Chapter

III Accompanying Measures in Members’ Exchange Markets

Author(s):
Kyong Huh, Benedicte Christensen, Peter Quirk, and Toshihiko Sasaki
Published Date:
May 1987
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Development of Forward Exchange Market

Institution of floating arrangements in the spot market may be important in setting the stage for the establishment of cover facilities that do not involve an official guarantee of an exchange rate and the attendant assumption of exchange risk and possibilities for large losses by the central bank. It may be difficult for a country to establish a forward foreign exchange market in which the exchange rate is market-determined if the spot exchange rate is fixed. One reason for this is that the judgments on the future movement of the spot rate which are an essential ingredient of a forward market become those of predicting the course of official action, and the scope for uncertainty and for abuse of inside information is therefore wide. The setting up of a forward market is, on the other hand, a difficult process that may require close monitoring and sponsorship by the central bank, in particular to ensure that adequate technical information is available to potential participants.

The development of forward exchange market facilities in the developing countries that have adopted floating spot exchange rates is at a relatively early stage. There is no such country at present that could be considered to have an organized and satisfactorily operating forward exchange market. Six countries (Bolivia, the Dominican Republic, The Gambia, Guinea, Uganda, and Zambia) at this time have no concrete plans for a forward market. A very limited volume of forward transactions has been observed in Jamaica, the Philippines, Uruguay, and Zaïre. In Jamaica, a detailed plan has been drawn up for a forward market and the system has been put in place, but there have been few transactions, initially because of the inflexibility of interest rates, which made trade financing in domestic currency more attractive. Nigeria has recently instituted arrangements for forward trade cover (up to six months’ maturities), but transactions have yet to take place. In the Philippines, developments in an unorganized forward market have been subject to generalized uncertainties and few transactions take place. In South Africa, the authorities have encouraged authorized exchange dealers to make a forward market outside the Reserve Bank to the extent possible. To facilitate the development of such a market, the Reserve Bank has itself continued to provide forward cover facilities to authorized dealers, but in diminishing amounts, and the official facilities were to be phased out completely by September 1986. However, since the advent of the debt standstill in September 1985, the phasing out period has been extended indefinitely. From January 1, 1987, the Reserve Bank has no longer extended forward cover to the public sector.

The exchange systems of these countries also affect the feasibility of forward transactions. Where currencies are subject to exchange controls, their delivery at future dates may be uncertain, as it may be prevented by the actions of the authorities. In addition, restrictions on flows of the foreign currency, coupled with rationing of domestic credit, may make it difficult to ascertain the appropriate forward discount or premium, in that the covered interest parity condition will no longer hold with precision.

Because forward markets provide, along with adequate reserves, a means of insulating the real economy from the effects of exchange rate instability, it is important that further work be done on institutional arrangements suited to conditions in developing countries. More basic forms of a forward market include one by which the central bank or commercial banks “broker” transactions, matching long and short positions at specific maturities.18 Another technical possibility is a forward auction market run by the central bank. The experience gleaned from the industrial countries, particularly smaller countries, also indicates that for a country considering the institution of a core forward exchange market, the major benefits are likely to accrue to the introduction of shorter-term facilities, primarily for trade cover. An important function of the authorities in this situation is to ensure that information is available to potential users of the market. Forward markets are typically regarded as complex by those unfamiliar with them, and simple misunderstanding may be a contributing reason for their relatively limited development.

Role of Exchange and Trade Liberalization in Floating Arrangements

The demand for foreign exchange in any market is determined partly by exchange and trade restrictions on import licensing, current exchange transactions, and capital transactions. (Surrender requirements, which affect supply rather than demand, have been considered above.) All developing countries that have adopted a floating exchange rate system, except Uganda, have reduced restrictions to some degree in the process of the change of regime or subsequently. Bolivia, The Gambia, and Uruguay liberalized their exchange and trade systems virtually completely at or about the time that their flexible arrangements were introduced (Table 4). Thus, in Bolivia, when the auction market in foreign exchange was introduced in August 1985, the system of import licensing and control of allocation of foreign exchange for imports was ended, as were restrictions on the allocation of foreign exchange for payments for invisibles and capital transfers. In The Gambia, however, there were initially some continuing restraints by commercial banks on customers’ access to the exchange market. Countries that have switched to floating regimes have liberalized their exchange and trade systems for current payments, particularly imports; and Uruguay, which did not apply any general quantitative restrictions on imports, or restrictions on invisibles, before the floating of its currency, lowered and reformed its tariffs shortly after its change of exchange rate regime.

Table 4.Floating Unitary Exchange Rate Regimes in Developing Countries: Exchange and Trade Liberalization
Liberalization Since FloatRemaining Restrictions on
Import licensingCurrent exchange transactionsCapital transactionsImport licensingCurrent exchange transactionsCapital transactions
BoliviaYesYesYesNoNoNo
Dominican RepublicNoYesNoYesYesYes
Gambia, TheYesYesYesNoNoNo
GhanaYesNoNoYesYesYes
GuineaYesYesNoYesYesYes
JamaicaYesYesNoYesYesYes
LebanonYesNoNo
NigeriaYesYesYesNoNoYes
PhilippinesYesYesNoYesYesYes
Sierra LeoneYesYesNoYesNoYes
South AfricaYesNo1No1YesYesYes
UgandaNoNoNoYesYesYes
UruguayNoYesNoNoNoNo
ZaïreYesYesYesYesYesYes
ZambiaYesNoNoYesYesYes
Source: Data provided by national authorities.
Table 5.Comparison of Macroeconomic Performance in Developing Countries with Independently Floating and Managed Flexible Exchange Arrangements Under Fund-Supported Programs Compared with Year Before Program(In percent of countries)
External Current Account Balance1Overall Fiscal Balance1
FloatingFlexibleFloatingFlexible
Improvement67676750
Unchanged33172231
Deterioration171119
100100100100
Broad Money2Prices2
FloatingFlexibleFloatingFlexible
Deceleration56445628
Unchanged141111
Acceleration44423361
100100100100
Exchange and Trade System3
FloatingFlexible
Liberalization5646
Unchanged3346
Intensification118
100100
Sources: Data provided by national authorities; and Fund staff estimates.
Table 6.Indicators of Economic Structure in Selected Developing Countries, 1985
Per Capita GDPRatio of Money Plus Quasi-Money to GDP1Ratio of Total Trade in Goods and Nonfactor Services to GDP1Ratio of Imports of Goods and Nonfactor Services to GDP1Ratio of Manufactures to Total ImportsRatio of Manufactures to Total ExportsExport Concentration2Import Concentration2
At official exchange rateAt parallel exchange rate
In U.S. dollarsIn percent
Bolivia1,305.0384.320.429.014.067.431.2Metals (39.2) and gas (55.7)Raw materials and intermediate goods (33.0), capital goods (42.0), and consumption goods (24.0)4
Dominican Republic745.2745.215.162.334.154.8554.3Raw sugar (21.4), ferronickel (16.3), and gold alloy (15.4)Fuels (33.1), consumer goods (18.9), intermediate goods (32.7), and capital goods (15.3)
Gambia, The6203.1157.431.1100.8758.2842.7Groundnut products (72.9) and fish and fish products (17.9)Manufactures (42.7), food and live animals (30.6), and mineral fuels (12.2)
Ghana467.1168.119.924.413.9Cocoa (65.2), gold (16.0)Petroleum (29.8) and food products (8.3)
Guinea9357.021.535.051.0727.38Bauxite (76.7) and alumina (21.7)
Jamaica1,159.038.4132.271.827.8334.0Bauxite and alumina (50.9), manufactures (34.0) and agricultural goods (4.8)Raw materials (29.3), fuels (32.2), and capital and consumer goods (24.7)
Lebanon91,646.41,646.4314.4102.31084.51039.011Agricultural products, foodstuffs, and beverages (16.0), chemicals (16.0), precious and semiprecious metals and jewelry (20.0)
Nigeria85429.644.014.946.0Petroleum (98.4)Manufactures (46.0) and chemicals (18.0)
Philippines594.5594.522.339.118.115.41222.813Electronics (22.8), coconut oil (7.9) and sugar (3.6)Raw materials and intermediate goods (43.0), mineral fuels and lubricants (28.4), and capital goods (15.4)
Sierra Leone32824.420.41010.31035.6Diamonds (20.2), bauxite (17.5), and rutile(21.2)Foodstuffs (31.7), fuel (15.0), and manufactures (35.0)
South Africa1,652.038.765.31430.31485.11510.316Gold (44.3), semifabricated goods of mining origin (15.6), and crude materials of mining origin (15.5)Intermediate goods (45.0) and capital goods (40.1)
Uganda17129.018.91841.723.319.119Coffee (93.5), cotton (3.4), and tea (0.7)Mineral fuels (21.0)
Uruguay1,825.51,825.558.745.320.520.02014.821Meat (22.1), wool (19.2), and textile manufactures (11.6)Intermediate goods (77.4) and capital goods (14.1)22
Zaïre137.310.886.943.9Copper (37.1), crude oil (16.5), cobalt (13.0), diamonds (10.9), and coffee (9.8)Machinery and mechanical equipment (18.3), mineral products (17.8), and transport equipment (13.4)
Zambia354.7120.333.284.62349.724Copper (81.8) and cobalt (8.9)Petroleum (23.3) and fertilizer (6.4)
Sources: Data provided by national authorities; and Fund staff estimates.
Table 7.Exchange Rate Arrangements as of September 30, 19861
PeggedFlexibility Limited vis-à-vis a Single Currency or Group of CurrenciesMore Flexible
Single currencyCurrency compositeSingle currency2Cooperative arrangements3Adjusted according to a set of indicatorsManaged floatingIndependently floating
U.S. dollarFrench francOtherSDROther
Antigua and

Barbuda

The Bahamas4

Barbados

Belize
Lao People’s

Democratic

Republic4

Liberia

Nicaragua4
Benin

Burkina Faso

Cameroon
Bhutan

(Indian

rupee)

Kiribati

(Australian

dollar)
Burma

Burundi

Iran, Islamic

Rep. of

Jordan
Algeria4

Austria

Bangladesh4

Botswana

Cape Verde
Afghanistan4

Bahrain5

Qatar5

Saudi Arabia5

United Arab

Emirates5
Belgium4

Denmark

France

Germany,

Federal

Republic of
Brazil

Chile4

Colombia

Madagascar

Portugal
Argentina

China

Costa Rica4

Ecuador
Australia

Bolivia

Canada

Dominican

Republic
Djibouti

Dominica

Egypt4

El Salvador

Ethiopia
Oman

Panama

Paraguay4

Peru4
Central

African

Republic

Chad

Comoros
Lesotho4

(South African

rand)

Swaziland

(South African

rand)
Kenya6

Libya7

Rwanda

Sao Tom6

and

Principe
Cyprus

Fiji

Finland6

Guyana

Hungary
Ireland

Italy

Luxembourg4

Netherlands
Greece

Guinea-

Bissau

Iceland

India8
The Gambia

Ghana4

Guinea

Jamaica

Japan
Grenada

Guatemala4

Haiti

Honduras

Iraq
St. Christopher

and Nevis

St. Lucia

St. Vincent

Suriname
Congo

Cote d’lvoire

Equatorial

Guinea

Gabon
Tonga

(Australian

dollar)
Seychelles

Vanuatu
Kuwait



Malawi

Malaysia6

Maldives

Malta
Indonesia

Israel

Korea

Mexico4

Morocco
Lebanon

New

Zealand

Nigeria4

Philippines
Syrian Arab

Republic4

Trinidad and

Tobago

Venezuela4

Viet Nam4
Mali

Niger

Senegal

Togo
Mauritania

Mauritius

Mozambique

Nepal

Norway
Pakistan

Spain

Sri Lanka

Turkey9

Uganda
Sierra

Leone

South

Africa4
Yemen Arab

Republic

Yemen.

People’s

Democratic

Republic of

Papua New

Guinea

Poland

Romania

Singapore
Western

Samoa

Yugoslavia
United

Kingdom

United

States

Uruguay
Solomon

Islands

Sudan4

Sweden10

Tanzania
Zaïre

Zambia
Thailand

Tunisia

Zimbabwe
Sources: Data provided by national authorities; and fund staff estimates.

In Guinea, Jamaica, Nigeria, the Philippines, Zaïre, and Zambia, the number of import goods which are restricted has been reduced substantially. In Jamaica, the import licensing system was overhauled in March 1984, and most remaining licenses and quotas were eliminated ahead of schedule in April 1985, leaving 20 percent of non-bauxite and non-oil imports subject to restrictions. Zambia liberalized its import licensing system when it adopted a flexible regime, and has a plan for complete import liberalization. The liberalization of import restrictions to date has been more moderate in the Dominican Republic and Uganda. In the Dominican Republic, a special exchange rate for petroleum imports was eliminated when the dual exchange markets were unified in January 1985, and two months later advance deposit requirements for imports financed under reciprocal credit agreements with Latin American central banks were halved. Nigeria abolished import restrictions, except for a short list of goods prohibited for health or security reasons. In the Philippines, the priority system for allocation of foreign exchange for imports was abolished when the peso was floated in October 1984, and most remaining quantitative restrictions were removed in May-September, 1986.

Liberalization of restrictions on transactions in invisibles has been less extensive compared with merchandise imports following adoption of floating. Jamaica has removed most of its restrictions, other than maximum allowances for travel. Otherwise, apart from Bolivia. The Gambia, Nigeria, and Uruguay, the countries that have adopted floating exchange rates have retained some degree of control, especially over the remittance of profits and dividends, the payment of commercial arrears, and travel and expatriate allowances.

Controls on outward capital transfers have been retained by the countries with floating arrangements, other than Bolivia, The Gambia, Lebanon, and Uruguay. In Jamaica, investments abroad by residents and the purchase of local assets by residents from nonresidents require exchange control approval, which is not granted unless it can be shown that there are tangible benefits for Jamaica. Foreign exchange is not made available to residents to make cash gifts to nonresidents, and nonresidents are not normally permitted to take out security in respect of loans made to Jamaican companies owned or controlled by them, or to raise local mortgages. Provision has been made by Nigeria for an early review of the maintenance of controls on capital outflows (inflows have been liberalized) in the light of the experience with the operation of the new exchange market. In addition, there is provision for authorization of capital outflows from Nigeria, if they are not deemed to be destabilizing to the market. In the Philippines, inward and outward capital movements, with some exceptions, are subject to the prior and specific approval of the central bank. In South Africa, outward transfers of capital by residents to destinations outside the rand monetary area require the approval of the Reserve Bank. In Zaïre, with minor exceptions, transfers abroad of capital owned by residents or nonresidents are not authorized. In each of those countries maintaining restrictions, an illegal parallel market continues to exist, limiting the supply of foreign exchange and of monetary data pertinent to the management of the monetary base by the authorities.

The cost of transactions tends to be very small, as the bank assumes no risk and therefore charges only a brokerage fee of, say, ¼ of 1 percent of the value of the transaction.

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