CHAPTER I OVERVIEW
- International Monetary Fund
- Published Date:
- March 2003
The rapid integration of international financial markets—under which the economic developments and policy decisions of one country may affect many other countries—underscores the importance of IMF surveillance to ensure that the international monetary system operates effectively and that each member observes the obligations set forth in the IMF’s Articles of Agreement. This report forms part of the IMF’s multilateral surveillance aimed at reviewing and analyzing progress in promoting a stable system of exchange rates and orderly exchange arrangements among its member countries.1
The report updates developments in exchange arrangements during 1998–2001.2 It also discusses the evolution of exchange rate regimes based on de facto policies since 1990,3 reviews foreign exchange market organization and regulations in a large number of developing and transition countries as of 2001, and examines factors affecting exchange rate volatility in these countries in 2001. The report does not revisit the appropriateness of policy responses to recent crises or assess IMF policy advice in the areas of exchange rate regimes and exchange and capital controls, all of which have been examined in depth in other publications.4
The report is organized in five chapters. This chapter summarizes the findings of the above developments, which will be useful in formulating IMF policy advice and designing technical assistance programs relating to exchange rate regimes, exchange regulations, and foreign exchange market development. Chapter II reviews the evolution of exchange rate regimes and analyzes factors underlying these trends. Chapter III evaluates progress toward currency convertibility for current and capital account transactions and analyzes factors bearing on the use of exchange regulations. Chapter IV looks at foreign exchange market organization and regulations in a large number of developing and transition countries, drawing on the 2001 Survey on Foreign Exchange Market Organization, and Chapter V examines factors affecting exchange rate volatility, focusing on structural features of the foreign exchange market, the types of exchange rate regimes, and the presence of exchange regulations.
Summary of Findings
Against the backdrop of continuing financial globalization and a series of emerging market crises since 1997, there have been important changes in the evolution of exchange rate regimes and the pace of liberalization of current and capital transactions among IMF member countries. Countries have moved away from intermediate exchange rate regimes toward floating regimes and, to a lesser extent, hard pegs.5 The momentum of liberalization—especially of capital transactions—appears to have diminished, possibly reflecting growing concerns about risks associated with the sudden reversal of capital inflows. These developments, combined with macroeconomic fundamentals and foreign exchange market organization and regulations, may have affected exchange rate volatility.
There has been a shift away from intermediate regimes according to the IMF’s official exchange rate regime classification system based on de facto exchange rate policies as detailed in Chapter II, which reviews the evolution of exchange rate regimes and analyzes factors underlying these trends. The shift, however, has been less pronounced than implied by the de jure classification system.6 The polarization of exchange rate regimes appears to have been more pronounced in countries that have already gained access to international capital markets. Statistical evidence suggests that in the past decade intermediate regimes tended to be more prone to market pressures compared with floating or hard peg regimes.
The evolution of exchange rate regimes reflects their changing role in national monetary policy frameworks and the degree to which countries are integrated into international capital markets. In particular, use of the exchange rate as the nominal anchor of monetary policy has declined. Also, an increasing number of countries have adopted an inflation-targeting framework, although the exchange rate still plays an important role in the monetary policy rule in cases where there is a high degree of pass-through from exchange rates to prices. Many countries with open access to international capital markets have either moved away from intermediate regimes toward more flexible regimes to gain greater monetary policy autonomy or were forced to do so in the face of severe pressures on their currencies. Only a limited number of countries have adopted hard peg regimes after exiting from intermediate regimes.
The de facto exchange rate classification system has helped to clarify the nature and role of members’ exchange rate regimes. It has facilitated discussions with country authorities about the implementation of exchange rate regimes and hence has contributed to more effective surveillance of the international monetary system. Assessing actual exchange rate policies was difficult in some cases, however, when countries informally targeted the exchange rate through direct or indirect intervention while officially announcing a floating exchange rate regime. The availability of timely information and a more transparent presentation of the functioning of exchange rate regimes have been crucial for the accurate classification of members’ regimes.
Chapter III evaluates progress toward currency convertibility for current and capital account transactions and analyzes factors underlying these trends. It finds that changes in the number of countries maintaining exchange controls during 1998–2000 indicate a slowdown in efforts to liberalize current, and especially capital, account transactions. The share of IMF member countries having exchange restrictions7 on payments and transfers for current international transactions subject to Article VIII or maintained under the transitional arrangements of Article XIV declined further to about 20 percent by end-2001.8 The share of countries with exchange controls on current transactions (including receipts), however, fell only marginally, to about 70 percent of total IMF members by end-2001.9 Moreover, virtually all members continued to maintain some types of controls on capital account transactions, although some measures were used for prudential and other purposes, and were not designed explicitly to restrict cross-border capital flows.
The use of exchange controls appears to have been little influenced by the degree of flexibility of exchange rate regimes or the occurrences of currency crises. Excluding countries in the euro area, which are classified as maintaining hard peg regimes and imposing virtually no controls on current transactions, no clear relationship was found between the type of exchange rate regimes and the use of controls on current transactions. Nor was a specific pattern evident with respect to capital controls. Countries that experienced crises tended to resort to exchange controls to reduce pressure on the exchange rate, although no systematic patterns were found in the choice of controls imposed by these countries.
Foreign exchange markets reveal wide variations in their key structural features in both developing and emerging market economies (Chapter IV). An IMF 2001 staff survey of foreign exchange market organization found that dealer markets in these countries predominate over auction markets and that foreign exchange accounts are permitted in a large majority of countries. Most countries seek to influence foreign exchange market organization through regulations, which can significantly affect exchange rate dynamics and often lead to some segmentation of the foreign exchange market. In addition, in the vast majority of countries, the central bank is an active participant in the foreign exchange market, but the form this participation takes is highly varied.
Notwithstanding technological and financial innovations, many countries continue to experience high exchange rate volatility. As financial markets around the world become more integrated, volatile exchange rate movements in one country may spill over to other countries, as seen in recent financial crises, underscoring a need to better understand factors affecting exchange rate volatility. In analyzing this volatility, greater attention should be given not only to macroeconomic fundamentals but also to other factors, especially the structural features of foreign exchange markets, the types of exchange rate regimes, and the presence of exchange regulations.
Some structural features of the foreign exchange markets appear to influence exchange rate volatility (see Chapter V). Even after taking into account other features of the countries in question—notably their macroeconomic performance, such as inflation, real GDP growth, and fiscal deficits—those with decentralized foreign exchange dealer markets tended to have lower volatility in 2001. The type of exchange rate regime also affects volatility: for example, countries with an independently floating regime tend to have higher volatility, while those with a crawling band regime tend to experience less volatility. In addition, the presence of exchange restrictions appears to be associated with higher volatility, while some prudential and foreign exchange market regulations—for example, limits on net foreign exchange open positions and restrictions on monetary use of domestic currency by nonresidents—are associated with lower volatility.
Ariyoshi, A., and others, 2000, Capital Controls: Country Experiences with Their Use and Liberalization, IMF Occasional Paper No. 190 (Washington: International Monetary Fund).
Eichengreen, B., and others, 1998, Exit Strategies: Policy Options for Countries Seeking Greater Exchange Rate Flexibility, IMF Occasional Paper No. 168 (Washington: International Monetary Fund).
International Monetary Fund, Annual Report on Exchange Arrangements and Exchange Restrictions (Washington: International Monetary Fund), various issues.
Johnston, B., and others, 1999, Exchange Rate Arrangements and Currency Convertibility: Developments and Issues, World Economic and Financial Surveys (Washington: International Monetary Fund).
“Country” in this report does not always refer to a territorial entity that is a state as understood by international law and practice; the term also covers the euro area and some nonsovereign territorial entities for which statistical data are provided internationally on a separate basis.
The previous report, Exchange Rate Arrangements and Currency Convertibility: Developments and Issues, was published in the World Economic and Financial Surveys series in September 1999 (see Johnston and others, 1999).
On November 24, 1998, the Board approved the staff’s proposal to report the exchange rate regime classification based on a country’s de facto policies. The de jure classification system in effect through 1998 was based on members’ official notifications of their exchange rate regimes.
Intermediate exchange rate regimes are defined as soft pegs (conventional fixed pegs to a single currency or a basket of currencies, horizontal bands, and crawling pegs with and without bands) plus tightly managed floating regimes (under which the authorities attempt to keep the exchange rate stable without any commitment to a predetermined path). Hard peg regimes include currency boards and exchange rate regimes with no separate legal tender (such as formal dollarization and currency unions). Note that the latter category includes countries where the currency chosen as legal tender may float freely with respect to the currencies of the rest of the world (for example, countries in the European Monetary and Economic Union (EMU)).
The de jure classification system in effect through 1998 had a number of shortcomings, including its failure to capture differences between actual and announced policies and between very rigid forms of pegged regimes and softer pegs. for details, see Johnston and others (1999). The de facto classification has formed the basis of the IMF’s official exchange rate regimes since January 1999.
An exchange restriction is a concept under the IMF’s jurisdiction that applies only to the making of payments and transfers for current international transactions. The broader concept of an exchange control includes—in addition to restrictions subject to IMF jurisdiction under Article VIII and restrictions maintained under the transitional arrangements of Article XIV—a range of measures that may affect any transaction by residents or nonresidents that involves the use of foreign exchange domestically or abroad, or cross-border flows associated with the acquisition of assets or issuance of liabilities denominated in domestic or foreign currency.
Payments for current international transactions, as defined under Article XXX, Section (d) of the Articles of Agreement, also include certain items that from an economic perspective, are capital in nature, namely: (i) normal short-term banking and credit facilities; (ii) investments; (iii) “moderate” amount for loan amortization or for depreciating direct investments; and (iv) “moderate” remittances for family living expenses. for the latter, the term moderate has not been precisely defined.
The changes in the number of countries with controls may reflect more accurate reporting and improved coverage of controls in the Annual Report on Exchange Arrangements and Exchange Restrictions (AREAER), a major information source for this report.