- Peter Quirk
- Published Date:
- April 1995
Continued integration of global financial markets and parallel developments in domestic financial systems were reflected in further liberalization of IMF members’ exchange systems in the early 1990s. The trend toward open financial systems has been particularly pronounced in industrial countries, where foreign exchange market liberalization was virtually completed by 1990. Only a few of the smaller industrial countries continue to maintain any form of control on foreign exchange transactions, other than for prudential purposes. The freeing of exchange controls by individual countries was not accompanied in general by a weakening of their overall balance of payments, although it had been widely believed that this would inevitably result from liberalization in countries with weak external positions.
Moreover, gains were made in the efficiency of allocation of capital. It should be emphasized, however, that freedom from exchange controls does not mean full freedom for international capital flows. In most industrial countries, controls and incentives remain on the underlying transactions, if not on the associated foreign exchange transactions. Restrictions on foreign direct and portfolio investment affect the mobility of capital, and, together with differential tax treatments, they continue to limit the efficiencies already gained from decontrolling foreign exchange markets. Likewise, continued trade protectionism is effected not through exchange controls, but through trade policy, in particular, customs mechanisms. However, recent progress under the Uruguay Round of multilateral trade negotiations now offers hope that the elimination of protectionism at the trade level will catch up, so that convertibility in the goods markets will match the high degree of currency convertibility that has developed over the last decade or so.
In the developing countries, an accelerating trend toward liberalization of international payments and transfers has reflected a growing recognition that exchange restrictions are an inefficient and largely ineffective way to achieve their intended objectives—to limit outflows of foreign exchange, protect certain classes of imports or exports, or even raise tax revenue. It has also reflected a strengthening of domestic financial markets and progress toward market-based instruments of monetary and exchange policy to achieve external and internal balance. Developments in Latin America in the 1980s demonstrate the difficulty of enforcing exchange controls, because many countries with seemingly comprehensive systems of exchange control experienced massive capital flight.
A second major reason for reduced recourse to exchange restrictions by developing countries has been greater flexibility and realism of exchange rate policies, and generally sounder macroeconomic policies, in the aftermath of the debt crisis. Such policies have enabled countries to restore vitality to the balance of payments without incurring the inefficiencies of exchange restrictions, in terms of both resource allocation and the heavy administrative costs. There is evidence that eliminating exchange restrictions can even help strengthen the balance of payments in the short run—when the measures are taken as part of a comprehensive adjustment package. A growing number of developing countries have eliminated all exchange restrictions as part of a package of macroeconomic adjustment and have experienced a rapid turnaround to net capital inflows, partly because of increased confidence in the country’s policies and because transferring and keeping capital offshore to evade restrictions was no longer profitable when yields on domestic assets rose as a result of improved exchange and interest rate policies. It has become increasingly evident that progress toward convertibility and well-functioning exchange markets requires internally consistent and mutually reinforcing reforms of (he exchange control regime, the exchange rate system, and exchange market structures on the one hand, and supporting reforms of the monetary control system on the other. The effectiveness of such structural reforms needs to be underpinned by sound macroeconomic policies.
Previous biennial surveys have noted the close link between the adoption of market-oriented exchange rates and the lifting of exchange restrictions.1 The present study notes that comprehensive foreign exchange control systems relying on foreign exchange budgeting have all but disappeared, being maintained now in only eight countries. The new liberalism is evident in the decrease in the number of measures taken by developing countries in 1991–93 to tighten exchange controls, as reported by the IMF in AREAER. In contrast, the number of liberalizing measures multiplied, particularly those affecting current payments for invisibles, although much remains to be done.
Exchange regimes in developing countries evoke two remaining concerns: one to do with the IMF’s jurisdiction, the other connected mainly with the aftermath of the debt crisis. Despite the trend toward currency convertibility, a large number of IMF members continue to maintain exchange restrictions, either inconsistent with Article VIII of the IMF’s Articles of Agreement, or invoking the transitional arrangements of the IMF’s Article XIV.2 Only about one-third of developing countries have accepted the obligations of the IMF’s Article VIII, and, of those countries that have accepted, about one-sixth have actually reimposed exchange restrictions inconsistent with their obligations under Article VIII, In response to this situation, the Executive Board in 1992 called for measures to accelerate the process of accepting Article VIII obligations. Intensified procedures have since been adopted by the IMF staff with the aim of monitoring and addressing issues of Article VIII acceptance in all IMF consultations. As a result of these intensified procedures, an additional 24 developing countries accepted the obligations of the IMF’s Article VIII in 1993 and 1994; over one-half of the IMF membership has now accepted the obligations of Article VIII.
The second concern relates to the continuing ad hoc restrictions on the availability of foreign exchange maintained by a number of countries as evidenced by external payments arrears. The Executive Board monitored the status of external arrears in the 1980s, emphasizing their drawbacks, both for the countries maintaining them and for the international payments system as a whole.
Exchange rate arrangements under the amended Articles have remained diverse, consistent with the freedom of members under Article IV to choose their own regime. While the general character of the international system, as manifested in the preponderance of cross-border transactions between the major countries, is a floating system, almost one-half of the IMF membership maintains some form of fixed exchange rate arrangement. The case-by-case approach implied by such an international regime is broadly consistent with the prevailing stale of policy cooperation and coordination. In part, the growing recourse to floating rates by developing countries has reflected continuing transition in stabilization and reforms. In a number of countries, it has been the result of a heightened awareness in the aftermath of the debt crisis that out-of-line exchange rates result in increasing disintermediation of foreign exchange through parallel markets and balance of payments crises. In other countries, the floating systems have been a response to uncertainties in the early stages of transition to market-based economies.
The existence of a range of feasible exchange rate regimes tailored to individual countries’ situations, coupled with a better balance between domestic demand and absorption, has increasingly obviated the need for exchange controls to offset the impact of domestic policy shortcomings. In some instances, as with tariffs replacing quantitative import controls, dual exchange rates have played a role in the transition to a liberalized exchange and trade regime. Virtually all cases of recent multiple exchange rates have fallen into this transitional category.
Bilateralism and regionalism in payments had declined substantially among IMF members in recent years, so that the proportion of world trade currently conducted under the official mechanisms is probably less than 1 percent. However, with the division of the U.S.S.R. into separate sovereign slates and the accession to IMF membership of the former centrally planned economies, there was initially a renewed increase in the use of official bilateral payments arrangements by members, although not for the global payments system as a whole. Countertrade and barter trade arrangements have since become important for Eastern Europe and the countries of the former U.S.S.R., in part substituting for the previous official regional payments mechanisms in the transition to market-based systems. Elsewhere, the recourse to barter and countertrade, which emerged during the debt crisis as normal payments mechanisms broke down under pressure from arrears, has been much reduced.