Abstract

Momentum toward currency convertibility has diminished since 1997, when a series of emerging market crises occurred.1 IMF members have continued eliminating—albeit at a slower pace—exchange restrictions on the making of payments and transfers for current international transactions subject to the IMF’s jurisdiction under Article VIII or maintained under the transitional arrangements of Article XIV (Box 3.1). Progress toward liberalization of the broader range of exchange controls on both current and capital account transactions, however, appears to have been limited. This assessment is based on the number of countries maintaining exchange restrictions and controls and does not necessarily reflect the degree of effectiveness of restrictions and controls, which depends critically on their design and on the degree of regulatory enforcement.2 Moreover, changes in the number of restrictions and controls need to be interpreted with caution in light of improved reporting by members and the greater coverage of foreign exchange and cross-border transactions in the Annual Report on Exchange Arrangements and Exchange Restrictions (AREAER), a major source of information for this report.

Momentum toward currency convertibility has diminished since 1997, when a series of emerging market crises occurred.1 IMF members have continued eliminating—albeit at a slower pace—exchange restrictions on the making of payments and transfers for current international transactions subject to the IMF’s jurisdiction under Article VIII or maintained under the transitional arrangements of Article XIV (Box 3.1). Progress toward liberalization of the broader range of exchange controls on both current and capital account transactions, however, appears to have been limited. This assessment is based on the number of countries maintaining exchange restrictions and controls and does not necessarily reflect the degree of effectiveness of restrictions and controls, which depends critically on their design and on the degree of regulatory enforcement.2 Moreover, changes in the number of restrictions and controls need to be interpreted with caution in light of improved reporting by members and the greater coverage of foreign exchange and cross-border transactions in the Annual Report on Exchange Arrangements and Exchange Restrictions (AREAER), a major source of information for this report.

This chapter discusses recent developments in the use of both exchange restrict ions and exchange controls. It also analyzes factors bearing on the use of exchange controls, focusing on the level of economic development and the choice of exchange rate regimes. Finally, it discusses exchange measures used in selected countries that experienced currency crises in the past five years.

Recent Trends in Exchange Restrictions on Current International Transactions

In 1998–2001, the elimination of exchange restrictions on the making of payments and transfers for current international transactions continued, albeit at a slower pace. The number of IMF members maintaining exchange restrictions subject to Article VIII or maintained under the transitional arrangements of Article XIV declined by only 8 in the period, compared with 11 in 1994–97.3 This decline was evident for both members that have accepted the obligations of Article VIII and those that continued to avail themselves of the transitional arrangements under Article XIV.

As of end-2001, about 80 percent of IMF members were maintaining exchange systems free of restrictions on payments and transfers for current international transactions. Of the remaining members that maintained exchange restrictions, 20 were under Article XIV status and 18 under Article VIII status (Appendix Table .A1 and Appendix Table 3.A2). Nearly all of these 38 countries maintained restrictions subject to Article VIII, which in most cases were not approved by the IMF.4

The slowdown in the elimination of exchange restrictions reflects a number of factors. First, the number of members accepting the obligations of Article VIII, Sections 2, 3, and 4 has fallen sharply since 1997, with only seven members5 moving to Article VIII status in 1998–2001, compared with 64 countries in 1994–97 (Figure 3.1).6 This development partly reflects the end of the rapid expansion of IMF membership and the significant progress made by transition countries in adopting market-oriented reforms. Second, some members have introduced exchange restrictions after accepting the obligations of Article VIII, Sections 2, 3, and 4. It is noteworthy that the majority of Article VIII members that still maintain exchange restrictions have relied on them for extended periods. Indeed, of the 18 Article VIII countries that maintained restrictions at the end of 2001, 12 did so for at least four years (Bangladesh, Belize, Botswana, the Dominican Republic, India, Kenya, the Russian Federation, Seychelles, Sierra Leone, Suriname, Tunisia, and Zimbabwe). Third, many members have continued to avail themselves of the transitional arrangements under Article XIV for a protracted period. More specifically, of the 33 members under Article XIV status as of end-2001, 23—mostly in the Middle East and Africa—have retained Artic le XIV status for 20 years or more, and 6 members for more than 50 years (Figure 3.2). In addition to balance of payments concerns, the motivation for maintaining restrictions may reflect reluctance to ease controls, which might reduce the capacity to detect and prevent money laundering and other illegal transactions.

Figure 3.1
Figure 3.1

Countries That Have Accepted the Obligations of Article VIII, Sections 2, 3, and 4, Relative to Total IMF Membership

(Number of countries at year-end)

Source: IMF, Secretary’s Department.
Figure 3.2
Figure 3.2

Status of IMF Membership Under IMF Articles of Agreement at End-2001

Source: IMF, Secretary’s Department.

Exchange Restrictions and Articles VIII and XIV

Article VIII, Section 2, 3, and 4 Obligations

Article VIII, Section 2(a), requires that members not impose restrictions on the making of payments and transfers for current international transactions without the approval of the IMF. While Article VIII, Section 2, specifically focuses on restrictions on current payments and transfers, Article VIII, Section 3, prohibits members from engaging in discriminatory currency arrangements or multiple currency practices, except as authorized under the IMF’s Articles of Agreement or if approved by the IMF. Article VIII, Section 4, requires each member, with certain specified exceptions, to buy balances of its currency held by another member if the latter represents that the balances have been recently acquired as a result of current transactions or that their conversion is needed for making payments for current transactions. At the time of membership or at a later date, a member may formally notify the IMF of its acceptance of the obligations of Article VIII, Sections 2, 3, and 4.

Article XIV Provisional Arrangements

When joining the IMF, members also have the option of availing themselves of the transitional arrangements of Article XIV, which permit the member to maintain and adapt to changing circumstances the restrictions on payments and transfers for current international transactions in effect at the time of membership. Such restrictions are not subject to approval under Article VIII, Section 2(a). Any member availing itself of the transitional arrangements of Article XIV is classified as being in Article XIV status until it formally accepts the obligations of Article VIII, Sections 2, 3, and 4. The imposition of new exchange restrictions by the member is subject to IMF approval under Article VIII, Section 2(a).

Exchange Restrictions Subject to Article VIII, Section 2(a)

With the sole exception of the exchange restrictions maintained by a member under the arrangements of Article XIV, any exchange restriction on the making of payments and transfers for current international transactions by a member is also subject to Article VIII, Section 2(a), which requires IMF approval. This is true whether the member has formally accepted the obligations of Article VIII, Sections 2, 3, and 4 or whether it avails itself of the transitional arrangements of Article XIV. This applies even to exchange restrictions formally maintained by the member under the provisional arrangements of Article XIV and eliminated thereafter, which are subsequently reintroduced by the member.

Many members under Article XIV status have been reluctant to remove exchange restrictions subject to approval under Article VIII, Section 2(a) even though the IMF has not approved them. This tendency may reflect these authorities’ reliance on direct controls in managing their economies, which are often represented by a large public sector and the maintenance of restrictive trade regimes (Table 3.1). In many cases, such members have also experienced internal or external conflict for extended periods, and some have been isolated from the international community, limiting incentives to pursue economic openness through measures such as acceptance of the obligations of Article VIII.

Table 3.1.

Selected Characteristics of IMF Members Under Article XIV Status, as of 2001

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Sources; IMF World Economic Outlook, Trade Liberalization in IMF-Supported Programs (1998); and various IMF staff reports.

Comprising the cental government, budgetary agencies, and local governments.

A higher number implies that the trade regime is more restrictive.

The central government only.

Accepted the obligations of Article VIII in 2002.

Some members have not formally accepted the obligations of Article VIII, Sections 2, 3, and 4 even though they have removed all identifiable exchange restrictions. At end-2001, 10 Article XIV members had no exchange restrictions, compared with 6 members at end-1997. Six of these members either had expressed their intention or had committed themselves to formally accepting the obligations of Article VIII. These members were in varying stages of discussions with IMF staff to clarify remaining issues, including those arising from new or revised laws and regulations. In the four remaining cases, acceptance of the obligations of Article VIII appears to be a low priority, mostly reflecting the absence of normal relations with the international community.

Members maintaining exchange restrictions have, nevertheless, reduced their recourse to such restrictions in the four-year period through end-2001. This reduction was limited to Article VIII-status countries, however, in which the average number of restrictions per member declined to about two at end-2001, compared with about three at end-1997 (Table 3.2). The most frequently used exchange restrictions are related to payments and transfers for invisible transactions—especially binding limits on foreign exchange allowances for remittances and travel—and multiple currency practices. The latter often involved exchange rate guarantees or forward exchange contracts. More restrictive measures—such as foreign exchange budgets, advance import deposit requirements, and bilateral payments arrangements with restrictive features—were maintained primarily by members under Article XIV status.

Table 3.2.

Types of Exchange Restrictions Under Article XIV and Article VIII Status

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Sources: Appendix Tables 3.A3 and 3.A4; and various IMF staff reports.

Excludes Afghanistan, Iraq, and Somalia. Recent and comprehensive information on restrictions in these countries is not available.

The composition of exchange restrictions has also changed in the same four-year period. The use of binding limits on foreign exchange allowances for current payments and remittances has declined most, followed by multiple currency practices.7 In contrast, several members have frozen foreign exchange deposits or taken actions restricting the convertibility of other deposits in ways that restrict transactions involving current payments and transfers. In particular, as of end-2001 exchange restrictions were maintained on bank deposit withdrawals (Argentina and Ecuador), some specific foreign currency deposits (Croatia, the former Yugoslav Republic of Macedonia, and the Federal Republic of Yugoslavia), the convertibility of bank accounts (Russia), and access to the banking system for current international transactions in the absence of central bank approval (Turkmenistan).

Some progress has been made in resolving external payments arrears, which frequently give rise to exchange restrictions.8 The total outstanding stock of public and private external payments arrears declined to an estimated US$69 billion at end-2001, from about US$74 billion at end-1997 after some increase during 1998–99 that partly reflected the emergence of external arrears in Indonesia (Figure 3.3). A large decline in the stock of arrears in 2000 reflects debt rescheduling by Nigeria. At end-2001, eight countries—Angola, the Democratic Republic of the Congo, the Republic of Congo, Indonesia, Myanmar, Russia, Sudan, and Zimbabwe—accounted for over 87 percent of the total stock of arrears.

Figure 3.3
Figure 3.3

Stock of Total External Payments Arrears

(In billions of U.S. dollars; at year-end)

Source: IMF, World Economic Outlook.

Recent Trends in Controls on Current and Capital Transactions

Progress in liberalizing controls on current and capital transactions appears to have been limited. Specifically, the number of countries maintaining controls on both current and capital transactions remained virtually unchanged between 1998 and 2000.9 An increase in members’ concern about risks associated with capital account liberalization following a series of crises in emerging market economies may have been an important factor. Indeed, there was a growing resort to certain types of capital controls (for example, those affecting institutional investors). In some cases, the increased use of capital controls may have reflected improved reporting by members. Nevertheless, some types of controls were relaxed, particularly with respect to selected controls affecting current account transactions.

Controls on Current Transactions

The number of countries maintaining exchange controls on payments, receipts, and transfers for current transactions declined only marginally during 1998–2000 (Table 3.3). There have been important changes, however, in the composition of such controls. Use of controls on payments for current invisibles, especially those involving travel, personal payments, and credit card transactions, continued to decline. Use of controls on receipts from exports, invisibles, and transfers also fell somewhat, mainly because some members eliminated repatriation and surrender requirements for export proceeds. By contrast, the use of controls on payments for imports (for example, advance payment requirements and several types of documentation requirements) and on export proceeds—especially documentation requirements for exports—increased, although this may partly reflect improved reporting by members.

Table 3.3.

Exchange Controls on Payments, Receipts, and Transfers for Current Transactions1, 2

(Countries with controls as percent of total countries reporting)

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Sources: Appendix Table 3.A6; and IMF, Annual Report on Exchange Arrangements and Exchange Restrictions, various issues.

Data reflect information available at year-end and are subject to reporting lags. Some countries did not provide information for certain categories of controls in their annual submissions.

Includes Aruba, the Netherlands Antilles, and Hong Kong SAR.

Includes requirements for domiciliation, import licenses used as exchange licenses, letters of credit, and preshipment inspection.

Includes requirements for domiciliation, guarantees, letters of credit, and preshipment inspection.

The use of exchange controls on payments, receipts, and transfers for current transactions has differed significantly among members, depending upon their level of development. As of end-2000, a large majority of both developing and transition countries maintained such controls, whereas advanced countries had virtually eliminated them (Table 3.4).10 In addition, developing and transition countries adopted different approaches to controls. In particular, a higher proportion of developing countries maintained controls on payments for imports and invisible transactions and current transfers, though the use of controls on the latter has diminished since 1997. Transition countries continued to rely more heavily on controls on proceeds from exports and invisibles transactions and current transfers.

Table 3.4.

Exchange Controls on Payments, Receipts, and Transfers for Current Transactions, by Type of Economy1, 2

(In percent of total countries reporting, unless otherwise indicated)

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Sources: Appendix Table 3.A7: and IMF, Annual Report on Exchange Arrangements and Exchange Restrictions, various issues.

Country classificalion corresponds to the World Economic Outlook classification.

Includes Aruba, Netherlands Antilles, and Hong Kong SAR.

Includes requirements for domiciliation. preshipment inspection, letter of credits, and import licenses.

Includes requirements for letters of credit, domiciliation, guarantees, and preshipment inspection.

Trends in Controls on Capital Transactions

The number of countries maintaining controls on capital transactions suggests that only limited progress in liberalizing capital transactions took place during 1998–2000 (Table 3.5). As of end-2000, almost all reporting countries maintained some form of exchange controls on capital transactions. The most widely used controls were those on transactions by commercial banks and other credit institutions, which were reported by about 85 percent of reporting countries. Other common controls were those applied to foreign direct investment (about 80 percent of reporting countries), and real estate transactions and capital and money market instruments (more than 70 percent each).11 In some cases, particularly those involving credit operations and transactions of commercial banks, controls may have been imposed for prudential purposes rather than to regulate cross-border capital flows. Controls on the liquidation of direct investment are less prevalent, possibly reflecting recipient countries’ concerns that such controls would deter foreign direct investment inflows.12

Table 3.5.

Countries Maintaining Exchange Controls on Capital Transactions1

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Source: IMF, Annual Report on Exchange Arrangements and Exchange Restrictions, various issues.

Includes Aruba, the Netherlands Antilles, and Hong Kong SAR.

Data reflect information available as of year-end and are subject to reporting lags. Some members did not provide information for selected categories of controls in their annual submissions.

While the overall use of capital controls did not change, a growing number of countries began to regulate selected capital transactions.13 For example, the number of countries maintaining controls on institutional investors rose sharply, reflecting the growing importance of such players in the financial markets of many developing countries. Many of these controls involve regulations that have a prudential aspect, for example, by placing limits on resident institutional investors’ acquisition of foreign assets. Some specify the channels (markets or institutions) for cross-border transactions. Significantly more countries maintained controls on transactions involving real estate, personal capital movements, and other controls imposed by securities laws. Many of these controls involve regulation of, and limits on, foreign ownership or control of real estate and financial institutions and, as such, are not concerned directly with influencing the overall volume of cross-border capital flows. In other cases, the controls reflect more general licensing and registration requirements related to tax, statistical, and similar objectives. They are also aimed at restraining resident investment in, or transfer of, assets that would result in capital outflows. In the case of controls on personal capital, external borrowing and lending by residents are often restricted.

Patterns of the use of controls on capital transactions also differed significantly when countries were grouped by level of development. In advanced countries, controls on transactions involving foreign direct investment and institutional investors were most prevalent, followed by those on capital and money market instruments and real estate transactions. Only a small number of advanced countries imposed controls on personal capital movements, derivative transactions, and credit operations. No advanced country maintained controls on liquidation of foreign direct investment (Table 3.6). Both developing and transition countries made heavy use of controls on capital and money market instruments, transactions by banks and other credit institutions, and credit operations; they also relied significantly on controls on foreign direct investment. Controls on the liquidation of foreign direct investment were more widely used in developing countries than in transition countries.

Table 3.6.

Countries Maintaining Exchange Controls on Capital Transactions by Type of Economy1, 2

(In percent of total countries reporting, unless otherwise noted)

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Sources: Appendix Table 3.A8: and IMF. Annual Report on Exchange Arrangements and Exchange Restrictions, various issues.

Country classification corresponds to the World Economic Outlook broad classification of countries introduced in October 2001.

Includes Aruba, Netherlands Antilles, and Hong Kong SAR.

Exchange Controls and Exchange Rate Regimes

The degree of flexibility of the exchange rate regimes adopted by countries appears to have little bearing on the overall use of controls on current payments, receipts, and transfers (Table 3.7). Excluding the 11 euro area countries, which shifted from a soft peg to a hard peg and maintained virtually no controls on current transactions, there was no clear relationship between exchange rate regimes and controls affecting current transactions.

Table 3.7.

Countries with Exchange Controls on Payments, Receipts, and Transfers for Current Transactions, by Exchange Rate Regime1

(In percent of total countries reporting, unless otherwise noted)

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Sources: Appendix Table 3.A9; and IMF, Annual Report on Exchange Arrangements and Exchange Restrictions, various issues.

Includes Aruba, Netherlands Antilles, and Hong Kong SAR but excludes the 11 countries of the euro area.

Includes exchange rates with no separate legal tender and currency board arrangements.

Includes conventional pegged arrangements, pegged exchange rates within horizontal bands, crawling pegs, and crawling bands.

Includes managed floating with no preannounced path for the exchange rate and independently floating.

Includes minimum financing requirements, advance payments requirements, and advance import deposits.

Includes requirements for domiciliation, preshipment inspection, and letters of credit.

The composition of controls employed by members was, however, related to the exchange rate regime. As of end-2000, countries with floating regimes regulated import payments more heavily (mainly through documentation requirements) and export proceeds (through surrender requirements). A similar pattern, albeit less pronounced, was observed for countries with soft peg regimes. By contrast, in countries with a hard peg no particular pattern in the use of various types of controls was evident.

No strong linkage between the exchange rate regime and the use of capital controls was found (Table 3.8).14 Although countries with hard peg regimes appeared to be less reliant on capital controls than countries with other exchange rate regimes, this relationship disappeared when the 11 euro area countries were excluded. With respect to the composition of capital controls, as of end-2000 hard peg countries were less reliant on controls on capital and money market instruments and those specific to commercial banks and other credit institutions—even when the euro area countries were excluded.

Table 3.8.

Countries Maintaining Exchange Controls on Capital Transactions by Exchange Rate Regime1

(In percent of countries reporting, unless otherwise noted)

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Sources: Appendix Table 3.A10; and IMF, Annual Report on Exchange Arrangements and Exchange Restrictions, various issues.

Includes Aruba, Netherlands Antilles and Hong Kong SAR but excludes the 11 countries of the euro area.

Includes exchange rates with no separate legal tender and currency board arrangements.

Includes conventional pegged arrangements, pegged exchange rates within horizontal bands, crawling pegs, and crawling bands.

Includes managed floating with no preannounced path for the exchange rate and independently floating.

Exchange Controls and Currency Crises

Most countries resorted to exchange controls to contain pressures on the exchange rate when faced with a currency crisis. A group of 10 countries that experienced major currency crises in the past five years were examined. Of these countries, 8—Argentina, Brazil, Ecuador, Indonesia, Malaysia, Pakistan, Russia, and Thailand—introduced new controls whose scope varied significantly among countries (Table 3.9). By contrast, two countries, Korea and Turkey, liberalized some inflows rather than imposing new controls. In Indonesia and Thailand, new controls were accompanied by other measures to liberalize capital inflows, which primarily involved removing or relaxing limits on foreign direct investment.

Table 3.9.

Exchange Controls Introduced in the Context of Currency Crises

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Sources: IMF, Annual Report on Exchange Arrangements and Exchange Restrictions, various issues; and various IMF staff reports.

Includes requirements for minimum maturity of financing (Argentina), advance import deposits (Russia), and restrictions on prepayments (Argentina and Pakistan).

Includes repatriation and surrender requirements (Argentina, Pakistan, and Russia) and requirements for export proceeds to be received only in foreign currency (Malaysia).

Includes controls on amortization of credits, repatriation of capital, as well as on same current payments and transfers (e.g., interest, dividends, and profit remittance) associated with capital transactions.

Limits on the export of foreign currencies.

Minimum maturity requirements for external loans.

Prohibition of the use of local currency for settlement of trade transactions.

Baht proceeds from sales of stocks by nonresidents were required to be converted into foreign currency at the offshore exchange rate.

A wide range of exchange controls were imposed by the eight countries noted above. Most of the controls were intended to reduce capital outflows, typically by limiting the ability of residents and nonresidents to remit funds abroad, through direct controls such as outright prohibitions, quantitative limits, prior authorization requirements, and documentation requirements. More extreme measures included suspension of private sector debt repayments (Russia). Some countries (Argentina and Pakistan) initially restricted import payments and current transfers, which in some cases gave rise to exchange restrictions subject to IMF jurisdiction under Article VIII. In conjunction with measures to reduce demand for foreign exchange, measures were used to increase the supply of foreign exchange by introducing (Argentina) or tightening (Pakistan, Russia, and Thailand) surrender requirements for export proceeds. In several instances, price-based controls were applied to contain capital outflows, including financial transaction taxes (Brazil and Ecuador) and dual or multiple exchange rate systems (Argentina, Pakistan, and Russia).

No clear pattern in the use of exchange control measures was evident in these countries, reflecting significant differences in the nature of crises as well as macroeconomic and structural conditions. In Asian countries affected by crises, which experienced significant speculative attacks, controls were focused on nonresidents’ access to local currency funds and offshore trading of local currencies (Ishii, Ötker-Robe, and Cui, 2001). Countries with severe banking sector problems resorted to imposing a freeze or quantitative limits on withdrawals from foreign currency accounts (Pakistan) and on bank deposits in general (Argentina and Ecuador). These measures are regarded as exchange controls because they restrict the making of payments and transfers abroad.

Appendix 3.1

Table 3.A1.

IMF Members Under Article XIV Status

(As of end-2001)

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Sources: Appendix Table 3.A3; and various IMF staff reports.

In some instances, the actual date that restrictions were imposed or removed may differ due to reporting lags resulting from the date of issue of staff reports from which such information was drawn. Afghanistan, Iraq, and Somalia are excluded because recent and comprehensive information is not available concerning restrictions.

Cambodia, the Federal Republic of Yugoslavia, and Zambia accepted the obligations of Article VIII in 2002.

The Federal Republic of Yugoslavia, comprising the Republics of Serbia and Montenegro, joined the IMF on December 20, 2000.

Table 3.A2.

IMF Members Under Article VIII Status Maintaining Exchange Restrictions1, 2, 3

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Sources: Appendix tables 3.A4 and 3.A5; and various IMF staff reports.

In some instances, the actual date that restrictions were imposed or removed may differ from end-year indicated because of reporting lags resulting from the date of issue of staff reports from which such information was drawn.

Code: A=approved; U=unapproved; B=both approved and unapproved restrictions.

Excludes optional bilateral payments agreements that provide for settlement periods longer than three months under the Latin American Integration Association (Argentina, Bolivia, Brazil, Chile, Colombia, Ecuador, Mexico, Peru, Uruguay, and Republica Bolivariana de Venezuela) pending a review of the jurisdictional aspects of these arrangements.

The former Yugoslav Republic of Macedonia accepted the obligations of Article VIII in June 1998.

Table 3.A3.

Restrictions Maintained by Countries Under Article XIV Status at End-20011

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Source: IMF Policy Development and Review Department restrictions database.

In some instances, the actual date on which restrictions were imposed or removed may not correspond to the cut-off date because of lags in reporting that result from the date of issue of the staff report from which such information is drawn.

The Islamic State of Afghanistan, Iraq, and Somalia are excluded because recent and comprehensive information on restrictions is not available.

Table 3.A4.

Restrictions Maintained by Countries Under Article VIM Status at End-20011

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Sources: IMF Policy Development and Review Department restrictions database; and IMF staff reports.

In some instances, the actual date on which restrictions were imposed or removed may not correspond to the table’s cut-off date because of lags in reporting that result from the date of issue of staff reports from which such information is drawn. Information on the approval of restrictions is subject to similar lags.

Table 3.A5.

Members Accepting Article VIII, Sections 2, 3, and 4, and Nature of Restrictions Maintained at the Time of Acceptance, 1997 Through End-June 2002

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Approval was not sought because the authorities indicated their intention to reduce this tax to no more than 2 percent as of February 1, 2000.