. External arrears have emerged, however.

Surrender requirements were eliminated in August 1995.

Repatriation requirement is 100%, unless license is issued by the national bank and Ministry of Finance.

Capital account transactions require approval from the national bank.

Open position in one currency limited to 30% of a bank’s capital; aggregate open position limited to 50% of a bank’s capital.
Foreign exchange intervention has been exclusively through the auction system. Foreign exchange market monitoring improved.

Coordination with monetary policy at weekly meetings.

Reserves management: National Bank is relatively advanced in management of precious metal reserve and is developing strategy and guidelines for other aspects of reserve management.

Internal controls and administration have been strengthened by a clearer distinction between front and back offices. New software systems to be purchased.
Kyrgyz RepublicArrangement: other managed floating.

Policy in practice: the exchange rate has been stable for over a year, within a band of som 10.5-11.0 per $4, with reserves stable at 2.6 months of imports.
Exchange rate unified.

Interbank trading is permitted, and an interbank market has started to develop, now accounting for 15% of turnover. Foreign exchange auctions held twice a week to channel down funds to the interbank market.
Accepted Article VIII status in March 1995, and system remains fully liberal, without arrears.

No surrender and repatriation requirements.

Capital account restrictions none.

Open position limits introduced in 1993.
Foreign exchange intervention through auctions, including sale of donor funds.

Foreign exchange intervention used in monetary management.

Reserves management has started to strengthen, with establishment of Investment Committee and reserves management guidelines. National bank is now permitted to sell gold holdings, and its obligation to purchase locally produced gold is likely to be abolished in 1996. Good progress being made in strengthening internal controls and administration.
LatviaArrangement: other managed floating.

Policy in practice: the exchange rate has been successfully pegged to the SDR. Reserves declined from $626 million to $540 million (mid-1995), about 3½ months of imports, before recovering to around $600 million in March 1996.
Exchange rate unified interbank trading is becoming increasingly organized and has graduated to a telephone system.Current account transactions remains fully liberal.

Capital account restrictions are minimal.

Open position limits tightened under new law.
Foreign exchange intervention is in the interbank market. Settlement lag for foreign exchange deals reduced to international 2-day standard. Market monitoring has been strengthened.

Reserves management is becoming relatively advanced, and investment committee has been established. Part of reserves managed by outside firm.

Internal controls and administration being strengthened, with a clearer distinction between front and back offices.
LithuaniaArrangement: pegged to U.S. dollar.

Policy in practice: the U.S. dollar rate has been stable reflecting the currency board arrangement. Full cover in gross terms has been maintained.
Exchange rate unified under the currency board arrangement.Accepted Article VIII status in May 1994, and the currency is fully convertible for both current and capital transactions.

Surrender and repatriation requirements have been abolished.
Central bank’s foreign exchange intervention is according to the currency board arrangement.

Coordination with monetary policy is similarly in terms of the currency board arrangement.
MoldovaArrangement: independently floating.

Policy in practice: The exchange rate against the U.S. dollar has been relatively stable, showing a moderate depreciation while reserves have grown significantly to 3.2 months of imports at the end of 1995.
Exchange rate unified

Foreign exchange auctions are held daily; interbank transactions are permitted.

Exchange bureaux are licensed liberally.
Accepted Article VIII status in June 1995.

Repatriation requirement.

Surrender of export proceeds has been abolished.

Capital account transactions remain restricted.

Open position limits.
Foreign exchange interventions have been primarily through auctions but are increasingly in interbank market.

Since more attention has been given to reserve money target at the end of 1995, foreign exchange intervention is well coordinated with monetary policy.

Reserve management is conducted in a secure way, and reserves have grown substantially.

Internal controls and administration: central bank’s dealing operations are properly organized.
RussiaArrangement: other managed floating.

Policy in practice: following the introduction of the exchange rate band in July 1995, the ruble has been relatively stable, showing slight appreciation. Gross reserves have doubled to 2.2 months of imports.
Exchange rates have been unified.

Interbank foreign exchange market has become active; foreign exchange is also sold at daily fixing (MICEX).

Forward and future exchange markets remain thin.
Plans to accept the obligations of Article VIII status this year.

Surrender requirement in use of which 50% is sold to the interbank market.

Capital account restrictions are in effect.

Open position limits exist, but not consistent with international practice.
Foreign exchange interventions are conducted both through the MICEX and the interbank market, with the bulk in the latter.

Reserve management: authorities intend to centralize foreign exchange reserve management at the central bank; some reserves are being held in domestic banks or former Soviet banks abroad.
TajikistanArrangement: independently floating.

Policy in practice: exchange rate depreciated rapidly after the introduction of the Tajik ruble from TR 50 per U.S. dollar in May 1995 to TR 285 in October, but has remained stable since then.

Reserves remain low with the national bank ($4million)
Unified market.

No interbank trading.

Foreign exchange bureau: The national bank operates 16 bureaus.

Foreign exchange auction system: auction system has not run smoothly and has sometimes been halted due to foreign exchange supply shortages. The national bank has started cash auctions.
Payment arrears.

Surrender requirement to national bank was eliminated in February 1996.

Repatriation requirements.

Capital account restrictions.

Open position limits: adequately set by national bank at 5% of capital for any one currency and 20% on aggregate open position.
Foreign exchange interventions: mainly through foreign exchange auctions.

Reserves management: reserves transferred to the national bank from Vneshekonom Bank, except for small amounts needed for daily operations of the government.
TurkmenistanArrangement: independently floating.

Policy in practice: in September 1995, official and commercial exchange rates were devalued and in November the commercial rate was abolished with banks free to set exchange rates with a limit on sales of $ 1,000 a transaction.

Effective January 1, 1996, a unified exchange was established on the basis of the rate at the interbank exchange market (manat 2,400 per U.S. dollar), although the official rate was adjusted to the market rate only once a month. After introducing a dual system in February 1996, the authorities have indicated their intention to devalue the official rate, currently at manat 1,000 per U.S. dollar to approximately the market rate (currently at manat 3,000 per U.S. dollar), during April 1996.

Reserves (gross) had risen to 10 months of imports by the end of 1995.
Commercial rate abolished. Unified rate established from beginning of 1996.

Foreign exchange auction system was reintroduced on January 2, 1996.

Allocation of foreign exchange is subject to official committee decisions.
Current account restrictions: small external payment arrears and a number of bilateral payments arrangements.

Surrender requirements: 70% for gas and oil exports and 50% for all other exports.

Capital account restrictions.

Open position limits, not applied.
Large reserves have been accumulated.

Reserves management mainly focused on one major Western bank. Major part of official reserves held at the Vneshekonom Bank.

Internal controls and administration: the back and front offices at the central bank has been separated, Society for Worldwide Interbank Financial Telecommunication installed.
UkraineArrangement: other managed floating.

Policy in practice: exchange rate was relatively stable against the U.S. dollar, around a more gradually declining trend since early 1995. After an unsettled period in the third quarter especially, the exchange rate ended the year about 70% lower than at the beginning. Gross reserves remained at less than one month’s imports.
Interbank trading outside the auctions was permitted from early 1995, and by year-end the volume of interbank transactions exceeded the volumes in the auctions.

Bureau market is quite active, and bureau premium over auction rates has been reduced.
Not yet Article VIII status; bilateral payments arrangements maintained, and further external arrears have accumulated. A new law on currency regulation is being prepared.

Repatriation requirement remains, as does a 50% surrender requirement for export proceeds; of the latter, the 10% surrender requirement to the national bank has been changed to surrender to the auction market.

Capital account restrictions remains.

Open position limits are not properly regulated
Foreign exchange intervention has been quite active, aimed at preventing a rapid depreciation, and has been mainly through the foreign exchange auctions held at the organized exchange.

Coordination with monetary policy is achieved in part, and on one side at least, through limits on the national bank’s foreign exchange purchases derived from monetary program targets. Work on strengthening both reserves management and internal controls and administration is under way, and some worthwhile initial progress has been made in modernization.
UzbekistanArrangement: other managed floating.

Policy in practice: currency has been quite stable against the U.S. dollar about a declining trend, since early 1995, with gross reserves maintained at six month’s imports.
Exchange markets not yet fully unified with the margin between auction rates and cash bureau rates widening recently to 25%.

Foreign exchange auctions are run twice a week for 16 authorized banks, with interbank trading permitted outside the auctions.

Bureau market is small.
Not yet Article VIII status. all limits on foreign exchange purchases by residents lifted: liberal and equal access to the auctions, through banks, allowed equally for residents and nonresidents (the former “patent system” for auction access has been eliminated). Restrictive aspects of bilateral payments arrangements have been eliminated.

Proceeds from exports in convertible currencies and receipts in the currencies of the Baltic countries are subject to a 30% surrender requirement. The Russian Federation and the other countries of the former Soviet Union are subject to a 15% surrender requirement.

The central bank may, on a case-by-case basis, permit residents to open and maintain accounts outside Uzbekistan.

Open position limits are in place.
Foreign exchange intervention has been active through the auction system.

Reserves management, for both gold and nonmetallic reserves, is now largely consolidated at the central bank.

Exchange Arrangements and Policy and Regulatory Framework

The exchange rate stability observed in many transition countries of late reflects, operationally, quite active foreign exchange market intervention in some cases. But it has generally been achieved in a more fundamental sense through restrained monetary and fiscal policies, rather than reflecting the type of exchange rate arrangement chosen and the amount of foreign exchange reserves usable for intervention. Nevertheless, it is interesting to note that such stability has been observed in those transition countries that have also maintained or moved further toward liberalized exchange markets.

By contrast, countries that maintained restrictive exchange regimes and lagged in the implementation of exchange reforms also faced depreciation of their nominal exchange rates during 1995. In Turkmenistan and Uzbekistan, currency depreciation and significant spreads between official exchange rates and bureaus and parallel market rates were observed, notwithstanding large holdings of foreign exchange reserves that were frequently used to intervene in the foreign exchange market. In Turkmenistan, recognition of the ineffectiveness of efforts to regulate access to foreign exchange and maintain overvalued official exchange rates led the authorities recently to indicate their intention to revert to an official exchange rate that closely approximates that of the interbank market, unify the exchange rate at the level of the interbank exchange market, and reintroduce a foreign exchange auction system. Similarly, Uzbekistan has also adopted some additional liberalization measures.

Significant progress has been made toward currency convertibility. In addition to the Baltic states, the Kyrgyz Republic and Moldova have accepted the obligations of Article VIII of the IMF’s Articles of Agreement. Russia plans to accept the obligations of Article VIII status this year. Efforts to achieve current account convertibility were also made by Azerbaijan and Kazakstan. Exchange rates were unified and surrender requirements eliminated in Armenia, Georgia, and Kazakstan. In addition, several countries (Armenia, Georgia, the Kyrgyz Republic) have lifted exchange controls on capital account transactions. Adherence to strong stabilization measures contributed to the growth of official foreign reserves in these countries. By contrast, less progress was made toward currency convertibility in Tajikistan, Ukraine, and Belarus, and the latter reintroduced some exchange restrictions. Particularly, active government intervention in the foreign exchange market appeared to be a common feature for these countries, reflected in depleted foreign reserves (which fell in Ukraine and Tajikistan to the equivalent of less than one month of imports), accumulation of external payment arrears, and widespread evasion of foreign exchange controls.

Foreign Exchange Market

Liberalization of exchange controls has had a significant impact on the structure and efficiency of the foreign exchange markets. In most countries, multiple exchange rates and wide spreads have been eliminated with the advent of interbank exchange and auction markets, and bureau markets.

An interbank foreign exchange auction, with the central bank acting as a major supplier to the commercial banks, appears to have served well as a transitional arrangement in an environment characterized by weak emerging banking systems, inefficient payments systems, and unstable or limited supply of foreign exchange in the market. As realistic exchange rates and currency convertibility have been established, auction arrangements have evolved into genuine interbank auctions with dealers trading on both sides of the auction. Auction systems were also extended by increasing auction frequency and opening access to a wider range of participants. For example, Armenia, Belarus, Georgia, Kazakstan, and Moldova have moved to daily auctions; the frequency of auctions was increased to three times a week in Azerbaijan, and to twice weekly in Uzbekistan; Turkmenistan, Tajikistan, and Ukraine reopened interbank foreign exchange auctions, previously suspended; Armenia established two additional auction centers with the objective of encouraging competition and reducing bid and offer spreads. It therefore joined Russia as the only other CIS country with regional auction centers. In a number of countries, auction sessions are not held on a daily basis and transactions outside the auction are limited to the exchange bureau operations. By permitting the banks to trade in foreign exchange on the days when no auctions are held, the authorities effectively promote continuous foreign exchange trade and the interbank market.

Favorable conditions for the development of interbank foreign exchange markets have been created in the Baltics, Kazakstan, Moldova, Russia, and in the Kyrgyz Republic through eliminating or lowering surrender repatriation requirements, introducing regulation on open position limits and prudential standards, improving payments systems, and strengthening correspondent banking relations. Such limits are set in most transition countries, but the calculation and monitoring of the limits vary significantly across the countries. Some have adopted and implemented adequate open position regulations (Estonia, Kazakstan, the Kyrgyz Republic, Moldova, Tajikistan, and Uzbekistan). In other countries, the regulations are ambiguous or do not comply with international norms—for example, Belarus and Russia. In Armenia, Azerbaijan, and Kazakstan, the limits are high (40 percent, 30 percent, and 50 percent, respectively, of the bank’s capital base), and while Georgia and Latvia have adequate regulations, they have not enforced them strictly. Open foreign exchange positions are not regulated in Turkmenistan and Ukraine.

In Latvia, foreign exchange dealing has graduated to a telephone-based system, a new law on credit institutions has tightened regulations on open foreign exchange positions, and interbank market participants have started weekly meetings. In Russia, where 50 percent of export surrender requirements could be sold in the interbank market from late June 1995, the share of the interbank market has increased to 80 percent of total exchange transactions (including MICEX) from 70 percent at the end of 1994.

In Ukraine, in the space of barely a year, interbank trading has gone from being prohibited to being larger than auction turnover. In Moldova, Kazakstan, and the Kyrgyz Republic, the share of interbank transactions in total exchange market operations has grown to 65, 30, and 15 percent respectively. Other countries have also made progress toward the establishment of the interbank markets by liberalizing interbank transactions outside auctions, either fully (Armenia) or partially. In some other countries where such transactions were not restricted, interbank market exchange transactions were impeded by weaknesses in the banking and payments systems.

Developments in exchange bureaus varied across countries but such institutions continued to be an important element in liberal exchange systems and served as a major channel for retail foreign exchange transactions. For example, in Kazakstan, the number of exchange bureaus has continued to grow (to reach 2,000); while in Armenia, increased competition and, in some cases, failures of banks to whom they belonged resulted in a decline in the number of bureaus by over one-third. In Uzbekistan, the number of bureaus has not changed much notwithstanding the liberalization of invisible transactions that in many other countries triggered a rapid growth in this market. Exchange bureaus there are owned by a few banks.

Central Bank Foreign Exchange Operations

In many countries, further progress has been made in the organization of the foreign exchange department, reserve centralization, and reserve management operations at the central banks.

In addition to the Baltic states, Russia, and Moldova, an adequate organization of foreign exchange departments has been generally completed in Armenia, Belarus, Georgia, Kazakstan, and the Kyrgyz Republic. Further steps in separating the front and back offices and streamlining operations of the foreign exchange department has been achieved in the central banks of Turkmenistan and Ukraine. In Latvia, further improvements in the efficiency of the foreign exchange department have resulted in the settlement period for foreign currency transactions dropping from five to two days. Close and frequent contacts with the market participants on all levels have also secured a better level of information on the situation in the market.

In almost all transition countries, the process of centralization of official foreign exchange reserves at the central bank has been completed. The Russian authorities intend to complete centralization of official reserves at the central bank in 1996. Tajikistan and Turkmenistan still have to complete the process.

Improvements in foreign exchange reserve management have been evident in most countries. To define the investment policy, Investment Committees have been formed in Armenia, Georgia, the Kyrgyz Republic, and Latvia. Reserve management guidelines recommended by the IMF have been reviewed in Latvia and are planned to be implemented in Georgia. Belarus has made progress in reserve management with regard to the maturity structure and currency composition of foreign exchange assets. The Bank of Lithuania has stopped the practice of pledging official foreign reserves as a collateral for the loans to the energy sector and has completed steps necessary for the release of pledges made earlier. The Bank of Estonia has ceased its forward operations. In Armenia, the central bank has closed its foreign exchange accounts with local banks. Kazakstan has started to apply some advanced techniques in managing precious metals reserves, and Latvia designed a system of currency exposure management on a net basis with real-time reporting of exposures. However, many weaknesses in reserve management systems are still evident. Such weaknesses often relate to exposures to particular institutions, or management of currency and interest rate risks. They sometimes also relate to internal controls and accounting and auditing procedures. For example, some part of official reserves in Azerbaijan, Belarus, and Russia are held with domestic banks, while Turkmenistan has concentrated its reserves with one major bank abroad. Russia has maintained part of its foreign reserves with Russian commercial banks established abroad.

Foreign exchange intervention operations have been active in those central banks that manage a floating exchange rate. In several countries, foreign exchange market intervention has substituted for domestic money operations reflecting the relatively underdeveloped nature of domestic markets and instruments. In countries that still have surrender requirements to the central banks, the need for central bank intervention in the foreign exchange market may be, in part, a direct result of such surrender. Coordination with monetary management, however, continues to be an issue in a number of countries (Armenia, Azerbaijan, Russia, and Tajikistan), not least because larger-than-anticipated foreign capital inflows are occurring in some cases. More generally, it is critical that foreign exchange policies be supported by the development of more active domestic liquidity management.

Priority Areas for Reform

The priority areas for reform in the foreign exchange operations of the central banks in the near future include (1) interbank market development, including convertibility issues (Table 13); (2) strengthening reserve management and (3) coordinating foreign exchange and monetary operations.

Table 13.Priorities for Future Reforms in the Foreign Exchange Area
ArmeniaAzerbaijanBelarusEstoniaGeorgiaKazakstanKyrgyz RepublicLatviaLithuaniaMoldovaRussiaTajikistanTurkmenistanUkraineUzbekistan
Interbank foreign exchange market
Adequate exchange regulations for interbank marketXX
Permission of outside auction transactionsXXXXX
Modification of surrender requirementXXXX
Exchange system supervisionXXX
Open position limitsXXXXXX
Reporting on foreign exchange transactionsXXXXXXXX
Market developmentXXX
Adoption of code of conduct and market rulesXXXXXXX
Training foreign exchange dealersXXXXXXX
Bringing settlement procedures in line with
international standardsXXXXX
Establishing foreign exchange
dealers associationXXXXX
Exchange bureaus
Providing access to interbank/auction marketXX
Permitting nonbank exchange bureausXX
Foreign exchange reserve management
Reserve management guidelinesX
Centralization of reserve
management at central bankXXXXXX
Management of credit risk and interest rate riskXXXXXXXX
Reserve management operationsX
Establishing of investment benchmarksXXXXXXX
Terminating reserves placement
with domestic banksXXXXX
Setting reporting proceduresXXXXX
Reserve management seminars
and training programsXXXXXX
Streamlining correspondents networkXXXXXX
Separation of back and front officesXXXXXX
Liquidity, safety, and structure of reservesXXXXXXX
Accounting and valuation
of foreign exchange reservesXXXXXX
Establishment of Investment CommitteeXXXXXX
Exchange and monetary operations coordination
Harmonization of a decision-making processXXXXXXX
Information exchangesXXXXXX
Development of intervention policy and guidelinesXXXXXXX
Intervention sterilization policies and techniquesXXXXXXXX
Current account convertibilityX
Elimination of exchange restrictions
including bilateral payments arrangementsXXXX
Adoption of new foreign
exchange laws or regulationsXXX
Acceptance of Article VIII obligationsXXXXXXXXX
Capital account convertibilityXXXX

Interbank foreign exchange markets should be further developed in all transition countries. So far, progress in implementing codes of conduct for dealers, establishing necessary reporting procedures on transactions, and enforcing adequate open position limits have been limited. Central banks may also need to improve the regulatory framework for the interbank market by permitting transactions outside auctions and by eliminating surrender requirements or shifting the requirements to the interbank market. In addition, the development of interbank exchange markets will also depend critically on the progress with strengthening domestic banking and payments systems, as well as the training of market participants, including central bank staff on foreign exchange intervention procedures.

Success in developing an efficient foreign exchange market also hinges on progress in liberalizing the exchange system. The authorities should continue to move toward current account convertibility (including acceptance of Article VIII) and the liberalization of capital account transactions. Some countries will need to establish improved legal frameworks for exchange transactions, and for foreign direct investment flows, and facilitate strengthened domestic financial markets and institutions, consistent with the liberalization of their capital accounts. Consideration should be given to the strategy for capital account liberalization.

Implementing prudent reserve management guidelines and operational procedures should continue to be a priority, given the growing size of the international reserves managed by the central banks. Greater attention will need to be placed on training. Proper accounting and valuation practices, and development of back offices also remain important areas of future work.

Continuing attention will need to be paid to strengthening central banks’ foreign exchange intervention policy and practice and coordination with monetary policy. Lack of coordination significantly weakens the effectiveness of monetary and exchange policy. At an organizational level, coordination should involve routine information exchanges, appropriate procedures for decision making, and if necessary, organizational changes to integrate monetary and exchange operations areas. At a more fundamental level, the central banks will need to be increasingly cognizant of the trade-off between interest rates and exchange market interventions in the ongoing pursuit of price stability, as well as in the adjustment to significant exogenous shocks.

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