Central Banking Technical Assistance to Countries in Transition
Chapter

Statement on Foreign Exchange Operations

Editor(s):
Susana Almuina, Ian McCarthy, Gabriel Sensenbrenner, and Justin Zulu
Published Date:
December 1995
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Our experience with IMF technical assistance started in April 1992. In the broad area of foreign exchange, we have received advice in a number of subjects, including legislation, theoretical considerations for the choice of the exchange rate regime, operational steps to be taken for the introduction of our new currency, and formulation of foreign exchange policy and foreign exchange operations. In the initial two visits, assistance of the collaborating central banks in this area was provided by the Bank of Belgium and, in the subsequent four general advisory missions, by the Swiss National Bank. As you know, the Kyrgyz Republic introduced its new national currency, the som, in May 1993. It would therefore be appropriate to provide an overview of our experience in three parts covering assistance before the decision to introduce the national currency, assistance to prepare its introduction, and assistance after its introduction.

When we received IMF technical assistance for the first time in April 1992, the National Bank of the Kyrgyz Republic had no foreign exchange holdings and performed no foreign exchange operations. Therefore, advice started at the basic level of conveying an understanding of the functions and specific tasks of a central bank in this area and of providing an assessment of the organizational and staffing needs for the prospective tasks. During this initial period one important institutional change was introduced with strong support from the IMF that had important implications in the foreign exchange area. The new central bank law went into effect in December 1992 and, among many other important aspects, laid the foundation for the National Bank to manage the nation’s official foreign exchange reserves. Assistance was therefore requested, and provided, on the development of the institutional capabilities of the National Bank to conduct foreign exchange operations and to manage the nation’s official foreign exchange reserves.

Once the Government had made the decision to introduce the national currency, the pace of assistance was stepped up. Three expert visits dedicated to this subject were arranged by the IMF. We received detailed explanations of the technical aspects of the preparation and guidance on the steps to be taken for the introduction, such as public announcement, distribution, and conversion procedures, as well as guidelines for the production of banknotes, including determination of initial value, denominations, and design. The conversion was successfully implemented in May 1993.

Concurrent with the preparations for the introduction of the som, we held intensive consultations with the IMF on the desirable features of the foreign exchange system to support the new currency. We chose a market-determined floating exchange rate system and introduced a fully liberal exchange system by eliminating all existing restrictions on foreign exchange transactions, current as well as capital account transactions. The exchange system was initially introduced by Presidential Decree, but it is expected that the law will be passed in the current parliamentary session. We believe that the establishment of a market-determined exchange rate and the removal of restrictions have helped instill confidence in the new currency while best serving the underlying economic goals of competitiveness and the rapid development of a healthy and well-functioning foreign exchange market in the Kyrgyz Republic. With IMF and Swiss help, we drew up a model license for authorized foreign exchange banks, a framework for an interbank foreign exchange market, guidelines for the foreign exchange auction by the National Bank, and a code of conduct of the foreign exchange market, which remain the basis of the present foreign exchange system of the Kyrgyz Republic.

Subsequent to the introduction of the som, advice in the foreign exchange area has focused on strengthening the internal organization of the Foreign Exchange Department and building the capacity of the National Bank to formulate foreign exchange policy and conduct foreign exchange operations under the new liberal foreign exchange system. In this context eight projects had been identified with the help of the April-May 1993 mission: (1) establishment of the front office, back office, and analysis and reporting unit as separate organizational units, and setting up of an adequately equipped dealing room; (2) preparation of a general framework for the official foreign exchange reserve management; (3) establishment of training programs for front- and back-office staffs; (4) planning for basic computerization with extensive use of personal computers; (5) establishment of new organizational structure for a two-tier (analytic/synthetic) foreign exchange accounting system; (6) further development and refinement of the principles governing foreign exchange operations by commercial banks; (7) review of the principles for setting net foreign exchange position limits; and (8) review of the reporting requirements of banks in the foreign exchange area.

Progress in implementing these projects has been reviewed by IMF technical assistance missions, which also provided detailed advice for their further development. The Swiss National Bank has provided bilateral assistance in designing investment guidelines for foreign reserves and in extending training to National Bank personnel in Zurich. In spite of our limited resources and our difficult economic situation, progress in executing the above projects has been satisfactory. The Foreign Exchange Department has been reorganized in line with the recommendations, and its staff is now familiar with the daily business of the department.

In addition, advice has been received on how to deal with unexpected problems. For example, the September 1993 mission recommended that we import cash foreign exchange to solve the problem of a shortage of cash foreign currency and the resultant emergence of a large spread between the spot and the cash transaction exchange rates. This large spread is not actually in place at present. The imports contributed not only to narrowing the spread, but also to the improvement of confidence in the national currency.

Although our foreign exchange market is still evolving, a number of encouraging developments have been observed recently. For instance, the spread between the official exchange rate and the retail exchange rate has been narrowed; the spread between the commercial banks’ exchange rate and the parallel market rate has virtually disappeared; commercial banks’ attitude toward the sales of foreign exchange has dramatically changed, and individuals are now readily able to buy foreign exchange at banks; and people have become much less eager to buy foreign exchange for speculative purposes. First steps to establish a forward market have been taken. The National Bank, in particular, carried out swap transactions with a number of authorized banks in 1993 in order to saturate the interbank market with soms and to test forward market mechanisms in the Kyrgyz Republic. We believe that these developments indicate that we are on the right track to a healthy and well-functioning foreign exchange market.

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