IMF History (1966-1971) Volume 1

Chapter 14: Compensatory Financing Extended and Liberalized

International Monetary Fund
Published Date:
February 1996
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Compensatory Financing started on an upward course in the years after 1965. The arrangements for compensatory financing of export fluctuations that the Fund had introduced in February 1963, and which had been little used, were extended and liberalized in 1966, and, when world prices for primary products declined in 1966–68, developing countries began to turn to these arrangements for financial assistance. Again, in the latter part of 1971, despite an extraordinary boom in commodity markets, an upsurge in compensatory drawings began to take place. As 1971 came to an end, several officials from developing countries were recommending further liberalizations in the Fund’s compensatory financing facility, recommendations which were harbingers of more extensive changes in the facility in years to come.

The Changes of 1966

The changes in the Fund’s compensatory financing arrangements that were made in 1966 were an offshoot of the discussions on international liquidity. When it appeared possible that any new scheme for deliberate creation of reserves might be limited to the few big industrial countries, representatives from some of these countries suggested that the Fund liberalize its policies on the use of its resources by developing members. Attention focused particularly on the compensatory financing facility. Reference has already been made in Part One to proposals along these lines made by the United Kingdom in 1965. These suggestions by the industrial countries paralleled similar calls for modifying the Fund’s compensatory financing facility by the Unctad in 1964 and by a number of Governors for developing countries at the Fund’s Annual Meeting in 1965.

As an aftermath of these recommendations, the Executive Board, in September 1966, after careful consideration, decided to extend and liberalize the compensatory financing facility.1 Since this action was reported in the earlier history, only the principal changes that were made in the facility will be noted here.2

First, the limit on outstanding drawings under the facility, which had been 25 per cent of a member’s quota, was extended to 50 per cent. Except for export shortfalls resulting from disasters or major emergencies, however, outstanding compensatory drawings could not increase by more than 25 per cent of a member’s quota in any 12-month period.

Second, when export shortfalls were calculated, greater weight than previously was to be given to qualitative estimates. Where countries had a rising trend of exports, explicit account was to be taken of this fact in calculating what were considered export shortfalls. In effect, if exports were not increasing at a sufficient rate, a shortfall in exports could be presumed to exist.

Third, compensatory drawings were separated from the other drawing facilities of the Fund in the sense that the amount of outstanding drawings that a member had under the compensatory financing facility was not to affect its ability to draw under the Fund’s other policies. The compensatory financing facility was to float alongside the credit tranches. The importance of this change was that compensatory drawings were no longer to affect the policy criteria applied to a member’s subsequent request for a regular drawing. Otherwise, later regular drawings would be subjected to the more severe criteria pertinent to drawings in the higher credit tranches.

Fourth, a member that made an ordinary drawing was permitted later to reclassify that drawing as one made under the compensatory financing facility. Such reclassification had to take place within six months of the initial drawing and the member had to meet the requirements for a compensatory drawing of the same amount at the time of the reclassification. In this way, the member’s other drawing rights could be restored for use for regular drawings, or for a new stand-by arrangement upon the expiration of an existing stand-by arrangement.

Fifth, a change was made regarding repurchases. Members making drawings under the compensatory financing facility were expected to repurchase within three to five years, just as with regular drawings. But the 1966 decision included a provision (paragraph 7) linking repurchases of compensatory drawings more closely to the recovery of a member’s exchange earnings, rather than making such repurchases subject to the usual three-to-five-year rule. It was provided that as soon as possible after the end of each of the four years following a compensatory drawing a member should, on the basis of a statistical determination that there existed what was called “excess exports” and on the basis of a recommendation by the Fund, repurchase an amount approximately equal to one half of the amount by which the member’s exports in value terms exceeded, in the special language of the compensatory financing arrangements, the “medium-term (five-year) trend value” of its exports. However, the Fund’s recommendation did not impose a legal obligation on the member to repurchase. The change regarding repurchases emphasized that use of the compensatory financing facility was geared to developments in a country’s exports: through use of a statistical formula, not only were drawings associated with shortfalls in export earnings but repurchases were expected when export earnings exceeded a medium-term trend.

After the decision setting up the original compensatory financing facility was amended, members began to use the reclassification procedure. They also continued to use stand-by arrangements to alleviate general balance of payments deficits, deficits which were attributable in part to shortfalls in export earnings. Because a member could draw from the Fund for an export shortfall either under the policies governing regular drawings or under the compensatory financing facility, it was necessary to ensure that the sum of any drawings made with respect to a given shortfall did not exceed the amount of the shortfall. In other words, “double compensation” had to be avoided. In the first half of 1967 the staff suggested some techniques for preventing double compensation; these were agreed by the Executive Board in August 1967.3

Another decision relating to compensatory drawings was taken in June 1969, when the Fund approved an arrangement to assist members in financing contributions to international buffer stocks of primary products: it was decided to place a joint ceiling on drawings under the new buffer stock facility and those under the compensatory financing facility. Drawings under either facility could amount to the equivalent of 50 per cent of quota, but drawings under the two facilities taken together could not exceed 75 per cent of quota.4

Usage Increases

After the compensatory financing facility was introduced in 1963, prices of many primary commodities turned sharply upward. Consequently, only three members made use of the facility during the first three years of its existence—Brazil and Egypt in 1963 and the Sudan in 1965, for a total of $87.25 million.5

In contrast, there was a notable acceleration of compensatory financing purchases almost immediately after the arrangements were extended and liberalized in September 1966. The Dominican Republic and Ghana drew amounts totaling $23.85 million in December 1966. Then, in the course of 1967 nine members—Burma, Ceylon, Colombia, Haiti, Iceland, India, Iraq, New Zealand, and the Syrian Arab Republic—all drew for a total of nearly $200 million. And in the first half of 1968 purchases under the facility were made by Afghanistan, Ceylon, Colombia, Egypt, Guatemala, and Uruguay for nearly $65 million; Colombia, Guatemala, and Iraq took advantage of the provision in the amended decision permitting part or all of other drawings to be reclassified as drawings under the compensatory financing arrangements. Table 4 at the end of this chapter gives the details of the transactions carried out under the compensatory financing decision from the time it was taken on February 27, 1963 until April 30, 1972, the end of the last fiscal year of the period covered by this history.

Table 4.Purchases and Repurchases Under Decision on Compensatory Financing of Export Fluctuations, February 27, 1963–April 30, 19721(In millions of SDRs)
PurchasesRelated Repurchases
MemberDateAmountTotalUnder para. (7)Outstanding Balance on April 30, 1972
Dominican RepublicDec.6,19666.606.603.30
El SalvadorDec.16,19696.254.304.301.95
Khmer RepublicMar.14,19726.256.25
New ZealandMay10,196729.2029.20
Syrian Arab RepublicSept.18,19679.507.122.38

Under E.B. Decision No. 1477-(63/8), February 27, 1963, as amended by E.B. Decision No. 2192-(66/81), September 20, 1966, except where noted. The decision as amended is reproduced below, Vol. II, pp. 198–201.

Under E.B. Decision No. 1477-(63/8), February 27, 1963.

Date and amount of reclassification of previous purchases.

Under E.B. Decision No. 1477-(63/8), February 27, 1963, as amended by E.B. Decision No. 2192-(66/81), September 20, 1966, except where noted. The decision as amended is reproduced below, Vol. II, pp. 198–201.

Under E.B. Decision No. 1477-(63/8), February 27, 1963.

Date and amount of reclassification of previous purchases.

Factors on both the demand side and the supply side explain the step-up in the rate of drawings in the 18 months from December 1966 to June 1968. On the demand side, there was once again evidence of the well-known fact that fluctuations in the pace of economic activity in the industrial world have a direct and forceful impact on primary producing countries. Most primary producing countries were affected by the general slackening of economic growth in several industrial countries that occurred in 1966–67, and by the accompanying weakness of world market prices for many agricultural raw materials. In response to high interest rates, importers in industrial countries also drew down their inventories of many commodities, thereby preventing any significant increase in the volume of demand for these commodities. Hence, in 1966–68 primary producing countries suffered either much reduced rates of export growth or actual export declines. Only a few primary producing countries in special situations expanded their exports in these years.

Demand elements were not, however, the only cause of lower export earnings of primary producers in this 18-month span. The capacity to export of several countries was adversely affected by a number of factors—poor crops, dislocations in transport or other export servicing industries, and the closing of the Suez Canal and other repercussions of the six-day war in the Middle East in June 1967. Also contributing to export shortfalls in the first part of 1968 was the temporary lag in any expansion of the volume of exports following the currency devaluations of several developing countries in November 1967. In value terms, exports were down inasmuch as those devaluations and the devaluation of sterling had reduced export prices in terms of U.S. dollars. All in all, the value of exports of the primary producing countries was only 4 per cent higher in 1967 than in 1966, whereas it had been 8 per cent higher in 1966 than in 1965.

Conditions in commodity markets were reversed, however, in the latter part of 1968, and that year as a whole proved relatively favorable for exports of primary products. The rise in demand and in output in industrial countries in the second half of 1967 was the main factor underlying the return to more satisfactory growth for most primary product exports, but better conditions for producing crops in some exporting countries were also a factor.

The marked upturn in the export earnings of the primary producing countries was mirrored by diminished recourse to the compensatory financing facility in the second half of 1968. After the relatively extensive and frequent use of the facility in the preceding year and a half, in the remainder of 1968 only Iceland, whose exports were depressed by poor fish catches, made a compensatory financing purchase—for $3.75 million. This purchase was made possible by the provision in the amended decision for a limit of 50 per cent of quota on compensatory financing purchases, instead of 25 per cent.

Similarly, during 1969 and 1970 there was no widespread need for compensatory financing of export fluctuations. Exports of primary producing countries continued to expand: their value was 13 per cent higher in 1969 than in 1968 and 11 per cent higher in 1970 than in 1969. Only two countries, Ecuador and El Salvador, made use of the compensatory financing facility during 1969, each for $6.25 million, Ecuador using the reclassification procedure under the amended compensatory financing decision. In 1970 Burundi alone made a compensatory purchase, for $2.5 million.

The situation changed again in the last four months of 1971. Despite the generally favorable payments situations of most countries, once more there was recourse to the compensatory financing facility. In September Burma purchased $6.5 million to alleviate payments difficulties that had arisen from a temporary shortfall in its export earnings during the 12 months ended May 31, 1971. During the shortfall period, rice shipments had increased substantially but no gain in export earnings from rice had been achieved because world prices for rice had declined. In November the Executive Board approved a request by Jordan for a $4.5 million purchase. Jordan had experienced an export shortfall owing to incidents in the Jordan valley that had adversely affected horticultural production, an important source of its export earnings.

Another cause of the accelerated use of the compensatory financing facility in the latter part of 1971 was a sharp drop at that time in world market prices for copper. World market prices for virtually all primary metals were low late in 1971 partly as a result of depressed demand in industrial countries accompanying the reactions of buyers to the international financial disturbances that occurred after August 15, 1971. But lower prices for copper reflected as well the relatively ample supplies available.

The five major copper exporters among the developing countries—Chile, Peru, the Philippines, Zaïre, and Zambia—were all to resort to the compensatory financing facility in the next 17 months, going beyond the time frame of this history. Chile and Zambia drew first, in December 1971. Chile’s copper earnings had dropped to 14 per cent below the pre-shortfall average, and to 19 per cent below the average for 1970, and it drew $39.5 million. Zambia’s purchase of $19 million was to alleviate a shortfall for the 12 months ended June 30, 1971. Zambia’s difficulties had been intensified by the flooding of a major mine, and its copper export earnings were down by 20 per cent compared with the pre-shortfall average.6

The first repurchases of drawings under the compensatory financing facility began in 1968. In January 1968 the staff had suggested a procedure to be followed in making recommendations to members for repurchases to take place out of their export excesses, as provided by paragraph (7) of the amended decision. Should calculations show that the member had an export excess, the Managing Director would notify the member by letter, recommend a repurchase of a specific amount, and inquire about the member’s intention to repurchase. The Executive Board would be informed through semiannual reports on the situations in which such recommendations had become applicable and on the members’ responses.

As time went on, such recommendations were sent to several members. Some members repurchased shortly after receiving the Fund’s recommendation. Others represented that, despite the improvement in their exports, their balance of payments deficits, low reserves, or heavy external indebtedness made it difficult for them to repurchase at that time. (Amounts of repurchases, by member country, are given in Table 4.)

Compensatory Financing Becomes Important

From September 20, 1966, when the facility was extended and liberalized, until December 31, 1971, total drawings under the compensatory financing facility came to $375 million, more than four times the amount used under the facility during the first three and a half years of its existence. Twenty-one members made compensatory drawings, five of them (Burma, Ceylon, Colombia, Haiti, and Iceland) twice, in contrast to the earlier use by only three members.

Thus a new upsurge in compensatory drawings was beginning as 1971 ended, despite the tremendous boom in commodity markets that was just getting under way. Strong demand in the industrial countries combined with supply shortages of several commodities was beginning to bring about unprecedented spurts in commodity prices. Commodity markets were soon to become so buoyant that, with the continuation and even intensification of inflation and the unsettling of exchange rates and the international monetary system after August 15, 1971, purchases of commodities and commodity stockpiling gradually became common hedges against inflation and against currency depreciation. Primary producing countries, as a group, accordingly began to experience unusually favorable balance of payments positions. Nevertheless, it was apparent that these developments did not obviate the need for compensatory drawings. The Fund’s developing members had become so large in number and so diverse in circumstance that there were always exceptions to general trends. Thus, even amid prosperous world commodity markets, a number of members continued to suffer from the circumstances which the Fund’s compensatory financing arrangements were intended to alleviate. Some members had adverse weather to contend with. Others exported commodities, such as rubber or copper, that did not share in the rise in commodity prices, at least not until much later. Still others were in the throes of special political difficulties that disrupted their production and export. In addition, the lag between commodity market developments and export returns necessitated calls on the compensatory financing facility despite the existence of a commodity boom.

At the close of 1971, the Fund’s compensatory financing arrangements were thus at last coming into their own and it was evident that, in future, they would receive enhanced attention. Indeed, within three years after the facility was liberalized in September 1966, that is, by the time of the 1969 Annual Meeting, several Governors, including Mr. Ali Wardhana (Indonesia), Mr. Kuo-Hwa Yu (Republic of China), and Mr. Hassan Abbas Zaki (Egypt), were advocating further liberalization.7 Suggestions for liberalization were made again at the Annual Meetings in 1970 and 1971 by a number of Governors, notably Mr. Diogenes H. Fernández (Dominican Republic), speaking on behalf of 19 Latin American members, and by Mr. Tan Siew Sin (Malaysia).8 In 1971 Mr. Bernard Bidias à Ngon (Cameroon), speaking on behalf of 5 Central African nations, also criticized the facility as being “inadequate to resolve the problem of erratic movements in prices of raw materials.”9

E.B. Decision No. 1477-(63/8), February 27, 1963, as amended by E.B. Decision No. 2192-(66/81), September 20, 1966; Vol. II below, pp. 198–201.

See History, 1945–65, Vol. II, pp. 424–27. The reader interested in the details is referred to the Fund’s second report on compensatory financing, which was reproduced in Volume III of History, 1945–65, pp. 469–96.

These techniques are described in Gold, Stand-By Arrangements, pp. 108–111.

The buffer stock facility is described in Chap. 15.

Strictly speaking this should be “the equivalent of $87.25 million,” since drawings from the Fund were usually made in a parcel of currencies, not only in U.S. dollars. The constant repetition of the words “the equivalent of” in such instances would, however, be tedious, and they have been omitted here and in later chapters.

Compensatory drawings were made by Peru in June 1972 and by Zaïre in July 1972 for $30.75 million and $28.25 million, respectively, and by the Philippines in May 1973 for $38.75 million.

Statements by the Governor of the World Bank for Indonesia, the Governor of the Fund for the Republic of China, and the Governor of the World Bank for Egypt, Summary Proceedings, 1969, pp. 84, 116, and 166.

Statement by the Governor of the Fund and the World Bank for the Dominican Republic, Summary Proceedings, 1970, p. 105, and Statement by the Governor of the World Bank for Malaysia, Summary Proceedings, 1971, p. 50.

Statement by the Governor of the Fund for Cameroon, Summary Proceedings, 1971, p. 137.

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