Chapter 18: Continued Evolution of Stand-By Arrangements
- International Monetary Fund
- Published Date:
- February 1996
Stand-by Arrangements became the crux of the Fund’s policies on the use of its resources during the six years covered by this history. This was apparent in three ways. First, the authorities of member governments, the Executive Directors, the management, and the staff were all fairly much agreed that only in exceptional circumstances could a member draw in the credit tranches without the Fund’s having authorized a detailed stand-by arrangement in advance. Second, requests for exceptional direct drawings were nearly always accompanied by letters of intent, which were not dissimilar to the letters of intent attached to stand-by arrangements. Third, after September 1968, any member making use of the Fund’s resources beyond the first credit tranche was required to consult with the Fund from time to time, in addition to the regular Article VIII or Article XIV consultations, whether the member’s use of the Fund’s resources was under a stand-by arrangement or by direct purchase.
The previous chapter noted the expanded use of stand-by arrangements and described those approved from January 1966 through December 1971 and the amounts drawn. This chapter explains the circumstances attending the approval and use of some stand-by arrangements of particular interest and the continued evolution of the Fund’s policies on stand-by arrangements.
Stand-By Arrangement for United Kingdom, 1967
The Fund approved two stand-by arrangements for the United Kingdom during the years 1966–71, one in November 1967 and one in June 1969. The arrangement approved in November 1967 was in the main responsible for bringing about a general review in the middle of 1968 of the conditions that the Fund attached to stand-by arrangements. The review is discussed below in the section, Terms of Stand-By Arrangements Reviewed; a discussion of the 1969 arrangement follows that section.
Background and Request
The United Kingdom’s recurrent balance of payments difficulties in the mid-1960s and the enlarged deficits in 1967 and 1968 had, as we have seen in Part Two, been part of the background to the discussions that led to the establishment of SDRs. While the discussions were still at a crucial stage, late in 1967, the external financial plight of the United Kingdom became acute, and in November 1967 there were both a devaluation of sterling and a request to the Fund for a stand-by arrangement. The devaluation is discussed in Chapter 21.
Sir Leslie O’Brien, Governor of the Bank of England, attending the Annual Meetings in Rio de Janeiro in September 1967 as Governor of the World Bank for the United Kingdom, alerted the Managing Director to the seriousness of the United Kingdom’s financial troubles. The circumstances worsened in October and the first days of November, and U.K. officials called on the Fund’s management in Washington early in November to discuss the possibility of financial assistance. Mr. Schweitzer told the U.K. authorities that there would be great interest in the corrective measures that would be pursued, and he explained the need for the full support of the other participants in the General Arrangements to Borrow, since those Arrangements would have to be activated to finance any U.K. drawing or stand-by arrangement.
Meanwhile, heavy pressure on sterling continued. Over the weekend of November 11–12, the U.K. authorities explored with the Fund’s management, and also with the central bankers of the countries of the Group of Ten, meeting in Basle, how much financial assistance they might obtain to support sterling and stave off devaluation: as the United Kingdom wished to marshal a total of $3 billion, the amount obtained from other countries directly influenced the amount that the United Kingdom would wish to request from the Fund.
Devaluation was a step that the U.K. authorities were eager to avoid because, among other considerations, a devaluation of sterling, as had happened in 1949, might precipitate a series of devaluations of other currencies, including those of the eec countries. Nevertheless, it was clear by Thursday, November 16, that a devaluation was imminent. Mr. Schweitzer told Mr. Maude that, in his view, a sterling devaluation, coupled with an adequate domestic program, would well support a request for a stand-by arrangement. An amount of $1.4 billion was agreed upon; that amount, if fully drawn, would bring the Fund’s holdings of sterling to not quite 200 per cent of the U.K. quota.
At about midday on November 17, Mr. Maude handed to Mr. Schweitzer and Mr. Southard a memorandum addressed by Mr. Callaghan, the Chancellor of the Exchequer, to the Managing Director requesting the Fund’s concurrence in a change in the par value of the pound sterling, giving the reasons for the proposed change, describing the related domestic measures that were being taken, and stating the United Kingdom’s intention to request a stand-by arrangement in the amount of $1.4 billion.
The situation was of the utmost urgency. A staff mission left Washington that evening and arrived in London on Saturday, November 18, the day that the devaluation of sterling was announced, to discuss the terms of the stand-by arrangement. Meanwhile, some senior Fund staff were abroad, and the Managing Director asked them to explore informally both the moves that other countries might take in reaction to the devaluation of sterling and the willingness of the participants in the General Arrangements to Borrow to activate that facility. These advance preparations meant that at the same time that the United Kingdom was devaluing the pound the Managing Director was able to circulate to the Executive Directors preliminary figures on financing a stand-by arrangement, as well as to indicate the understanding of the management regarding the intentions of other members concerning their exchange rates (see Chapter 21). Meanwhile, the U.K. authorities had borrowed $1.6 billion from the central banks of the Group of Ten, so that the total of $3.0 billion that had been sought was in fact obtained.
The formal request to the Fund, along with the letter of intent, came from the Chancellor of the Exchequer on November 23. The requested stand-by arrangement was for 57.4 per cent of quota and, as noted above, could bring the Fund’s holdings of sterling (taking into account a repurchase on November 20, 1967) to almost 200 per cent of the U.K. quota if fully drawn. In other words, the amount of the requested stand-by arrangement began in the upper reaches of the second credit tranche and ended in the uppermost reach of the fourth credit tranche.
The Fund’s management supported the request for the stand-by arrangement. As described in Chapter 21, the staff’s analysis was that the change in the parity for sterling, the supporting measures announced on November 18, and the policies to be introduced as outlined in the Government’s letter of intent laid the basis for a substantial improvement in the balance of payments within the next 12 months and for further improvement thereafter. The measures already adopted included raising the bank rate from 6½ per cent to 8 per cent, the highest rate since 1914; reimposing severe but selective ceilings on bank credit to the private sector, except for exports; and tightening the terms of hire purchase (installment credit) on motorcars. A number of measures of fiscal restraint that were to become effective early in 1968 were also announced: the imposition of heavy taxes, mainly indirect ones, and an increase in the corporation tax, and reductions in public expenditures, both civil and defense, including investment by nationalized industries.
Executive Board’s Discussion and Approval
The Executive Board considered the request on November 29, 1967, only 11 days after the devaluation and 12 days after the staff mission had left for London. (The Board had discussed devaluation of the pound sterling on November 18.) The U.K. stand-by arrangement of 1967 was thus the most quickly negotiated one in the history of the Fund to this time. It was also equal to the largest transaction in which the Fund had so far engaged—the U.K. drawing in May 1965. But most Executive Directors did not regard the amount as unduly large when considered as a percentage of the U.K. quota ($2,440 million).
The Managing Director was sensitive to the fact that the Executive Directors for developing countries, as well as monetary officials from those countries, would compare the terms of this stand-by arrangement with those of the stand-by arrangements that the Fund worked out with the members that elected them. The United Kingdom was the only large industrial member with which the Fund had so far negotiated a stand-by arrangement, whereas many stand-by arrangements had been approved for developing members. Hence, in an opening statement to the meeting of the Executive Board, Mr. Schweitzer took pains to explain the reasoning behind the proposed terms of the U.K. stand-by arrangement. Action was necessary to forestall or cope with an impairment of the international monetary system. There was a devaluation of a major currency, the need to support a return to confidence in that currency with maximum speed, and the need to maintain that confidence in the future. In these circumstances, it seemed to him that all of the financial support which the Fund could make available to the member ought to be forthcoming en masse whenever needed. This reasoning explained why no phasing of the amount available under the stand-by arrangement had been included.1
Nonetheless, the management and staff had made maximum and, Mr. Schweitzer thought, successful efforts to reach understandings on a program and had endeavored to find effective procedures other than phasing for following the progress of the United Kingdom while it was making a massive use of the Fund’s resources. The Chancellor of the Exchequer had agreed to consult the Fund on a quarterly basis to review the U.K. economy and the balance of payments. If necessary, there would be more formal consultations, that is, at the Executive Board level, on any further action that might be required should the given policies not be producing the desired improvement in the balance of payments. In addition, the authorities stood ready to consult the Fund as long as the Fund’s holdings of sterling were in excess of 125 per cent of quota.
Mr. Maude was able to announce at the Executive Board meeting that short-term funds had been flowing back to London from abroad and that the exchange rate for sterling being quoted in world markets was consistently above the new parity. He said that the U.K. authorities conceived of the future in two stages. In the first stage the aim was to increase employment at home while the external situation was being redressed; it would involve the measures already taken. The second stage was to come in a few months’ time, when it was expected that unemployment would be lower, the export drive would have become effective, and growth of the domestic economy would have picked up. Then tighter fiscal policies were to be considered.
All Executive Directors supported the request. Most of them commended the U.K. authorities for their courageous decision to change the par value of the pound and for their actions on the domestic front. They hoped that the devaluation and the associated domestic measures would lead to the decisive turning point that everyone desired. Some regretted the series of adverse external events that had frustrated the objectives of the policies of financial restraint that the authorities had followed in the last few years and that had affected not only the United Kingdom but the entire international financial community.
Several Directors, however, remained very much concerned about the U.K. economic situation and about the adequacy of the domestic measures being taken. Mr. Plescoff supported the stand-by arrangement because the United Kingdom needed urgently to repay its debts and confidence in sterling must be restored, but he believed that the supplementary policy measures announced were not adequate: for devaluation to be successful, it had to be accompanied by a comprehensive program of immediate restrictive measures designed to produce the necessary shift of real resources from domestic to external uses. Mr. Stone doubted that a substantial improvement in the United Kingdom’s external position would come about in 1968. Mr. Diz commented on the difficulties of forecasting economic events, even for a member, like the United Kingdom, that had much economic data at its disposal and was rich in economic research.
Because of these uncertainties about the U.K. economy, the Executive Directors attached very great importance to the provisions, both in the letter of intent and in the stand-by arrangement, for frequent consultations between the U.K. authorities and the Fund.
There were, in addition, concerns of another type. Mr. Kafka, while supporting the proposed stand-by arrangement, drew particular attention to the fact that it contained no provisions for phasing, no performance clauses, and relatively few ceilings on variables, such as credit expansion, that were often subject to ceilings under the terms of stand-by arrangements (i.e., performance criteria). In other words, although this stand-by arrangement was in the highest credit tranches, it lacked both a quantitatively defined program and the usual clauses contained in stand-by arrangements. Instead, it included unusually far-reaching provisions for consultations.
Mr. Kafka thought that the U.K. stand-by arrangement would certainly be studied with great interest by members, and that many might wish the stand-by arrangements that were approved for them to be modeled on the same lines, unless it could be demonstrated that their situations differed substantially. Such demonstrations were difficult, or even impossible, however, unless there was a simple, readily understood criterion, such as the tranche position of a member.
Nearly all of the Executive Directors for the developing members supported Mr. Kafka’s position. Mr. Phillips O. commented on the absence of quantitative targets in the U.K. stand-by arrangement and their replacement by a series of consultations and hoped that this type of stand-by arrangement would be more widely used in the Fund’s operations, thus ensuring uniform standards for all members. Mr. Albert Mansour (Egypt, Alternate to Mr. Saad) and Mr. Williams (Trinidad and Tobago) hoped that the emphasis in the U.K. stand-by arrangement on general policy measures and consultations, rather than on quantitative targets and ceilings, signaled a departure from what they called the more rigid form of stand-by arrangement that had been customary.
Following these deliberations (on November 29, 1967), the Executive Board approved the United Kingdom’s request for a stand-by arrangement for $1.4 billion.
Terms of Stand-By Arrangements Reviewed
The discussion of the U.K. stand-by arrangement in November 1967 touched off a general review of the Fund’s policy on the use of its resources under stand-by arrangements. In effect, the comments of several Executive Directors, especially those for the developing members, suggested that they had serious misgivings about the equality of treatment that members were receiving in respect of the terms of stand-by arrangements, particularly those applying to the higher credit tranches. Were industrial members subject to terms as severe as those being applied to developing members?
In the next seven or eight months, Mr. Diz, Mr. González del Valle, and Mr. Kafka, among other Executive Directors for the developing members, voiced their concern about the need for uniform treatment for all members in respect of the operative clauses in stand-by arrangements. They believed that the topic might be raised by some of the Governors at the forthcoming Annual Meeting. Therefore, it was agreed that the Executive Board would consider the provisions associated with stand-by arrangements and with use of the Fund’s resources before then, and it did so in August and September 1968.
The terms of stand-by arrangements had developed gradually.2 The overall examination in mid-1968 was thus, in a sense, the first of its kind, and was to lead to another milestone decision on the use of the Fund’s resources and stand-by arrangements.
When they began to consider this topic on August 14, 1968, the Executive Directors had before them a staff paper that evaluated existing policies on the use of the Fund’s resources under stand-by arrangements and recommended the continuation of the same policies on stand-by arrangements that had been followed, including the recent arrangement with the United Kingdom. The staff suggested that appropriate clauses providing for consultation, phasing, and performance criteria should continue to be incorporated in all stand-by arrangements, with three exceptions: (1) performance clauses need not be put into stand-by arrangements that did not go beyond the first credit tranche; (2) phasing could be omitted from stand-by arrangements that did not go beyond the first credit tranche when the Fund did not advocate any major adjustments in the member’s policies; and (3) phasing should not be stipulated when the stand-by arrangement had been requested to maintain confidence in the member’s currency, ready availability of the full amount of the arrangement was considered essential as a deterrent to speculation, and maintenance of the value of the currency was important for the stability of several other currencies. In this third situation, the performance clauses would provide for consultation with the Fund even if the entire amount of the stand-by arrangement had already been purchased.
The staff gave two arguments in defense of the continuation of existing policy, that is, the use of stand-by arrangements more or less in their same form as the main vehicle for making the Fund’s financial resources available to members. One, stand-by arrangements as they had evolved had successfully met the twin objectives of assuring members access to the Fund’s resources on agreed terms and assuring the Fund that the use of its resources would be consistent with its Articles and with its tranche policies. Two, each stand-by arrangement had to be individually designed; no general rule for the number and content of performance criteria could be adopted. Because members had economies that operated in different ways, and because they had various types of institutional arrangements for implementing their monetary and financial policies, the economic effects of any ceilings and targets, such as limits on the expansion of money supply, credit ceilings, and the like, that might be included in performance clauses could not be the same for all members.
Inclusion of fiscal criteria, such as budgetary deficits, total budgetary expenditures, or particular categories thereof, had been relatively rare. If the Fund included fiscal criteria in performance clauses in stand-by arrangements, the impression might be created that the Fund was making a judgment on the priorities of the member: budgetary operations and the operations of public agencies reflected the social and economic priorities of the member, and usually came about after internal political compromises had been made. Moreover, fiscal criteria in performance clauses were normally not necessary because in most situations the substance of what they might achieve could be adequately handled by ceilings on aggregate credit expansion and credit expansion by the public sector. Furthermore, for many members fiscal data were both less reliable and less available than monetary data.
The Executive Board’s discussion revealed the familiar dichotomy of view on a number of issues between Executive Directors for industrial members and Executive Directors for developing members. Messrs. Biron (Belgium), Dale, Hattori, Lieftinck, Mentré (France, now Alternate to Mr. Plescoff), Patrick M. Reid (Canada, Alternate to Mr. Handfield-Jones), and Schleiminger endorsed the continuation of the existing policies on the use of the Fund’s resources and on stand-by arrangements. They recognized the importance of policies that gave equitable treatment to all members, but in their opinion the policies that the Fund had been following were in the right direction and were for the benefit of all members.
Several of them thought that performance clauses might be made even more specific. For instance, greater reliance on use of targets for fiscal policy was favored. Was it really true that monetary policy lent itself better to performance clauses than did fiscal policy? Mr. Schleiminger also wondered whether some “quantitative bench marks” might not be used to serve as “warning lights” when economic and monetary targets were not being observed. Such indicators of the country’s economic situation had been used in the eec and were being considered by Working Party 3 of the oecd. Mr. Lieftinck wanted more attention to be paid to the exchange rate policies of members that ran persistent balance of payments deficits and that were regularly drawing from the Fund in the higher credit tranches. It was essential that the Fund’s resources not be used to support unrealistic rates of exchange.
Mr. Guy Huntrods (United Kingdom, Alternate to Mr. Maude) defended the absence of specific safeguards in the U.K. stand-by arrangement of November 1967. The U.K. economy was the subject of close examination by the Fund; therefore, the form of the stand-by arrangement did not mean that the United Kingdom could make use of the Fund’s resources on terms that were any less stringent than those for other members. Performance criteria had been expressed largely in qualitative rather than in quantitative terms because the difficulties of accurate forecasting were particularly marked in the case of the United Kingdom. The letter of intent had included certain precise figures as goals, and the staff had frequently expressed their views in quantitative terms. But quantitative performance criteria would not have been effective and would have lessened the confidence-building effect of the stand-by arrangement, the key reason for having the arrangement.
Messrs. Diz, Faber, González del Valle, Kafka, Madan, Nikoi, Phillips O., Rajaobelina, and Yaméogo, in contrast, had much greater difficulty with the existing policies. Mr. Kafka wanted to know what specific criteria governed the number and content of performance clauses and the periodicity of drawings in stand-by arrangements that went above the first credit tranche. Was it not possible to spell out some minimum performance criteria which would ordinarily be both necessary and sufficient according to the tranche position? Messrs. González del Valle and Faber were also concerned that the differentiation in policy was between the first credit tranche and the other tranches. Mr. Diz questioned whether additional numbers of clauses and a complex system of safeguards had permitted larger amounts of funds to be authorized under stand-by arrangements: since 1959, when stand-by arrangements had become more complicated, the average amount of a stand-by arrangement had remained at about 50 per cent of quota. Mr. Madan argued that detailed conditions and clauses made for undesirable rigidities in a member’s economic policies.
The Executive Directors for the developing members, pointing to the detailed figures in the staff paper which showed that the number of performance criteria in the stand-by arrangements for members in the Western Hemisphere and in Asia was on average much greater than for members in Europe, also raised other questions about the Fund’s present policies on stand-by arrangements. Was there such a substantive difference between drawings in the first credit tranche and drawings in the upper credit tranches that no performance and phasing clauses were needed for the former while the latter required several specific ones? Since monetary ceilings and targets could not be forecast with certainty, how useful were such quantities at all in performance clauses? Did not the same reasons why fiscal criteria were not useful for performance clauses apply as well to monetary criteria?
Some Executive Directors, including Mr. Nikoi, urged that greater reliance be placed on regular consultations with the member rather than on quantitative safeguards written into performance clauses. Mr. Diz and Mr. Rajaobelina liked quantitative criteria because they were precise and objective, but they suggested that there might be some kind of consultation by geographic region so that members with similar economies could talk simultaneously to the Fund about their related economic problems and possible common solutions.
Decision on Stand-By Arrangements
The positions of Executive Directors were not as far apart, however, as this line of argument suggests. Those for industrial members agreed that equality of treatment for all members was essential and that such treatment should explicitly be seen as being equal. Those for developing members agreed that equality of treatment did not mean identity of treatment; in particular, it did not require identical performance clauses in stand-by arrangements. The issue of policy, therefore, came down to reconciling the need for flexibility with the requirement that all members be treated uniformly.
To this end, a comprehensive decision was taken on September 20, 1968, the basic elements of which were as follows:3
One, clauses requiring the member to remain in consultation with the Fund were to be included in all stand-by arrangements.
Two, provisions would be made for consultation with a member, from time to time, during the whole period in which the member was making use of the Fund’s resources beyond the first credit tranche, whether or not that use resulted from a stand-by arrangement.
Three, clauses providing for phasing of the amounts that might be drawn, and clauses requiring the achievement of certain performance criteria if drawings were to continue, would be omitted in stand-by arrangements that did not go beyond the first credit tranche. (This provision brought the policy on the use of the Fund’s resources in general and the policies on stand-by arrangements closer together.)
Four, in all other stand-by arrangements, phasing and performance clauses would normally be included, but they would be applicable only to purchases beyond the first credit tranche.
Five, in exceptional cases, phasing would not be stipulated if it was essential that the full amount of the stand-by arrangement be available promptly. In such a case, the performance clauses would require the member to consult the Fund about new or amended performance criteria even if there was nothing left to be drawn. This consultation was to include a discussion by the Executive Board that could culminate in a communication of their views to the member under Article XII, Section 8.
Six, performance clauses would be limited to stipulating criteria necessary to evaluate the implementation of the member’s financial stabilization program, with a view to ensuring achievement of the objectives of that program.
Seven, language having a contractual flavor would be avoided in the documents relating to stand-by arrangements.
Shortly thereafter, standard texts were devised for the consultation and performance clauses in stand-by arrangements.4 It was expected that the consultation clause would not have to be regularly “invoked.” Rather, if the member’s external situation caused concern, the staff would visit the country at least once a year, such visits to be arranged by mutual consent. Only where such visits could not be arranged would the “125 per cent” clause, as it was referred to within the Fund, be invoked (see the second basic element above).
At the Twenty-Third Annual Meeting, Mr. Schweitzer, observing that the stand-by arrangement had become an increasingly effective tool of collaboration between the Fund and many members with widely differing situations, explained that the review that had just been completed had “sought primarily to preserve the uniform and equitable treatment of all members” He said that he was “confident that this basic principle will be upheld without impairment of necessary flexibility.”5
Stand-By Arrangement for United Kingdom, 1969
As is discussed in Chapter 21, the U.K. economy responded slowly to the 1967 devaluation of sterling. Early in 1969 the authorities indicated informally to the management and staff of the Fund that they would like to negotiate another one-year stand-by arrangement (the 1967 arrangement had expired in November 1968). The new arrangement would facilitate $1.3 billion of repurchases of sterling from the Fund regularly falling due between February 1969 and the end of May 1970; these were repurchases in connection with a drawing of $1,400 million in May 1965 and a drawing of $122.5 million in March 1966 in connection with payment of the gold portion of the increase in quota. Repurchases of the first two installments of part of the sterling held because of the 1965 drawing had already been made, in August and November 1968.
At the suggestion of the Managing Director, the U.K. authorities requested an amount of $1.0 billion, rather than an earlier-considered figure of $1.3 billion. They made repurchases totaling nearly $500 million in February, March, and May 1969, and the Fund’s holdings of sterling at the end of May 1969 amounted to 173 per cent of quota, so that the stand-by arrangement would fall in the upper credit tranches.
The terms had been negotiated under the comprehensive decision of September 20, 1968. Although there were no performance criteria related to credit or fiscal policies, the Managing Director assured the Executive Board, when it considered the request on June 20, 1969, that he was satisfied that the stand-by arrangement was in accord with the Fund’s current policy. The U.K. authorities had stated that, for the financial year ending in March 1970, their objective was to obtain a surplus of at least £300 million on the current and long-term capital accounts of the balance of payments, and they had specified how budgetary and monetary measures were working toward that end. They intended to limit domestic credit expansion to not more than £400 million, compared with some £1,225 million in the financial year 1968/69. Rather than performance criteria, the letter of intent and the stand-by arrangement provided for full-scale reviews of performance through consultations. Drawings under the stand-by arrangement, after the initial one, would be phased to follow such reviews. These terms were readily accepted by the Executive Board, especially because the Managing Director assured the Executive Directors that other members could, if they wished, also be considered eligible for this form of stand-by arrangement.
Reporting on developments in the U.K. economic situation, Mr. Maude said that the U.K. authorities agreed with the staff that the performance of the U.K. economy and the balance of payments position were beginning to look encouraging. The authorities were even more optimistic than the staff that the balance of payments surplus would be sizable in 1969/70. They believed that devaluation was having a powerful effect on exports, especially of manufactured goods, and that resources were being switched away from internal consumption and into exports on a significant scale. Mr. Maude also pointed out that U.K. monetary policy had now become extremely tight.
The 1969 Article VIII consultation was considered at the same time as the request for a stand-by arrangement. Most of the Executive Directors observed that pronounced improvements were beginning to take place in the United Kingdom’s financial prospects. Mr. Dale said that he was able to welcome the proposed stand-by arrangement because of the comprehensiveness of the targets and programs of the U.K. authorities. Mr. Johnstone commented on the value to all members of the close working relationship that had been established between the Fund and the United Kingdom.
The discussion of the U.K. stand-by arrangement prompted other comments of a general nature. Mr. Schleiminger, as on other occasions, wondered how useful monetary policy was compared to fiscal policy. Mr. Lieftinck, Mr. Plescoff, and Mr. Stone pointed to the long time lag, more than a year, between the devaluation of the pound sterling and the implementation of firm budgetary and monetary restraints and suggested that the U.K. situation represented the failure generally of economic forecasting. Mr. Kafka and Mr. Williams were concerned about large outflows of private long-term capital to high-income countries in the sterling area. Mr. Madan was worried about the implications for developing members of the upward trend of interest rates in international money markets.
The stand-by arrangement was approved. One week later, on June 27, 1969, the United Kingdom purchased $500 million, one half of the amount authorized by the stand-by arrangement.
Dramatic Improvement in U.K. Economic Situation
By September 1969, when the first review of monetary and fiscal policies under the stand-by arrangement took place, the U.K. financial situation had clearly been reversed. Tight controls on public expenditures and heavy taxation had been continued, and the public debt had been managed in such a way as to yield substantial net sales of government securities to the nonbank public, rather than net purchases, as had been expected. Total bank credit had thus declined. Private consumption in real terms had fallen, largely reflecting the absorption of increasing money incomes through the massive increases in tax rates that had been put into effect in 1968. Pressure on foreign exchange reserves had moderated.
On September 17, 1969, the Executive Board adopted a decision to the effect that the United Kingdom had consulted on its monetary and fiscal programs in accordance with the stand-by arrangement and that no further understandings need be reached between the Fund and the United Kingdom to enable that member to make further purchases under the stand-by arrangement through September 30, 1969. On September 26, 1969 the United Kingdom purchased $175 million.
By December 1969, when the next quarterly review took place, a surplus in the foreign trade account, arising particularly from increases in exports, had emerged. The strengthening of the U.K. position was evident from what had been happening in the world’s foreign exchange markets. During the first three quarters of 1969 there had been large-scale speculative international capital movements that had culminated in changes in the exchange rates for both the French franc and the deutsche mark in August and October 1969, respectively. Yet, for the first time in several years sterling had not come under pressure.
The Executive Board again agreed that the United Kingdom had consulted on its monetary and fiscal programs and could make further purchases under the stand-by arrangement through December 31, 1969. On December 29, 1969 the United Kingdom again purchased $175 million.
At the time of the third quarterly review in March 1970, a dramatic improvement in the balance of payments was clearly a reality. The surplus on current account in 1969, over £400 million, had been the largest ever recorded—in relation to the gross domestic product it was roughly equivalent to the large surplus of 1958—and a peak postdevaluation surplus of more than £800 million (annual rate, seasonally adjusted) had been achieved. This strengthening of the balance on current account had been accompanied by a pronounced shift in capital flows. With the continuation of stringent policies in the United Kingdom and a calmer climate in the exchange markets in late 1969 and the first part of 1970, short-term capital had flowed into London on a large scale. This inflow was supplemented by unusually large increases in official sterling holdings, reflecting exceptionally favorable developments in the balance of payments of the overseas sterling area as a whole.
It was in the light of these developments that the Executive Directors, many of whom congratulated the U.K. authorities on the success of their efforts, took a decision in March 1970 indicating that the United Kingdom had consulted the Fund under the stand-by arrangement concerning its monetary and fiscal programs and could draw the remainder of the amount authorized by the stand-by arrangement. On March 26, 1970 the United Kingdom did so, with a purchase for $150 million.
The model of the 1969 U.K. stand-by arrangement, in which the amounts that could be drawn were phased to come after consultations between the Fund and the member on the member’s monetary and fiscal policies—in some respects a more stringent condition than the usual terms of stand-by arrangements—was not used again.
United Kingdom Repays the Fund
Because of the vast improvement in the balance of payments that began in 1969 and continued through 1971, the U.K. authorities were able to repay external debts in very large amounts. In the 18 months to the end of June 1970, short-term and medium-term foreign obligations were reduced from over $8 billion to $3.5 billion. By the end of 1971 the United Kingdom had virtually eliminated its short-term and medium-term obligations. These repayments included repurchases of sterling held by the Fund. Consequently, also by the end of 1971 the Fund’s holdings of sterling were below the level where further special consultations under stand-by arrangements were required.
The details of the repayments are as follows: Under the terms of the November 1967 stand-by arrangement, the $1.4 billion drawn in June 1968 was, to the extent that the outstanding amount had not otherwise been reduced (as through sales of sterling by the Fund to other members), to be repurchased beginning June 18, 1971. These obligations overlapped with repurchase obligations in respect of the $1.0 billion of drawings under the 1969 stand-by arrangement, which would begin to fall due in June 1972. Because of these overlapping repurchase obligations in respect of the drawings under these two stand-by arrangements, and in view of the U.K. balance of payments surplus, the U.K. authorities wanted to make some advance repurchases of the June 1968 drawing. Accordingly, on March 22, 1971 the Executive Board agreed to a U.K. proposal that the repurchase of the then outstanding amount ($1,324.75 million) be discharged in accordance with a schedule of eight quarterly installments that would start on or before March 31, 1971 and end on December 31, 1972. With Board approval, the United Kingdom repurchased, in advance, the first four installments, totaling $684.8 million, on March 31, 1971 and repurchased a further $614.1 million on August 9, 1971. These repurchases, together with the Fund’s sales of sterling, completed the discharge of the outstanding balance of the $1.4 billion drawn in June 1968 and reduced the Fund’s holdings of sterling from 139.8 per cent to 117.9 per cent of the U.K. quota of $2.8 billion.
Stand-By Arrangement for France
During the years 1966–71 the Fund approved only one stand-by arrangement for an industrial member other than the two for the United Kingdom, the one with France of September 19, 1969. That stand-by arrangement followed strictly the form of the Fund’s general decision on stand-by arrangements of September 1968.
Request Is Made
France’s request to the Fund in September 1969 for a one-year stand-by arrangement followed a series of crises involving the French franc from the spring of 1968 onward, which culminated in a devaluation of the franc on August 10, 1969.6 The use of its gold tranche in 1968 to make its first purchase from the Fund in more than a decade, described in Chapter 17, had been prompted by the first of these crises. Hence, in 1969 the Fund’s holdings of French francs were equal to 100 per cent of quota.
Because of the frequency with which short-term capital funds had moved from French francs into deutsche mark in the previous 16 or 17 months, the French authorities feared that, even after devaluation of the franc, there would be more such movements. This fear was not unjustified. As we have seen in the discussion in Part Two, the 1969 Annual Meeting opened on September 29 in the midst of another crisis in European exchange markets. A renewed flow of funds into deutsche mark, including movements out of French francs, had forced the German exchange markets to close, and the German authorities had introduced a floating rate for the deutsche mark.
Because its reserves had already been seriously depleted by previous capital outflows, France wanted an arrangement with the Fund whereby during the next year it could, after making full use of any gold tranche position it might have, purchase from the Fund a sum equal to the whole French quota at the time ($985 million). The stand-by arrangement, if fully drawn, would thus bring the Fund’s holdings of French francs to 200 per cent of quota.
Arriving in Paris on August 11, 1969, the day after the franc had been devalued, the staff team had to come quickly to an informal understanding with the French authorities, both on what might be the terms of such a stand-by arrangement and what stabilization plan would support it. In fact, negotiations were completed in ten days, when it became apparent that France would probably want to draw at least half of the amount of the stand-by arrangement in the next four weeks, that is, before the Annual Meeting, which was to be held in Washington at the end of September. That the package of currencies involved would necessitate activation of the General Arrangements to Borrow, that the amount of the stand-by arrangement would cover all four credit tranches, that negotiations were taking place under a relatively new general decision on stand-by arrangements, that any performance clauses would be closely examined to see if they were comparable to those that the Fund had included in the stand-by arrangements for other members, and that the various measures already taken by the French authorities to restore external equilibrium had by no means solved the crisis that was facing the French franc, all added to the complexities that attended the drafting of the stand-by arrangement.
As with the U.K. stand-by arrangement of the previous June, the working out by the staff and the French authorities of the proposed stand-by arrangement with France was done in a very short time.
Executive Board Approves
The official request for a stand-by arrangement was communicated to the Managing Director by Mr. Giscard d’Estaing, Minister of Economy and Finance, on August 27, 1969 and was considered by the Executive Board on September 19. As Mr. Plescoff indicated at the outset of the Board meeting, the Executive Directors were considering the French economy for the third time in 1969: they had discussed it in March in connection with the 1968 Article VIII consultation and in August when the par value of the franc had been changed.
In support of the request for a stand-by arrangement, the Executive Directors had before them details of a stabilization program, the main objective of which was equilibrium in the current account of the balance of payments by the end of June 1970. To this end the French Government had taken measures designed to eliminate excess demand in the domestic economy as rapidly as possible, to check the growth in imports, and to promote a shift in resources to the external sector. The deficit in the government budget was to be drastically reduced in 1969 and eliminated in 1970. Quantitative controls on bank credit were to be tightened and continued until mid-1970. Interest rates were to be raised. Extremely severe restrictions were to be imposed on consumer credit.
Mr. Plescoff said that the French authorities well understood that the goal of eliminating the current account deficit of the balance of payments by mid-1970 was a demanding one. But they considered it essential to establish confidence, both at home and abroad, in the new par value of the franc, and both the stand-by arrangement and the stabilization program were important in this regard. He went on to say that, if the Executive Board approved the request, the Bank of France would make an immediate drawing of $500 million under the stand-by arrangement and at the same time draw some $800,000 remaining in the gold tranche.
Before June 30, 1970 the French authorities were to review the country’s economic and financial developments and prospects with the Fund; in addition, the Article VIII consultation would provide a further review of economic developments during the period of the stand-by arrangement.
The Executive Directors warmly supported the stand-by arrangement. Mr. Yaméogo, speaking after Mr. Plescoff, commended the courageous program of the Government and pointed out how much the stability of the franc meant to all members of the French franc area, which included the members that had elected him. The measures announced seemed fully adequate to re-establish equilibrium in France’s balance of payments.
On the whole, the Executive Directors were satisfied with the stabilization policies proposed, although they recognized how difficult the achievement of budget equilibrium in 1970 and of current account equilibrium by the middle of that year would be. Mr. Johnstone suggested that perhaps these goals were more ambitious and precise than they need be. Mr. Palamenghi-Crispi, joined by Mr. Phillips O., was not at all certain that they could be achieved. Mr. Kafka noted that the stand-by arrangement was in full conformity with the Board’s decision of September 20, 1968.
Several Executive Directors took the occasion to speculate generally as to what the deterioration in the French economic position and the proposed ways of dealing with it, taken in conjunction with the course of economic events in the United Kingdom and the United States, implied for the kinds of financial policies that would best be pursued by members. Mr. Schleiminger, for instance, observed that the experience of the United Kingdom and the United States had been that the fight against inflation could not be won without an aggressive monetary policy. Noting that the French Government’s program put the burden of adjustment about evenly on monetary and fiscal policies, he stressed the need for France to keep the expansion of domestic credit well below the quantitative credit ceilings that had been agreed as part of the stand-by arrangement. Other Executive Directors, pointing out how much the rate of inflation and the balance of payments deficit in France, as in other countries, had departed from those forecast earlier, were concerned that economists had no very accurate guidelines for the economic consequences of monetary and fiscal policies. Mr. Lieftinck queried the relationship between monetary and fiscal policies and real economic phenomena: How sensitive to import competition would the French economy remain? What were the implications for agricultural production and imports? What rate of growth of the gross national product was envisaged? Mr. Suzuki noted the difficulty of holding wage increases to those that could be absorbed by rises in productivity.
Following this discussion, the stand-by arrangement was approved—on September 19, 1969.
Rapid Recovery of French Economy
The 1969 Article VIII consultation involved discussions between French officials and the staff in Paris in December 1969 and an Executive Board deliberation in March 1970. Meanwhile, France had drawn the entire amount of the stand-by arrangement ($985 million), raising the Fund’s holdings of French francs to just under 200 per cent of quota.
A staff mission visited Paris from April 29 to May 12, 1970 so that the Executive Board could review the French economic position in full by June 30, as provided by the stand-by arrangement. It was found that the various commitments and undertakings included in the French program had all been carried out. The current account of the balance of payments had swung into surplus early in 1970. Thus, the objective of a current account surplus was achieved ahead of schedule.
When they met to conduct the review, on June 29, 1970, the Executive Directors congratulated the French authorities on the effectiveness of their stabilization efforts. Several of them, including Mr. Dale, nonetheless noted that, in addition to the tight reins on the domestic economy, there were external explanations for the sudden turnaround in the French current account. Coming as it did so rapidly after devaluation in August 1969, the improvement in the external account could not yet be attributable to the major effects of devaluation on the relative prices of French exports and imports. Because restrictive policies had been in force for a number of months prior to devaluation, the pressure of domestic demand had probably begun to subside by the time the franc was devalued. Hence, a change in the current account shortly after devaluation was facilitated. Another factor that had played a role in the quick recovery, and that had both enlarged the deficit before devaluation and reduced it afterward, was the prevalence of speculative imports in the earlier period. Large stocks of imported goods had been accumulated before August 1969 in anticipation of the change in par value, swelling the size of predevaluation imports; the subsequent depletion of these stocks helped to account for the sudden decline in imports after devaluation.
Another factor contributing to the improvement in the balance of payments was the continued buoyancy of demand for French exports. This had enabled exporters to keep the dollar prices of their goods relatively close to predevaluation levels. In addition, the outflow of speculative short-term funds had been sharply reversed when the deutsche mark was revalued in October 1969.
The next discussions with the French authorities were in connection with the 1970 Article VIII consultation. They took place at the staff level in December 1970 and in the Executive Board in March 1971. In December 1970 the economic situation in France was showing still further improvement. Helped by favorable external circumstances, the stabilization program had brought about a restoration of confidence in the franc and a shift of the necessary additional resources to the external sector without unduly restricting the growth of domestic demand, output, and employment. The overall balance of payments surplus for 1970 was sizable ($2.0 billion in contrast to a deficit of $1.1 billion for 1969), and net official reserves at the end of 1970 (nearly $5 billion) were about three times as large as they had been in August 1969.
There remained, however, a number of potential trouble spots in the domestic economy. The expansion of exports and of investment had put pressure on the capacity of a wide range of industries. To make up for commodity shortages, the volume of imports in 1970 was very much higher than had been foreseen. Consequently, while the authorities responded to the improvement in the balance of payments with a selective relaxation of fiscal policies, they resisted the temptation to pursue more expansive measures, even though unemployment was edging upward. In December 1970 a seminar similar to ones with U.K. officials was conducted in Paris between Fund staff and officials of the Bank of France and the Ministry of Economy and Finance.7 The purpose was to consider on a technical basis the impact on aggregate economic activity of changes in the total supply of money and in its various components. Inasmuch as the emphasis was on the practical policies of France, the seminar turned out to be somewhat less general than those held with U.K. officials.
During 1971 the French economy continued to expand at a very satisfactory pace compared with the economies of its trading partners. Prices and wages rose fairly rapidly, but the increases were smaller than in most other industrial countries and France’s competitive position remained strong. The progress made since 1969 by the French authorities in strengthening the overall balance of payments was further consolidated.
This success enabled France to repurchase from the Fund the extra francs held. Under the terms of the stand-by arrangement, special consultations were to be held in mid-1971, just a few months after the Article VIII consultation, if the Fund’s holdings of French francs remained in excess of 125 per cent of quota. However, these consultations did not need to be held. On December 14, 1970 France paid in gold 25 per cent of the increase in quota authorized under the fifth general review of quotas. In addition, France discharged repurchase obligations in 1970 and early in 1971. By April 30, 1971 the Fund’s holdings of francs were down to 75 per cent of quota. By August 1971, as a result of some sales of francs by the Fund, France had attained a small super gold tranche position.
Restrictions on Travel Allowances
In the course of their economic difficulties in 1968, the French authorities instituted exchange controls, in May and June and again in November. The controls comprised a comprehensive range of restraints on capital movements and certain restrictions on allowances for foreign travel by French residents. New restrictions by France were followed by comparable regulations on capital and travel by the African countries of the CFA franc area.
In memoranda to the Managing Director from Mr. Plescoff on November 25, 1968 and Mr. de Maulde on November 29, 1968, France provided details of these control measures and requested the approval of the Executive Board under Article VIII for such restrictions on payments and transfers for current international transactions as had been introduced. Capital controls not being subject to the Fund’s jurisdiction, it was the restrictions relating to foreign travel that required the Fund’s approval. The staff recommended approval of the restrictions on travel allowances on a temporary basis, that is, for a few months, and the Executive Board agreed. In March 1969 approval of these restrictions was extended through the end of 1969.
At the time the stand-by arrangement was approved in September 1969, the French authorities declared their intention to abolish the restrictions on allowances for travel as soon as the balance of payments position allowed. In view of the continuing payments difficulties, however, the Executive Board in December 1969 approved another extension of these exchange restrictions through December 31, 1970.
During 1970 the French authorities made substantial progress in easing both capital controls and restrictions on allowances for travel. With regard to the latter, they raised the limits within which the banks could make foreign exchange available for travel, and they usually authorized additional amounts for bona fide travel. The authorities defended the restrictions that remained as being necessary to prevent disguised capital flight: because they found it difficult to distinguish suspected capital transfers from legitimate tourist expenditures, the restrictions helped them to prevent illegal outflows of capital.
Mr. Marc Viénot (France) requested the Executive Board to approve the remaining restrictions for another year, and in December 1970 the Board approved their use until December 31, 1971. However, in view of France’s strong balance of payments position, they, like the management and staff, had some reservations about the continuation of restrictions in France and so made their approval subject to review a few months later on the occasion of the 1970 Article VIII consultation.
In March 1971, just before that consultation in the Executive Board, the French authorities announced that the basic travel allowance was to be further increased. At the meeting of the Board, the Executive Directors commented favorably on France’s general economic situation. They welcomed the relaxation of the restrictions on travel allowances, but urged that they be abolished as soon as possible. In the meantime, their extension was approved until the end of 1971.
In August 1971 there were further relaxations of these restrictions, and on December 27, 1971 the Fund was informed that the restrictions on allowances for travel had been abolished.
Stand-By Arrangements for Developing Members
Illustrative of the stand-by arrangements between developing members and the Fund are those for Colombia, Indonesia, and Brazil.
Colombia had a stand-by arrangement with the Fund virtually continuously beginning in October 1959. The Colombian authorities undertook in September 1965 an exchange reform, most features of which were carried out during the course of 1966, supported by a stand-by arrangement approved in January 1966 for $36.5 million. However, a marked decline in world prices for coffee, which constituted about 65 per cent of Colombia’s total export earnings, contributed to a serious deterioration in the country’s payments position for 1966 as a whole. Extensive exchange controls and restrictions had to be reimposed in November 1966 and there was a renewed accumulation of payments arrears.
Consequently, in March 1967, with the help of the Fund staff, the Colombian authorities introduced another comprehensive financial program centering on a new exchange rate system. A dual market was introduced. A certificate rate primarily determined by market forces was to be applicable chiefly to trade transactions. Another rate applied to most capital movements and payments for invisibles. Most transactions remained subject to controls, but these controls were to be liberalized gradually. New tax measures were instituted to strengthen the fiscal situation, and current expenditures were to be limited. A cautious wage policy was to be continued and monetary controls improved. A one-year stand-by arrangement, this time for $60 million, nearly twice as large as Colombia’s other stand-by arrangements, was approved in April to provide the Colombian authorities with a secondary line of reserves in the event of temporary balance of payments difficulties.
By the time this stand-by arrangement expired, in April 1968, the full amount had been drawn. Significant progress had been made, however, and the Fund authorized another stand-by arrangement, for $33.5 million, in that same month. The Colombian authorities were continuing the financial program and were now aiming at equilibrium in Colombia’s external and budgetary finances and at still greater freedom in its international transactions. The balance of payments position was much stronger and controls were being relaxed.
Again, the amount of the stand-by arrangement was fully utilized and the financial program was remarkably successful. The flexible exchange rate was adjusted periodically and unification of the two exchange markets was achieved. Exports were somewhat diversified by the promotion of the so-called minor exports, that is, commodities other than coffee and petroleum.8 Imports were gradually liberalized and exchange reserves increased. On the domestic front, the rate of increase of domestic prices had slowed, and in fact economic growth had accelerated since public investment had been able to expand.
In order to consolidate this progress, the Fund in April 1969 approved yet another stand-by arrangement for Colombia, the tenth for that member. The amount authorized was $33.25 million, and this was fully utilized by April 1970.
As Colombia continued to make progress, and wished to continue to keep its own rate of price increase low despite rising import prices associated with inflation in other parts of the world, and to continue to augment its exchange reserves, the Fund approved a stand-by arrangement for another year in April 1970, this time for $38.5 million. By April 1971 purchases under this arrangement totaled somewhat less than the full amount. Nonetheless, after the highest annual rate of growth since 1959, Colombia requested a stand-by arrangement for $38 million, which the Fund approved. At that time, Colombia asked also for technical assistance from the Fund to undertake a study of budgetary reform aimed at introducing effective procedures for controlling budgetary expenditures.
The new Indonesian Government that came into power in March 1966 adopted, in October 1966, a broadly based economic program aimed at slowing down the very high rate of inflation and at rehabilitating the national economy, which had deteriorated badly. The principal elements of this program were tightened credit policies and a balanced budget; the reduction of internal price distortions by increasing the prices of certain essential goods that had been subject to control and by raising the rates of tariff on public utilities charged by the Government; and the reactivation of market forces, especially in the foreign trade sector, by completely decontrolling imports and introducing a more realistic rate of exchange. With the agreement of creditor countries, repayments of external debt were also rescheduled.
Indonesia re-entered the Fund in February 1967 (having withdrawn from membership in August 1965) and in February 1968 asked for a stand-by arrangement for $51.75 million. Some success in reducing the rate of inflation was already being achieved, and a stronger anti-inflationary effort was being planned. In requesting the Fund’s support, the authorities stated their beliefs that the exchange reserves, which were very low, were not adequate to guard against unforeseen contingencies, and that such support would provide much-needed flexibility and would strengthen public confidence in the proposed new program.
The Executive Board, noting that the current leadership in Indonesia had demonstrated an ability to pursue stabilizing financial policies and to lay the conditions for new economic growth, believed that the forthcoming program was worthy of support and agreed to the request. Detailed performance criteria and specific objectives in the fields of monetary, fiscal, and exchange policy were written into the stand-by arrangement, and the amounts to be drawn were phased. Throughout the rest of 1968 and in February 1969 Indonesia drew the full amount authorized. Despite some temporary setbacks because a serious scarcity of rice caused sharp increases in consumer prices, the Indonesian authorities managed to achieve a marked deceleration in the rate of price inflation, to balance the budget, and to add to their net exchange reserves. In March 1969 they requested a stand-by arrangement for $70 million, to support a five-year development plan beginning April 1, 1969. This arrangement was approved in April, and Indonesia drew most of the amount authorized before it expired in April 1970.
The year 1969 seemed to be an important turning point for the Indonesian economy. Rapid inflation was effectively brought under control, the exchange rate remained stable, and the Indonesian policymakers were turning their attention to the promotion of economic growth. The financial program for 1970/71 was to include, inter alia, a reform of the exchange system to encourage exports and strict controls on the contracting of short-term and medium-term debt. The stand-by arrangement for $46.3 million, requested and approved in April 1970, was expected to strengthen confidence in the rupiah and to allow flexibility in the management of the external sector. Indonesia drew $38 million under the arrangement.
As Indonesia continued to make progress, a one-year stand-by arrangement for $50 million was approved in April 1971, but no purchases were made under this arrangement. At the end of 1971 the Fund was continuing to keep the Indonesian situation under close surveillance, not only through the annual consultations under Article XIV but also through the quarterly reviews required under the terms of stand-by arrangements.
After 1964 Brazil began to experience what some observers labeled an economic miracle. In that year the country was suffering from stagnant output, rampant inflation, and an acute shortage of foreign exchange. The inflation that had plagued the economy since World War II, especially after 1958, had caused prices to rise in 1964 and 1965 by as much as 90 per cent. Recurrent balance of payments deficits had led to the accumulation of commercial and financial arrears, and large foreign indebtedness had resulted in a heavy burden of debt repayment. Upon taking office in April 1964, a new Government introduced, and then continued to apply, economic policies aimed at gradual stabilization of prices, rapid growth, and a strong balance of payments position. By 1971, the end of the period examined here, impressive results had been achieved. For the fourth consecutive year the annual rate of economic growth was more than 9 per cent in real terms and the balance of payments was in surplus by a substantial amount. The 18 per cent rise in the cost of living in Rio de Janeiro was the smallest since the mid-1950s. Automobiles, tractors, cement, drugs and chemicals, nonmetallic minerals, wood and furniture, and paper and printing all had become leading growth industries. Exports of many manufactures expanded and exports as a whole had become quite diversified. (These developments continued after the end of 1971. In fact, in 1973 Brazil’s annual exports totaled $6 billion and gross official reserves at the end of that year reached $6.4 billion, by far the highest ever recorded.)
During these years the Fund, through its annual consultations under Article XIV, through participation in the rescheduling of debt repayments, through stand-by arrangements, and through frequent informal contacts and exchanges of visits, kept in close touch with the Brazilian authorities and their economic programs and achievements.
The Fund approved the first in a series of stand-by arrangements for Brazil on January 13, 1965. The amount authorized on that date was $125 million. (The Fund had previously approved stand-by arrangements for Brazil in 1958 and 1961.) The program submitted in support of the January 1965 arrangement placed emphasis, initially, on containing inflation, reducing the imbalances in the economy that were stifling output and exports, and creating an institutional environment appropriate for growth. During the year a central bank was created, credit controls strengthened, public finances revamped, and exchange policies liberalized. By the end of the year, the fiscal and balance of payments positions had improved markedly, the rate of increase in prices had decreased considerably, and some reduction in the rate of monetary expansion had been achieved. There had, however, been a temporary slowdown in economic activity. The authorities drew $75 million of the $125 million authorized by the stand-by arrangement. They planned to exercise continuing restraint over domestic credit expansion and to bring about a further improvement in the Government’s financial position, and in February 1966 the Fund approved another stand-by arrangement, again for $125 million. No drawings were made, and Brazil in fact reduced its indebtedness to the Fund. The next stand-by arrangement, authorized in February 1967, was for $30 million.
The year 1967 was the one in which the momentum of the Brazilian inflation was finally broken. The rate of increase in prices slowed appreciably. Although there was a deterioration in the country’s net foreign exchange position in 1967, this had been reversed by April 1968, when the Fund approved the fourth in the series of stand-by arrangements, for $87.5 million. The purpose of this arrangement was to enable Brazil to meet its repurchase obligations. The 1967 arrangement had not been used, but drawings under the new arrangement were expected.
In 1968 the authorities turned their attention to accelerating the rate of economic growth. Reform of the tax system had been undertaken in 1967 to assure that rising income and output would generate a steady growth in government revenues and to provide tax incentives for the stimulation of investment and exports, and to encourage the development of a capital market. In August 1968 a flexible exchange rate policy was introduced, which allowed adjustments in the exchange rate by small amounts at frequent, irregular intervals so as to maintain relative parity between the cruzeiro and the currencies of Brazil’s major trading partners. This policy aimed at encouraging exports and at rationalizing capital movements by curbing speculative capital flows and stimulating long-term investment.
In 1968 the pace of economic growth did accelerate. A high rate of economic activity induced greater capital inflows, and the capital account of the balance of payments began to show a surplus. Official reserves began to increase. Some problems could, of course, be expected; in particular, prices continued to rise at much the same rate as in 1967. The objective of the Government that took office in 1969 was to achieve a gradual but steady reduction in the rate of inflation. A total of $75 million was drawn under the 1968 stand-by arrangement.
In April 1969 the Fund approved a stand-by arrangement for $50 million. This arrangement was not drawn upon. Nonetheless, the authorities considered stand-by arrangements important to their objectives and stand-by arrangements were approved for Brazil in February 1970 and in February 1971, each for $50 million. In the programs submitted in support of the 1970 and 1971 arrangements, the authorities continued to have as their primary objectives the maintenance of a high rate of economic growth, further gradual reduction in the rate of inflation, and the preservation of a sound balance of payments position. In the financial sphere, three targets continued to be of importance: reducing the cash deficit of the government treasury, slowing down the expansion of domestic credit, and building up foreign exchange reserves. The 1970 and 1971 stand-by arrangements also were not drawn upon.
As 1971 came to a close, production, particularly in the industrial sector, was continuing to rise rapidly and inflation was below 20 per cent a year and continuing to decline. The Fund staff was negotiating with the Brazilian authorities a letter of intent requesting the eighth in the series of stand-by arrangements, again for $50 million.9 Moreover, serious inflation was gradually developing into a worldwide phenomenon, and Brazil’s experiences with anti-inflationary policies were becoming of general interest. In particular, interest began to center on a technique used by the Brazilian authorities that was called “generalized indexing,” in which costs and prices were tied closely together.10
Financial Programming—A Major Activity
The particular circumstances that attended each stand-by arrangement differed, but, as we have seen in the foregoing examples, usually a stand-by arrangement was intended to support a member’s program to achieve or restore monetary stability in its domestic economy and equilibrium in its balance of payments. In other words, a stand-by arrangement and a stabilization program usually went hand in hand.
The stabilization programs agreed between the Fund and its members customarily consisted of an understanding on the domestic monetary and fiscal policies that would be pursued. By the late 1960s these stabilization programs had come to be referred to rather formally as financial stabilization programs, and they had become very specific. Virtually all the programs submitted to the Fund by members requesting stand-by arrangements in the upper credit tranches contained detailed quantitative ceilings on credit expansion. Most programs contained separate ceilings on the extension of credit by the central bank to the government or to the public sector as a whole. Often credit expansion by the entire banking system was also subject to limits.
Ceilings on domestic credit expansion were emphasized because performance criteria in stand-by arrangements were based on the view of the staff and of the Executive Directors that changes in the supply of money and credit in an economy had a strong impact on aggregate domestic demand and a related effect on the balance of payments. Practical considerations as well led the Fund to the use of credit controls in stabilization programs. Credit policy was an instrument used by the authorities of nearly all members for short-term control of their economies. Moreover, most members kept monetary statistics that were readily available and detailed enough to permit the Fund to follow closely the achievements of the program. Nevertheless, direct fiscal measures—either additional taxes or cuts in aggregate public expenditure or both—were usually also stipulated in members’ financial stabilization programs. In effect, the total impact of monetary and fiscal policies was summed up in the form of credit ceilings.
In addition, as we have seen in the examples discussed in the foregoing section, many programs contained exchange rate provisions. Frequently, especaily among developing members with overvalued exchange rates, fluctuating rates were specified as a way to obtain more realistic rates. To ensure that exchange rates would in fact fluctuate freely and that central banks would not intervene in the market, members were committed to acquiring and then maintaining minimum levels of foreign exchange reserves. As another way to ensure that exchange rates were realistic, members were often obligated not to impose restrictions on imports and exchange payments.
Any changes made in the performance criteria during the period that the stand-by arrangement was in existence were subject to review and approval by the Executive Board.
How Programs Were Devised
Helping a member to prepare a comprehensive financial program in support of its request for a stand-by arrangement, and negotiating with the monetary authorities of a member the related credit ceilings and balance of payments goals, had for years played a large part in the Fund’s technical work with Latin American members. But as the membership of the Fund grew and as stand-by arrangements became commonly used by members in all regions, the working out of a financial program as a prelude to a stand-by arrangement became almost a standard practice. In addition, as time went by, the staff began to go through essentially the same programming discipline when it held discussions with members for the Article VIII and Article XIV consultations. After 1965 there was a notable decrease in the exchange controls and restrictions and in the bilateral agreements maintained by many of the Fund’s members and correspondingly less emphasis in the annual consultations on the nature and purpose of exchange restrictions, which had originally been the raison d’être of these consultations. Many of the annual consultations subsequently turned on the question of the financial policies that would best enable members to keep their domestic costs and prices down and their external payments in balance, especially as inflation plagued practically every member.
Financial programming was, in essence, an exercise aimed at determining a set of monetary and fiscal policies for the next 12 to 18 months that would reconcile resource availabilities with resource needs in such a way as to produce minimum strain on the member’s domestic price level and a desired balance of payments result. The programs went into ever-greater detail, covering not only the total supply of money but the different sources of expansion of money and quasi-money, the structure of interest rates and interest rate policies, the handling of cash balances, the management of domestic debt, and other sub-sectors of members’ monetary activities.
The greater part of the time and attention of the staff, especially of the five area departments, was increasingly devoted to working with members to devise specific credit ceilings and targets suitable for inclusion in stand-by arrangements and to reviewing members’ performances under these arrangements. As stand-by arrangements were initiated with more and more members, as changes in financial programs associated with stand-by arrangements were renegotiated and had to be approved by the Executive Directors, as the financial policies agreed became increasingly specific, and as assistance was requested by members for both the formulation and the execution of their financial policies, the staff’s work in this regard became extremely intensive.
The Fund tried to make certain that the programs set up for different members were as consistent and uniform as possible. The Stabilization Policies Division was created in the Exchange and Trade Relations Department in 1965 for just this purpose.
Financial programming also became increasingly subject to quantitative analysis, that is, advanced econometric techniques were applied to working out particular targets of monetary policy. Many of the techniques evolved by the Fund for quantifying monetary targets, as well as the economic concepts and analysis underlying the use of that quantification, had not previously been used by economists. Monetary economists gradually came to refer to the type of analysis that summarized the monetary picture of a country in terms of a few aggregate figures, which in turn were used to estimate the size of a potential balance of payments deficit, as a new “IMF-inspired” monetary approach.
The Fund staff and the officials of a member planning to request a stand-by arrangement often sat down together, in advance of the request, to make quantitative estimates of the total supply of the economy’s financial resources (such as bank deposits, government revenues, private savings, loans and credits from abroad) and of the total demand for financial resources (private consumption expenditures, current government expenditures, investment plans of the private and public sectors, and foreign debt repayment). Projections were made of the major flows of funds through the banking system. The projections frequently required a reshuffling of the government’s accounts so as to show the prospective effects of the financial operations of the government on the banking system and on the balance of payments. Attempts were often made to extend the analysis of governmental operations to the entire public sector rather than to only that part of it represented by the budget of the national government. The estimates of the demand and supply for financial resources thereby derived were then juxtaposed, to enable a determination of the extent of the possible pressure on a member’s internal prices or on its balance of payments. Frequently, this financial programming involved quantifying the effects on prices and on the balance of payments of alternative sets of financial policies. Similarly, a forecast of the consequences of a set of financial policies for the year ahead was often required.
Preliminary calculations were sometimes based on economic models that indicated, if only in an approximate way, the likely relationship between credit creation and the balance of payments. Over time the staff had developed a number of such models. One well-known one was the Polak Model.11 In 1970 Mr. Polak refined the model, initially developed from 1957 to 1960, so as to incorporate more complex relationships, and he built an alternative model that was more suited to economies with highly developed financial markets, for use in industrial countries.12 Once estimates of exports and capital movements for the coming year had been made, such economic models permitted calculations of the change in external reserves associated with any assumed amount of domestic credit expansion.
The results obtained by these or other technical methods were, of course, modified by judgment which took into account members’ past experiences with various financial policies. Often the computer was used to appraise expected results, using data from past experience. Many further alterations in suggested policies were subsequently worked out in the course of frequent discussions between Fund staff and the authorities of the member concerned. Only then were monetary and fiscal policies agreed upon and aggregate credit ceilings, ceilings for particular parts of the banking system, and targets for reserves determined.
Because financial stabilization programs were worked out with the authorities of numerous countries in which economic circumstances and banking and monetary institutions were widely diverse, the methodology used and the depth of analysis and detail necessarily varied.13 In effect, there was no standard way in which the quantitative ceilings on credit expansion and the targets for foreign exchange reserves were derived. The ceilings and targets in each stand-by arrangement were adapted to the economic circumstances and the financial institutions of the member concerned and resulted from continuing discussions between the member and the Fund, both at the management and staff level and at the Executive Board level.
Programming Methodology Under Study
The Executive Directors were very much interested in the general philosophy of the financial programming related to stand-by arrangements and in the models and techniques used. At the time of the general review of the Fund’s policy on stand-by arrangements in mid-1968, Mr. Kafka and Mr. Palamenghi-Crispi urged that the Fund regularly review the methodology of financial programming. Then, and on later occasions, they asked for reviews of, for example, the models used and the Fund’s experience with the ceilings imposed under stand-by arrangements.
Consequently, to gain more insight into the efficacy of monetary and fiscal policies, the staff of both the functional departments and the area departments undertook to examine the evidence of the past. This examination was considered more fruitful than earlier examinations because the Fund had built up an accumulated experience with members. Some of the studies looked generally at what could be learned about the demand for money.14 Others examined the effects of money and monetary policy in developed countries.15 Conclusions were also drawn concerning the experiences of selected developing members with money supply and with interest rates.16
In a study wider in coverage and broader in scope, the balance of payments performance of 23 countries in Latin America and the Caribbean area from 1966 to 1970 was evaluated empirically.17 The evaluation included examining the relationship between balance of payments performance and governmental policies. A special examination was made of policies of credit restraint and the effects of exchange rate adjustment. Among the conclusions were that the countries that managed demand by restraining credit were, by and large, the smaller ones, while all the larger ones, except Mexico, followed active exchange rate policies.
Early in 1971, Executive Directors began to inquire more closely into the ways in which particular programs had been formulated. For instance, in January, on the occasion of a Board discussion on a stand-by arrangement for Korea, Mr. Palamenghi-Crispi asked several questions: By what analysis and mechanics had the staff estimated the ceiling for the increase in total domestic bank credit for the next 12-month period? What underlying assumptions had been made about the growth in the gross national product, both in real and in money terms? What was the relationship between the financial programs and the growth of the economy? Could not detailed projections be given for the fiscal, monetary, and reserve accounts? Later, other Executive Directors—among them Mr. Maurice P. Omwony (Kenya) and Mr. Yaméogo—asked for analyses of the degree of success attained with previous financial programs. The Managing Director promised greater quantification in papers relating to stand-by arrangements and a general paper on how credit ceilings were made up.
The paper on credit ceilings was considered by the Executive Board toward the end of 1971. It showed a high positive correlation between members’ observance of credit ceilings and their achievement of balance of payments goals. The staff emphasized that credit ceilings reflected the monetary consequences of all financial policies; they did not reflect monetary policy alone. The staff did not believe that monetary policy necessarily must play the prime role in balance of payments adjustment, as the emphasis on credit ceilings seemed to suggest. In most programs the burden of adjustment fell on fiscal policy and, at times, also on incomes policy.
These discussions indicated that, although the Fund’s advances in the analysis of monetary policy had been considerable, much remained to be done. Among the questions that needed further consideration were the following: To what extent was a monetarist approach—that is, one based on the assumption that changes in the stock of money are a primary determinant of changes in total spending—valid for all countries? In particular, was a monetarist analysis equally applicable to both developed and developing countries? Were there not important differences between countries in respect of the transmission mechanism explaining how monetary influences affect real output, employment, and the price level?18 Could monetary variables other than credit ceilings—such as total money supply—be used as an index of financial control? What methods could be devised to adjust credit ceilings more easily? Were not parameters based on past experience given too much weight as against projections of the future? To what degree did programs based on credit ceilings affect domestic employment and the distribution of income? Were aggregative techniques useful for influencing the newly emerging socio-economic objectives of enhancing employment and redistributing income?
Expediting Purchases Under Stand-By Arrangements
On a number of occasions the question had been raised in connection with purchases under a stand-by arrangement whether the time between the receipt from a member of an authenticated request to draw and the completion of the transaction by the Fund could not be shortened; five business days was the normal interval. There appeared to be no reason why the time required for handling valid requests for purchases under stand-by arrangements needed to be longer than that for gold tranche purchases, for which the procedure had been shortened in September 1969. Therefore, in March 1970 the Executive Board decided that purchases under stand-by arrangements would be handled like gold tranche purchases. This would speed up the procedure by at least two days.19
I.e., no clauses providing for drawings by installments were included. In other words, the United Kingdom would be able to purchase the full amount in one transaction.
E.B. Decision No. 2603-(68/132), September 20, 1968. The full decision is reproduced in Vol. II below, p. 197.
Opening Address by the Managing Director, Summary Proceedings, 1968, p. 27.
The reader who wishes to look first at the events leading up to the devaluation is referred to Chap. 22.
The seminars with U.K. officials are discussed in Chap. 21, pp. 443 and 445.
For a study of Colombia’s minor exports and how they responded to Colombia’s export promotion system, see José D. Teigeiro and R. Anthony Elson, “The Export Promotion System and the Growth of Minor Exports in Colombia,” Staff Papers, Vol. 20 (1973), pp. 419–70. A discussion of the rationale of Colombia’s differentiated rates for exports, and of its experiences with such rates, can also be found in Margaret G. de Vries, “Multiple Exchange Rates: Expectations and Experiences,” Staff Papers, Vol. 12 (1965), pp. 282–313.
The arrangement was approved in March 1972, but through the middle of 1974 no further request was made for a stand-by arrangement in view of the large size of Brazil’s external reserves.
A brief appraisal of Brazil’s experience in using indexing can be found in Jack D. Guenther, “‘Indexing’ Versus Discretionary Action—Brazil’s Fight Against Inflation,” Finance and Development, September 1975, pp. 25–29.
J. J. Polak, “Monetary Analysis of Income Formation and Payments Problems,” Staff Papers, Vol. 6 (1957–58), pp. 1–50; and J. J. Polak and Lorette Boissonneault, “Monetary Analysis of Income and Imports and Its Statistical Application,” Staff Papers, Vol. 7 (1959–60), pp. 349–415.
J. J. Polak and Victor Argy, “Credit Policy and the Balance of Payments,” Staff Papers, Vol. 18 (1971), pp. 1–24.
For a description of how a stabilization program was formulated and executed, see Rattan J. Bhatia, Gyorgy Szapary, and Brian Quinn, “Stabilization Program in Sierra Leone,” Staff Papers, Vol. 16 (1969), pp. 504–28.
See, for example, Joseph O. Adekunle, “The Demand for Money: Evidence from Developed and Less Developed Economies,” Staff Papers, Vol. 15 (1968), pp. 220–66; and Yung Chul Park, “The Variability of Velocity: An International Comparison,” Staff Papers, Vol. 17 (1970), pp. 620–37.
See, for example, Victor Argy, “The Impact of Monetary Policy on Expenditure with Particular Reference to the United Kingdom,” Staff Papers, Vol. 16 (1969), pp. 436–88, and “The Role of Money in Economic Activity: Some Results for 17 Developed Countries,” Staff Papers, Vol. 17 (1970), pp. 527–62.
See, for example, Rattan J. Bhatia, “Factors Influencing Changes in Money Supply in BCEAO Countries,” Staff Papers, Vol. 18 (1971), pp. 389–98; and Anand G. Chandavarkar, “Some Aspects of Interest Rate Policies in Less Developed Economies: The Experience of Selected Asian Countries,” Staff Papers, Vol. 18 (1971), pp. 48–112.
E. Walter Robichek and Carlos E. Sansón, “The Balance of Payments Performance of Latin America and the Caribbean, 1966–70,” Staff Papers, Vol. 19 (1972), pp. 286–343.
The staff had already begun work on some of these questions. For example, for a review of the divergent views among monetarist and nonmonetarist economists on the transmission process of monetary policy, see Yung Chul Park, “Some Current Issues on the Transmission Process of Monetary Policy,” Staff Papers, Vol. 19 (1972), pp. 1–45. For a discussion of the efficacy of monetary policy in developing countries, see Deena R. Khatkhate, “Analytic Basis of the Working of Monetary Policy in Less Developed Countries,” Staff Papers, Vol. 19 (1972), pp. 533–58.
E.B. Decision No. 3006-(70/24), March 20, 1970; Vol. II below, p. 198.