Current Developments in Monetary and Financial Law, Vol. 3
Chapter

CHAPTER 14 International Reserves—Legal Aspects of Concept and Usage at the IMF

Author(s):
International Monetary Fund
Published Date:
April 2005
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Author(s)
ROY C. BABAN

This chapter examines the legal aspects of the concept of international reserves and its usage at the International Monetary Fund (IMF). As an indicator of the external position of a member country, international reserves is a key determinant in its financial relations with the IMF, whether the member is a creditor to the IMF or a user of IMF credit.

Traditionally, international reserves data that members report to the IMF have been compiled in accordance with a balance of payments accounting methodology that applies to all members. The Asian financial crisis of the late 1990s revealed that international reserves data reported by some central banks were not accurate indicators of their external positions. In particular, the data did not reflect the constraints on their liquidity posed by off-balance-sheet items. In the aftermath of the crisis, the IMF adopted in March 1999 a new standard, the so-called “reserve template,” for the reporting of international reserves by members who voluntarily subscribe to the Special Data Dissemination Standard (SDDS). The reserve template integrates the concepts of international reserves and foreign currency liquidity in a single framework. This framework departs from certain principles underlying traditional balance of payments accounting. While the reserve template adds to the quiver of analytical tools for certain situations, most IMF operations continue to use a definition of international reserves directly related to balance of payments accounting.

The first section describes the obligation of members to provide information on international reserves to the IMF. The next section examines the main principles underlying traditional balance of payments and international reserves accounting. The third section describes the usage of international reserves in determining access to IMF credit and as a performance criterion in the associated conditionality. The fourth section discusses the usage of international reserves in the financial transactions budget, designation in the Special Drawing Rights (SDR) Department, and early repurchases. The final section examines the principles underlying the liquidity concept of international reserves as set forth in the reserve template of the SDDS.

Obligation of Members to Provide Information on Reserves

The IMF Articles of Agreement require members to provide information on 12 categories of national data “as the minimum necessary for the effective discharge of the Fund’s duties.”1 One of these categories refers to “official holdings at home and abroad of (1) gold, and (2) foreign exchange.”2 The Articles also require members to provide the IMF with “information necessary for [firm] surveillance” over exchange rate policies.3 A decision on the principles of IMF surveillance identifies the reserve position and external indebtedness as part of the background against which a member’s exchange rate policies would be assessed.4

The IMF has not adopted a definition of what is necessary for surveillance, that is, a definition that would apply to all members. However, it has identified a core set of statistical indicators, including international reserves, the provision of which to the IMF would be monitored through the annual Article IV consultation process through which surveillance is mainly conducted.

Principles Relating to Balance of Payments Accounting and the Definition of International Reserves

Balance of Payments Methodology

The balance of payments is a central concept in IMF operations. The term is mentioned in two of the six purposes of the IMF set forth in the Articles of Agreement. One purpose is to make general IMF resources temporarily available to members, “thus providing them with the opportunity to correct maladjustments in their balance of payments without resorting to measures destructive of national or international prosperity.”5 Another purpose is “to shorten the duration and lessen the degree of disequilibrium in the international balances of payments of members.”6

The IMF Balance of Payments Manual, 5th Edition, published in 1993, (BOPM5) contains the methodology used by the IMF to guide member countries in compiling statistics for the balance of payments and international reserves.

The BOPM5 methodology for calculating the balance of payments is based on several key principles, of which the following are most relevant in the present context. First, it records transactions between residents and nonresidents. Second, the timing of the recording of transactions relates to the notion of realization or accrual For example, trade in goods is generally to be recorded when ownership is transferred; however, given the uncertainty of when this occurs, trade in goods is generally recorded when goods cross the border, as shown in customs records. Service transactions are generally recorded when services are rendered or when performance is due. Financial transactions are generally to be recorded when the creditor records a claim and the debtor records a liability. However, given the uncertainty of when this occurs, loan disbursements, for example, are generally recorded when made, while loan repayments are recorded when due. Third, the currency denomination of relevant transactions has no effect on classification. Thus, for example, a transaction denominated in local currency by a resident with a nonresident would be captured in the balance of payments, while a transaction denominated in foreign currency between residents would not. Finally, assets and liabilities are subject to symmetrical treatment.

International Reserves Methodology

The balance of payments and international reserves are methodologically linked. Balance of payments transactions are divided into two sets. Above-the-line autonomous transactions are undertaken for their own sake and thus contribute to or result in an overall payments deficit or surplus. Below-the-line transactions accommodate the surplus or, exceptionally, finance the deficit. An overall deficit in the balance of payments results in a decline in net international reserves. An overall surplus in the balance of payments results in an increase in net international reserves.

Though the Articles of Agreement identify certain components of international reserves (i.e., gold and foreign exchange holdings), they do not define the concept. They also do not specify reporting periodicity (e.g., monthly or quarterly) or reporting timeliness (i.e., the lag between the end of the reporting period and the communication of the information). Rather, the definition of reserves and the desired periodicity and timeliness of information have been established by a statistical methodology formulated in light of developments in international transactions, the operational needs of the IMF and its members, and expert opinion.

Reserve Assets

For an asset to be a reserve asset, it has to be (1) an external asset, (2) readily available, (3) controlled by the monetary authorities, and (4) for the purposes of direct financing of the balance of payments or for intervening in the foreign exchange market.7 The criterion of ready availability implies the notion of minimal conditionality. In general, liquid and marketable assets satisfy the criterion of ready availability. The criterion of control is satisfied by official ownership. However, effective control may also be satisfied even if the assets are not officially owned, if the authorities exercise direct and effective control over the assets. As the main purposes of reserves are payment and intervention, reserves must be external assets.

The assets that satisfy all these criteria include (1) holdings of monetary gold; (2) holdings of SDRs; (3) reserve position in the IMF (comprises the reserve tranche—the subscription to the IMF in convertible currency or SDRs—and any creditor position in the IMF); and (4) foreign exchange in the form of currency, deposits, and securities with the requisite characteristics.8 If not netted against reserve liabilities, the sum of these assets is termed “gross reserve assets.”

Reserve Liabilities

The principle of symmetry implies that a debtor’s liability that is considered by the creditor as a reserve asset should conceptually be treated as a reserve liability of that debtor. The counterparts to foreign exchange assets are foreign exchange liabilities. In the IMF, a member’s reserve position in the IMF is an asset, while IMF credit to a member is that member’s liability. The symmetry principle does not apply to two items. There are no liability counterparts for holdings of monetary gold or holdings of SDRs because there are no debtors involved. When reserve liabilities are netted out against reserve assets, the result is termed “net international reserves,” which could be either a positive or negative figure.

Usage of International Reserves in Conditionally

Balance of Payments Need

To use the IMF’s resources, whether from its General Resources Account or the SDR Department, a member must show that it has a balance of payments need. A member must show that it has a need to make the purchase because of (1) “its balance of payments” or (2) “its reserve position” or (3) “developments in its reserves.”9 These are alternative, not cumulative, criteria; thus, satisfaction of one criterion is sufficient. The IMF imposes conditionality so that a member’s balance of payments need will be addressed and the IMF repaid.

The Articles of Agreement do not define these three alternative criteria. However, their meanings have been clear from the legislative history of the Second Amendment and subsequent IMF practice. According to the first criterion, a member is deemed to have need if it has an overall deficit in its balance of payments. According to the second criterion, a member has a need if it has an inadequate reserve position.10 Unlike the overall balance of payments deficit, which is an objective numerical measure, assessing reserve position adequacy requires judgment. Typically, a member that had a fixed exchange rate or a more open economy or whose trade is subject to price volatility would have greater need of reserves than one that had a floating exchange rate or a less open economy or whose trade prices were more stable.

The third criterion of need was intended to cover certain special circumstances whereby a member may be deemed to have a need even though it does not have a balance of payments deficit or a weak reserve position. For instance, under this criterion, a member whose currency is a reserve currency would be deemed to have need when faced with a sudden demand to discharge its external liabilities. Also, to make contributions to the Poverty Reduction and Growth Facility Trust liquid, a lender to the Trust that had temporary liquidity problems would also be deemed to satisfy the third criterion, enabling it to use IMF resources in lieu of withdrawing its loans to the Trust. Another application, now moot, is the use of IMF resources for the settling of balances under the European Economic Community “snake arrangement.”

Performance Criterion on International Reserves

Strengthening the reserve position, or preventing a further weakening, is a typical objective of an IMF arrangement. If a performance criterion is adopted, it could be specified as a floor or a minimum increase or maximum decline. The reserves indicator could be defined as a measure of either gross or net reserves. A gross reserves indicator is simpler and data on its components are easier to collect, but it may not necessarily be a good indicator of a member’s reserve position. For instance, a member that borrowed abroad with a maturity long enough for the debt to avoid being classified as a reserve liability would increase its gross reserves without increasing its reserve liabilities. Thus, an improvement in the reserve position would be recorded, when its reserve position may not have strengthened at all. This dilemma has been partly alleviated by the inclusion of limits on the contracting or guaranteeing of public external debt in IMF arrangements.11 Nevertheless, IMF arrangements that have a performance criterion for reserves typically use a net reserves concept so as to directly capture the effect of liabilities on a member’s reserve position.

Staff teams that negotiate credit arrangements with members have some flexibility in defining performance criteria.12 With respect to a performance criterion on reserves in particular, a reserves concept closer to the reserve template (see below) than to traditional reserve accounting may be adopted if deemed applicable and if data are available on a timely basis. Also, if some lumpy international transactions are anticipated, the performance criterion on reserves could be defined with built-in adjusters. This way, if the lumpy transaction does occur, the criterion is automatically adjusted without need of renegotiation, thereby reducing the likelihood that the criterion would not be observed.

Usage with Respect to the Financial Transactions Budget, Designation in the SDR Department, and Early Repurchases

The IMF selects members who are deemed to be in a strong position to participate in the financial transactions budget,13 to be designated SDRs,14 and to reduce outstanding financial obligations to the IMF, if any, ahead of schedule (i.e., in IMF jargon, to make “early repurchases”). An assessment of strength for these purposes is based on a member’s “balance of payments and gross reserve position,” which is “a combined concept, under which strength in one element may compensate for moderate weakness in the other.”15

Two points should be noted about this concept of strength. First, it uses a gross reserve concept. However, net reserves, if available, are relevant to the assessment. A decision states that “[t]o the extent that recent data on changes in a member’s net reserves are available, these shall be taken into account as an indicator of the member’s balance of payments position.16 Second, the use of a combined concept of strength increases the potential pool of members that could be assessed as strong. Thus, for example, a member could be assessed as strong even though it may have a moderate balance of payments deficit.17 The use of alternative concepts of balance of payments need, discussed above, has a similar effect in that it increases the likelihood that a member can demonstrate need and qualify to use IMF resources.

“Reserve Template”—A Liquidity Concept of International Reserves

The reserve template involves a concept of reserves different from the concept derived directly from the balance of payments. The reserve template has six component categories.18 In the column of foreign currency resources are (1) official reserve assets and (2) other foreign currency assets (i.e., assets that are not reserve assets). In the column of foreign currency “drains” (outflows net of inflows) are predetermined drains—namely, (3) foreign currency liabilities and (4) financial derivative positions in forwards, futures, and swaps—and contingent drains—namely (5) contingent foreign currency liabilities and (6) financial derivatives in options. Predetermined drains are known or fixed contractual obligations in foreign currencies. Such drains are triggered by an event certain to happen (e.g., the lapse of a given time period). Contingent drains are contractual obligations that involve potential or possible future additions or depletions of foreign currency assets. Such drains are triggered by an exogenous event not certain to happen.

Several key characteristics distinguish the reserve template from traditional international reserves accounting. First, official reserve assets (item 1 above) are claims on nonresidents, the only category in the template that maintains the distinction between residents and nonresidents. Other foreign currency assets (item 2) are claims on residents and nonresidents and the predetermined and contingent drains (items 3 through 6) are net liabilities to residents and nonresidents. The inclusion of residents is meant to capture situations where transactions between the monetary authorities and residents could result in a loss or gain of reserves under official control. Second, while official reserve assets, other reserve assets, and foreign currency liabilities (items 1 through 3) are on-balance-sheet items, items 4 through 6 are off-balance-sheet items. Disclosure of items 4 through 6 provides transparency with respect to otherwise hidden liabilities. Third, the institutional coverage includes not only the monetary authorities but also other public sector entities (mainly the central government, excluding social security funds) whose foreign currency assets could be called upon in case of currency crises or whose liabilities give rise to demands on the authorities’ foreign currency resources. Fourth, in contrast to the notions of realization or accrual associated with balance sheet entries, the reserve template includes contingent liabilities.

The reserve template is neutral with respect to the openness of a member country to capital inflows and outflows. The provision of a fuller picture of the foreign currency liquidity of a member should lead to more informed investor decisions. In the case of the Asian crisis, it is reasonable to argue that a significant portion of the capital that fled at its outbreak would not have entered to start with had investors known the extent of official off-balance-sheet liabilities.

Conclusion

The balance of payments and international reserves, which records transactions and claims between residents and nonresidents, are key concepts in IMF operations. These concepts share a common statistical accounting methodology, applicable to all members, under which the overall balance of payments is conceptually equivalent to the change in net international reserves. As thus defined, international reserves is a key indicator in the IMF’s analysis of a member’s external position and surveillance of exchange rate policies and in determining a member’s eligibility for certain IMF transactions, whether as a creditor or user of credit.

The reserve template, a standard to which a member country may voluntarily subscribe, sets forth a different concept of international reserves, one that does not bear a direct correspondence to balance of payments accounting. The template defines official foreign currency resources more broadly and employs the concept of “drains,” that is, liabilities, whether owed to residents or nonresidents, whether on-balance-sheet or off-balance-sheet, whether predetermined or contingent. Underlying the template are the notions that all such liabilities do and may drain official foreign currency resources and their transparency would lead to better-informed investor decisions.

Notes

IMF, Articles of Agreement of the International Monetary Fund, Article VIII, Section 5(a).

IMF, Articles of Agreement of the International Monetary Fund, Article VIII, Section 5(a)(i).

IMF, Articles of Agreement of the International Monetary Fund, Article IV, Section 3(b).

“The Fund’s appraisal of a member’s exchange rate policies shall be based on an evaluation of the developments in the member’s balance of payments, including the size and sustainability of capital flows, against the background of its reserve position and its external indebtedness.” Selected Decisions and Selected Documents of the International Monetary Fund, Twenty-Seventh Issue (IMF, 2003) [hereinafter Selected Decisions], at 13.

Article I(v).

Article I(vi).

Balance of Payments Manual, 5th Ed., para. 424.

Lending to the Poverty Reduction and Growth Facility (PRGF) and PRGF-HIPC Trusts is also treated as reserve assets, as the authorities can withdraw them with notice to the IMF as Trustee.

The criteria of need are identical for use of general resources (Article V, Section 3(b)(ii)) or of SDRs (Article X, Section 111(a)). The PRGF uses a different criterion of need, namely “protracted balance of payments problem,” which may not necessarily manifest as an overall balance of payments deficit or a weak reserve position.

Legislative history indicates that the phrase “reserve position” was meant to refer to gross, not net, reserves.

An increase in external indebtedness may not be preventable because IMF arrangements do not limit disbursements from existing external borrowing contracts.

Definitions that apply in a particular arrangement may be found in appendices to an arrangement or in a separate Technical Memorandum of Understanding. If the member concerned agrees, these documents are published on the IMF’s website.

In accounting terms, participation results in the IMF making available the members’ currencies, resulting in a net reduction in the IMF’s holdings of such currencies.

The SDRs that members with balance of payments need turn in to the IMF in exchange for currencies are “designated” to members who provide those currencies.

IMF, Selected Decisions, at 344.

Id., at 344–45.

Id., at 345.

A detailed description of the reserve template is found in IMF, Data Template on International Reserves and Foreign Currency Liquidity—Operational Guidelines, October 1999.

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