There is a close relationship between the foreign exchange regime and the microstructure of the foreign exchange market. Foreign exchange market microstructure is an important consideration in the choice of an exchange rate regime, along with macroeconomic policy objectives.1 Conversely, the adoption of a particular exchange rate regime, and the related foreign exchange regulations, have a considerable influence on the development and structure of the foreign exchange market. These interactions need to be taken into account to ensure the smooth functioning of the overall exchange rate and monetary policy regime.

There is a close relationship between the foreign exchange regime and the microstructure of the foreign exchange market. Foreign exchange market microstructure is an important consideration in the choice of an exchange rate regime, along with macroeconomic policy objectives.1 Conversely, the adoption of a particular exchange rate regime, and the related foreign exchange regulations, have a considerable influence on the development and structure of the foreign exchange market. These interactions need to be taken into account to ensure the smooth functioning of the overall exchange rate and monetary policy regime.

This chapter discusses foreign exchange market organization and regulations in a sample of developing and transition countries, drawing on the 2001 Survey on Foreign Exchange Market Organization (referred to hereafter as the Survey).2 Responses to the Survey were received from about 90 IMF member countries. It covers a wide range of issues, including the organization of foreign exchange trading, the regulation and supervision of foreign exchange activities, and central bank and public sector foreign exchange operations. Such detailed information on foreign exchange markets in a broad range of countries had not been previously available and may prove helpful in guiding policy advice on foreign exchange markets.

Foreign Exchange Market Organization in Developing and Transition Economies

Developing and transition economies have in place diverse regulations on the exchange of their currencies for other currencies, resulting in a variety of market structures and outcomes. In countries where a foreign exchange market is allowed to operate, the authorities typically control several aspects of market design, including the choice of market structures. The pure forms of market structure are auction markets and dealer markets (see Lyons, 2001). Pure forms are abstractions that help to explain the pricing decisions of economic agents in economic models based on market microstructure theory.

Actual foreign exchange markets are more complex and often include elements of both auction and dealer markets. Thus, individual trading platforms can combine elements of auctions and dealing. Foreign exchange voice brokers, for example, serve as a bridge between dealers’ demand and supply without transacting for their own account, in essence adding an auction feature to an otherwise dealer market.3 Moreover, in many foreign exchange markets participants may use different trading platforms, depending on the nature of the transactions. Foreign exchange operations among dealers may be conducted through a continuous electronic dealer market, while transactions with the central bank or the government may take place at one-sided foreign exchange auctions.4 The predominance of dealer or mixed markets over simple periodic auctions reflects the advantages of greater continuity and liquidity that such markets typically offer. Table 4.1 and Figure 4.1 provide information on the different types of foreign exchange market structures in the countries covered by the Survey.

Table 4.1.

Foreign Exchange Market Structures in Developing and Transition Economies with Flexible Exchange Rate Regimes, 20011

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Sources: IMF, Survey on Foreign Exchange Market Organization (2001); and Canales-Kriljenko (2002).

A total of 90 countries responded to the Survey. Of those, 35 had fixed exchange rate regimes (6 hard pegs and 29 soft pegs). The remaining 55 countries are deemed to have flexible exchange rate regimes, which include independent and managed floating, as well as crawling bands and pegs.

Banks could not hold net open foreign exchange positons or conduct foreign exchange operations on their own behalf in three Survey countries (Honduras, Guyana, and Papua New Guinea) and therefore could not be properly considered as dealers.

Includes countries with electronic brokered systems for trading domestic currency.

Figure 4.1
Figure 4.1

Foreign Exchange Market Structures in Developing and Transition Economies with Flexible Exchange Rate Regimes, 20011

Sources: IMF (2001); and Canales-Kriljenko (2002).1 Based on the 55 countries with flexible exchange rate regimes that responded to the survey (see Table 4.1, footnote 1).

Market structures differ not only in the institutional setting but also in the information available to market participants at the time they make their pricing decisions. Market structures define the conditions under which price discovery takes place and, in particular, influence the way in which public and private information is aggregated and disseminated, as well as affecting the mapping from information into prices. The market structure along with foreign exchange regulations determine the way in which a particular economy allocates foreign exchange.

Foreign exchange market structure and the associated regulations are closely related to the development, liquidity, and volatility of the foreign exchange market. Markets vary considerably in liquidity and depth depending on a wide variety of factors, including the overall availability of foreign exchange in the economy, the size of the financial system, and the volume of trade or capital transactions. The market structure will also have an effect on exchange rate behavior, most notably on the bid-ask spread and on exchange rate volatility.5 Most of these issues are beyond the scope of this paper, but Chapter V presents a systematic examination of the relationship between exchange rate volatility and foreign exchange market organization.

Dealer Markets

Dealer markets are characterized by the presence of individuals or institutions dedicated to the purchase and sale of foreign exchange. Dealers, typically banks, are usually allowed to take net open foreign exchange positions within certain limits. The ability to take such positions allows dealers to provide liquidity to the market. Some dealers may become market makers by setting two-way prices at which they are willing to deal (usually up to a given amount based on market practices). Market makers compete with each other in setting two-way prices. Their ability to observe the exchange rates set by other market makers depends on the transparency of the market. About 50 percent of Survey respondents indicated that market makers emerged naturally, while 20 percent indicated that market makers were appointed by the central banks. Market makers tended to emerge more readily in countries with flexible exchange rate regimes.

There are two types of foreign exchange dealer markets: centralized and decentralized. Centralized dealer markets are much less common than decentralized markets. Among the countries responding to the Survey, Madagascar was the only one that operates a centralized dealer market. In such a market, quotes by market makers are publicly announced. This may be achieved by establishing a physical trading location, similar to a trading pit in an exchange, or a medium such as an electronic dealing system that announces the market orders of market makers. Because centralized dealer markets are very transparent, prices in simultaneous foreign exchange trades will exhibit only a minimal dispersion. Decentralized dealer markets, in which dealers have only partial information on the rates at which transactions are settled, are the norm in developing and transition economies. About 95 percent of Survey respondents indicated the existence of such markets.

In decentralized dealer markets, market makers may offer two-way, bid-offer quotes on demand, and several bilateral trades may take place at the same time at different exchange rates. Bilateral trades may take place in telephone conversations that are later confirmed by either fax or telex. They may also take place on electronic trading platforms that allow for bilateral conversations and execution, such as the Reuters Dealing 2000-1 system (Box 4.1) and the 3000 Spot Dealing system.6 Bilateral conversations may also take place over networks provided by central banks (Kyrgyz Republic) and over private sector networks. These private networks may grant access to the central bank (Azerbaijan, Brazil, Chile, and Paraguay), or they may not (Swaziland).

Dealing Technology: The Reuters 2000-1 System

The most widely used system for online decentralized dealing is Reuters 2000-1. It provides a means for secure one-on-one electronic conversations (similar to e-mail messages) between dealers. Reuters explicitly allows only dealers to trade in the system.

The system follows the dealer protocol, under which the dealer initiating the conversation requests a two-way quote. Usually a two-way quote with a very narrow spread will be given, which the initiating party must accept or reject within seconds. An accepted message constitutes a trade. The information exchanged in these conversations remains private and only known to the parties.

Because this dealing system allows several of these conversations to take place at the same time, several transactions may take place at different prices. Nevertheless, given the information available to all participants, it is unlikely that a large price dispersion exists (Lyons, 2001).

Auction Markets

In auction markets, price formation and market clearing take place without dealer involvement. An auctioneer or auction mechanism allocates foreign exchange by matching supply and demand orders that are placed either directly or through intermediaries. In practice, the central bank, voice brokers, or brokerage systems play the role of auctioneers. In auction markets, supply and demand may meet either continuously or periodically: in thin markets, auctions take place at discrete periodic intervals to allow sufficient supply and demand to accumulate.

The Survey indicates that periodic foreign exchange auctions took place in 15 countries. An overview of periodic auction markets is provided in Table 4.2. Almost all such auctions were for spot foreign exchange contracts. One exception was Colombia, which auctioned only option contracts that give the right (but not the obligation) to buy or sell foreign exchange at a predetermined rate from the central bank.7 The frequency of periodic auctions varied significantly across countries. Most were not conducted on a regular schedule. Daily auctions took place in seven countries and weekly auctions in one.8

Table 4.2.

Foreign Exchange Auction Design in Developing and Transition Economies, 20011

(Number of countries responding to the Survey)

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Sources: IMF, 2001 Survey on Foreign Exchange Market Organization; and Canales-Kriljenko (forthcoming).

The countries conducting periodic foreign exchange auctions (among those that responded to the Survey) are Angola, Azerbaijan, Belarus, Bolivia, Brazil, Chile, Colombia, Croatia, Honduras, Kazakhstan, Mauritius, Sierra Leone, Turkey, Yemen, and Zambia. The Annual Report on Exchange Arrangements and Exchange Restrictions reports that Armenia, Burundi, Ethiopia, Guinea, Tajikistan, and Turkmenistan also conducted foreign exchange auctions.

Foreign exchange auctions may be one-sided (to buy or sell a given amount of foreign exchange) or two-sided (to simultaneously buy and sell foreign exchange). One-sided auctions were more common than two-sided auctions. A one-sided auction can help allocate foreign exchange to its most valued uses. In some countries, the central bank used one-sided auctions to sell foreign exchange, while in others (Brazil and Turkey) the central bank conducted such auctions to either buy or sell foreign currencies, depending on market conditions. Onesided auctions are considered particularly helpful when the government receives the bulk of its foreign exchange receipts in the country or has instituted a requirement to surrender foreign exchange to the central bank. In five countries, two-sided auctions permitted the centralized trading of foreign exchange.

In most countries with foreign exchange auctions, these are conducted by the central bank. In some countries, however, the auctions were conducted by the stock exchange. In Mauritius, the auctions were held by a local exporters’ association.

Foreign currency receipts accruing to the government were the most widely reported source of foreign exchange in the auctions. These receipts arose primarily from financial aid, export receipts from state enterprises, and government borrowing abroad.9 In addition, the stock of central bank international reserves was an important source of foreign exchange in the auctions, notably for banks that undertook interventions through foreign exchange auctions.10 The surrender of export receipts was also reported as a source in several countries. In some countries where auctions were conducted outside the central bank, sources of foreign exchange included the foreign exchange assets of commercial banks (Azerbaijan) and export receipts (Mauritius).

Additional Rules Governing Foreign Exchange Auctions

Auction participation was typically limited to primary dealers, usually chosen among resident financial institutions. Other institutions permitted to participate included foreign exchange bureaus (Honduras, Sierra Leone, and Yemen), importers and exporters (Belarus, Honduras, and Sierra Leone), nonresident financial institutions (Belarus, Colombia, and Sierra Leone), the public treasury (Bolivia and Colombia), and mutual funds, cooperatives, and private financial funds (Bolivia).

Competitive bids were the only ones allowed in most countries so that all bids were considered in making the pricing and allocation decisions. In noncompetitive bidding, by contrast, some participants may be allowed to buy at the exchange rate that resulted from the competitive bids presented at the auction. Moreover, auction participants were required to bid minimum amounts in all countries except for Belarus and Bolivia.

The number of bids per bidder was restricted in about half of the countries. The number of permitted bids was typically established before the auction, except in Azerbaijan and Croatia.

Disqualification from the auction was usually specified in writing, which included the reasons for disqualification, except in Belarus, Brazil, Chile, Mauritius, and Turkey.

Domestic currency cover had to be documented by bidders in Azerbaijan, Belarus, Bolivia, Honduras, Sierra Leone, and Yemen for the bid to be valid, in order to minimize settlement risk.

Different auction formats were used to determine the market clearing exchange rates. In single or uniform price auctions, all winning bidders pay the same market clearing exchange rate, while in multiple price, so-called Dutch auctions, all winning bidders pay their winning bids. The price determination mechanism in the auctions varied among Survey respondents: about half of the countries conducted single-price auctions and the rest were Dutch auctions. In certain circumstances, foreign exchange auctions, especially multiple-price auctions, have given rise to a multiple currency practice that is subject to the IMF’s Articles of Agreement. Additional rules governing foreign exchange auctions in various countries are discussed in Box 4.2.

Continuous two-sided multiple price auctions usually take the form of electronic brokered systems. In these markets, participants place orders to buy or sell foreign exchange that are matched in a centralized scheme. The orders may specify an amount to buy or sell when the exchange rate reaches a given level (limit orders) or an amount to buy or sell at the best available rate (market orders). The best available bid and offer rate is computed from competing limit orders. The providers of electronic brokered systems vary by country (Table 4.3). In one country, the central bank provided the electronic brokered platform—which may or may not give the central bank privileged access to trading information—while in others the domestic private sector provided the platform. In many cases, these systems are provided by well-known international vendors (Box 4.3).

Table 4.3.

Providers of Electronic Dealing and Matching Systems in Selected Developing and Transition Economies, 2001

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Sources: IMF, 2001, Survey of Foreign Exchange Market Organization; and Reuters.

Denotes a matching or electronic brokered system.

The central bank has access to information in the system in all countries, except Brazil, Lebanon, and Swaziland.

EBS Spot Dealing System is a dealing system offered by the EBS Partnership, which groups the main international banks.

Argentina adopted the brokered system in early 2002.

Regulations Affecting Foreign Exchange Market Organization

Many important aspects of foreign exchange market organization are affected by regulations. These regulations are an integral part of the organization or infrastructure of foreign exchange markets. They typically place limits on the use of foreign and domestic currencies, operations by intermediaries, the types and characteristics of contracts, and the trading locations. They can significantly alter exchange rate dynamics by circumscribing how individuals and institutions interact in the market, and may result in the segmentation of the market.

Regulation of the Use of Foreign and Domestic Currencies

Regulations can affect customers’ demand for and supply of foreign and domestic currencies, among other things, by defining the monetary and other uses that residents and nonresidents can make of foreign exchange, and by defining the transactions that can legally be made with domestic currency.11

Electronic Brokered Systems

The Reuters 2000-2 system anonymously matches dealers’ spot limit and market orders. The system ranks and displays the best available exchange rates for buying and selling to all dealers, but it does not reveal the name of the dealer making the order until the orders are matched. Because the system is blind in this respect, and foreign exchange dealing implicitly involves bilateral credit, the system requires dealers to negotiate bilateral credit lines before they can start trading. Only matching orders that fall within the bilateral credit limits can be matched. Quantity information is available for deals below US$10 million. The Reuters Dealing 3000 Spot Matching system superseded the Reuters 2000-2 systems in 2000.

EBS Spot Dealing system is a screen-based anonymous dealing system for trading interbank spot foreign exchange. One to six currency pairs can be traded at any time, with deals completed by keystroke or automatic deal matching within the system. EBS has a prescreened credit facility, by which dealers can only see prices that they can “hit,” thereby eliminating the potential for failed deals because of counterparty credit issues.

SIOPEL is the software for the electronic brokered systems in Argentina, Brazil, and Uruguay. It allows anonymous matching of spot and forward limit and market orders. Dealers can see all available prices and quantities offered, including those they cannot hit. The software requires bilateral credit lines for brokered services.

Monetary regulations define the roles that foreign currencies can play in the economy and the permissible uses of the domestic currency abroad. Most countries that issue their own currencies have granted certain legal privileges to their domestic currency (Baliño and Canales-Kriljenko, 2001). for instance, a domestic currency may have the privilege of forced tender (making it the exclusive means of payment) or of legal tender (so that it must be accepted in payment for financial obligations). About half of Survey respondents explicitly prohibited their residents from making payments to other residents in foreign currencies.

Many countries permit their financial sectors to offer foreign currency-denominated financial assets. Well over half of Survey respondents reported that domestic banks were allowed to take foreign currency deposits or make foreign currency loans.12 Even so, almost half of Survey respondents indicated that residents were prohibited from holding foreign currency-denominated assets abroad; about one-third explicitly prohibited residents from denominating domestic financial contracts in foreign exchange; and some prohibited residents from holding notes and coins in foreign currency.

Many countries also require the surrender of foreign exchange and, in particular, of export earnings. Surrender requirements may be comprehensive or they may be partial, in that only a certain portion of foreign exchange or proceeds from only certain types of exports must be sold 10 the central bank or the market. Exporters may be allowed to repay export financing or pay for imports with some export receipts. Even here, exporters may be allowed to open foreign currency accounts with domestic banks, where they could deposit the foreign exchange before having to surrender it. Surrender requirements are also common when residents are not allowed to hold foreign exchange or foreign currency-denominated assets as a store of value.

Market segmentation may arise when the authorities try to influence the use of foreign exchange through regulation.13 For example, country authorities may require that foreign exchange used for international current and capital transactions be traded in separate markets at different rates. To facilitate enforcement, the authorities may impose different structures on the separate markets, for example, a centralized two-sided auction scheme for current transactions and a decentralized multiple-dealer market for capital transactions. The premium that may emerge in the market for foreign exchange used in capital transactions can be thought of as a tax on capital flows. A similar type of segmentation may arise when illegal capital transactions take place on parallel markets that, although illegal, may be tolerated.

Regulation of Intermediaries

The effective enforcement of foreign exchange regulations typically involves the regulation of intermediaries, who also often play an important role in upholding various types of market segmentation. The regulation of intermediaries may also serve an important prudential purpose. Most developing and transition economies limit foreign exchange dealings to authorized institutions. In some countries, a foreign exchange license is required, while in others a particular type of institution, often a bank, is automatically authorized to conduct foreign exchange business. Authorized foreign exchange dealers must comply with—and often play a crucial role in—the enforcement of foreign exchange and monetary regulations, including reporting requirements, exchange and capital controls, and anti-money laundering legislation. In some countries, authorized dealers may only make an exchange once they have verified that the underlying transaction is legally permitted. Strict enforcement may lead to the emergence of illegal parallel markets for foreign exchange.

Licensing of intermediaries in the foreign exchange market is common. Institutions eligible for licenses to deal in foreign exchange typically include banks and foreign exchange bureaus. All Survey respondents requiring licenses allowed resident financial institutions, mostly banks, to deal in foreign exchange. About three-quarters of the respondents required dealing licenses for resident foreign exchange bureaus, and a similar proportion allowed branches and subsidiaries of foreign banks to deal in foreign exchange. Fewer than one-quarter of the respondents licensed resident brokerages, foreign brokerages, and exporters or importers to deal in foreign exchange.

In a few countries, banks are not permitted to deal in foreign exchange for their own account, and may buy and sell foreign exchange only on behalf of their customers. Consequently, these banks act as brokers, matching demand for and supply of foreign exchange. In some of these countries, banks were agents of the central bank and charged a commission for intermediation.

Foreign exchange bureaus are typically allowed to deal in foreign currency cash and traveler’s checks, but cannot deal in foreign exchange transfers or hold accounts abroad. In particular, foreign exchange bureaus are uniformly permitted to deal in cash and about three-quarters of the sample were also permitted to deal in traveler’s checks. In about half of the countries with foreign exchange bureaus, they were more numerous than banks, thus providing additional competition at the retail level. In about one-third of the sample, the bureaus were required to verify compliance with exchange controls before conducting a transaction.

Regulation of Contract Types

Regulations may also define permissible types of contracts involving the trading of foreign exchange. Virtually all Survey respondents allowed banks to buy and sell foreign exchange in spot markets. About 70 percent of the respondents allowed banks to conduct forward transactions, and about 50 percent allowed them to buy and sell futures contracts, offer nondeliverable foreign exchange forward contracts, or buy and sell foreign exchange options. Reflecting these regulations, the general perception among countries in the sample was that their spot markets are more developed than their forward markets.14

Regulatory limits on forward contracts reflect concerns about their use in speculative transactions. Often, regulations permit spot contracts only, which may be defined as contracts involving settlement within a few days. Also, suppressing the forward market will usually require regulations on other types of derivatives, such as swaps and options, that may be combined to closely replicate the payoffs from a forward contract. In some countries, forward contracts were limited to hedging operations directly related to permissible international transactions. In some cases, regulations also limited the maturity of the forward contract, sometimes linking it to the timing of the underlying transaction.

Regulation of Trading Locations

Foreign exchange regulations may determine the geographical location where the domestic currency can be traded in exchange for foreign currencies. These regulations may also reduce the likelihood that assets denominated in a particular currency will be included in a diversified worldwide portfolio. These regulations may include an outright prohibition of offshore domestic currency trading and restrictions on the export and import of domestic currencies. These measures are typically taken to close off avenues for speculative attacks.

About a third of countries responding to the Survey explicitly prohibited certain nondomestic uses of their currencies. Examples include prohibitions on using domestic currency for payments abroad, holding domestic currency notes and coins abroad, holding national currency deposits abroad, and receiving national currency loans abroad. A slightly lower percentage of respondents prohibited nonresidents from denominating international financial and nonfinancial contracts in domestic currency.

A few countries have allowed the trading of their currencies on well-known international exchanges. Futures contracts in the currencies of Brazil, Mexico, Russia, and South Africa are listed on the Chicago Mercantile Exchange. South Africa also allows futures trading of the rand on the New York Board of Trade.

The Regulatory Framework and the Exchange Rate Regime

There is a systematic relationship between the use of certain types of foreign exchange regulations and the exchange rate regime. Specifically, some of the regulations discussed above were most prevalent in countries maintaining a conventional fixed peg to another currency or a basket of currencies. These include restrictions on payments to residents in foreign currencies, restrictions on the use of foreign currency as a store of value, restrictions on interbank dealing, and regulatory limits on forward contracts. Some of these regulations were also used extensively in countries that relied heavily on external financing. The use of these regulations appears to be intended to reduce the vulnerability of pegged regimes to speculative attack. The use of these regulations was far less common in countries with a currency board, possibly reflecting the higher degree of commitment to exchange rate stability and monetary discipline that this exchange rate regime requires.

A slightly different pattern emerges with respect to regulations affecting the geographical location of currency trading. Most countries with a conventional fixed peg to a single currency permitted only onshore trading of their currency, while countries with a currency board permitted both onshore and offshore trading. However, a majority of countries pegging to a basket of currencies also permitted offshore trading. The reasons for this difference are not well understood, but may reflect the difficulty of developing a sufficiently active onshore market in more than one foreign currency.

Measures To Counter Exchange Rate Pressures

Foreign exchange market regulations that influence market structure and conduct have also been used extensively to counter pressures on the exchange rate and on foreign exchange reserves. These measures are typically used as an adjunct to macroeconomic adjustment and are often intended to address specific sources of pressure on the exchange rate and reserves and to buy time for the adoption of more fundamental policy changes. In so doing, they seek to modify the conduct of both customers and intermediaries in the foreign exchange market and to regulate contract types and trading locations. Significant measures of this kind are listed in Box 4.4.

Combinations of these measures were used in a number of countries that experienced a currency crisis. While these measures may temporarily reduce pressures on the exchange rate, they are also distortionary (see Ariyoshi and others, 2000). For example, segmenting the foreign exchange market may result in an inefficient allocation of foreign exchange and may adversely affect the ability of financial institutions and others to manage foreign exchange exposures and related risks. Also, regulations that interfere with preexisting contracts may have long-lasting effects on the confidence of market participants and on foreign exchange market development.

Role of the Central Bank

Central banks in developing and transition economies are active in their foreign exchange markets even if they follow independently floating regimes. The Survey responses indicated that central banks in developing and transition economies with flexible exchange regimes traded foreign exchange mainly with banks and governments (Table 4.4). Very often, the central bank conducted foreign exchange operations with banks on behalf of the government. This fact partially explains why about 90 percent of those countries following independently floating regimes reported also conducting foreign exchange operations with banks. In fact, in more than 80 percent of the Survey respondents, the central bank traded foreign exchange with the government. In about 60 percent of the respondents, the central bank was the exclusive foreign exchange agent of the government, and the government traded foreign exchange exclusively with the central bank.

Table 4.4.

Central Bank Intervention Practices in Developing Countries with Flexible Exchange Arrangements, 2001

(In percent of countries responding to the Survey in each category, unless otherwise noted)

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Sources: IMF, 2001, Survey on Foreign Exchange Market Organization; and Canales-Kriljenko (forthcoming).

The central government sells foreign exchange only to the central bank and purchases foreign exchange only from the central bank.

Auctions are conducted by the central bank.

Orders to buy or sell a given amount of foreign exchange at a given price.

The Survey also provides information on the trading platforms used by central banks in the buying and selling of foreign exchange on a discretionary basis. The trading platform used can influence the effectiveness of foreign exchange intervention, inter alia by affecting the visibility or speed of execution of central bank transactions. The Survey showed that most central banks conducted these operations through telephone lines. It also revealed, however, that in about one-third of the cases central banks in countries with flexible exchange rate arrangements also made use of online trading platforms.15 The most prevalent online dealing system was the Reuters 2000-1 dealing system.16 In several countries, the central bank provided the online trading platform directly, while in others it was provided by the domestic private sector. Only a few countries used trading platforms that allowed simultaneous, multiple foreign exchange transactions; these platforms were provided mainly by the domestic private sector. Use of the Reuters matching system was very limited. In addition, central banks often managed the foreign exchange auction, as discussed above.

Regulatory Measures to Counter Exchange Rate Pressures

Countries have taken a variety of regulatory measures to counter pressures on the exchange rate and foreign exchange reserves. The measures listed here are illustrated by country examples. In many cases, these measures have been supplemented by moral suasion.

  • Temporary closure of foreign exchange markets: Although rare, market closures are most commonly used when major changes are made in the exchange rate regime or in exchange market organization or regulations. For example, Argentina has heavily used “foreign exchange holidays” since December 2001.

  • Dual or multiple-exchange rates: This segmentation of the foreign exchange market into one or more official markets and one or more free markets is used to allocate foreign exchange at subsidized rates to specific transactions, such as imports of essential goods and services. Pakistan adopted a multiple exchange rate system in July 1998 during the crisis brought on, among other things, by the nuclear rivalry with India. The system comprised an official rate, a floating interbank rate, and a composite exchange rate.

  • Multiple-currency trading sessions: The allocation of foreign exchange is influenced through restrictions on currency trading sessions. This type of measure was adopted by Russia in September 1998.

  • Restrictions on the offshore use of currencies: Countries have imposed or reimposed such regulations when offshore trading in domestic currency was considered to be a major source of speculative pressure. Malaysia introduced in September 1998 comprehensive regulations of this type.

  • Restrictions on foreign exchange outflows: Such controls may limit the ability of nonresidents to remit locally held funds abroad, prohibit or impose quantitative limits on residents’ transactions, and attempt to reduce leakages of foreign exchange by requiring documentation. In early December 2001, Argentina temporarily prohibited all transfers of funds abroad, with certain exceptions including those for trade operations, unless the transfers were directly authorized by the central bank.

  • Restrictions on the foreign exchange positions of banks: Overnight positions may be subject to stricter exposure limits or other administrative restrictions, and intraday positions may receive greater scrutiny. Romania imposed an overnight cash limit on foreign exchange bureaus.

  • Measures affecting the timing of foreign exchange flows: These measures include, among other things, an advance import deposit requirement. In 1997, India imposed an interest rate surcharge for importers in response to pressures on the rupee during the Asian crisis.

  • Steps to increase the supply of foreign exchange: These measures most often take the form of surrender requirements for exporters, either at free market or official exchange rates (Argentina in 2002, Pakistan in 1998, Thailand in 1997). Some countries have also liberalized foreign direct investment inflows during a crisis (Korea).

Several other interesting characteristics of central bank foreign exchange operations emerged from the Survey. About 90 percent of the respondents indicated that foreign exchange operations took place in the spot markets. The lack of forward or other derivative transactions may reflect central banks’ concerns about their risks.17

Seventy-five percent noted that their central banks usually initiated foreign exchange operations. According to the literature on market microstructure, the price effect of such operations tends to be greater than that of interdealer transactions; for example, central banks may have relatively more access to information about fundamentals, such as the monetary policy stance. About 70 percent of central banks avoided limit orders with banks,18 or declined to establish a fixed bid/ask spread. Very few respondents reported that the monetary effect of foreign exchange interventions was never sterilized. Finally, about half of the respondents did not announce foreign exchange intervention operations, and even more did not publish the intervention amounts after the fact.


  • Ariyoshi, A., and others, 2000, Capital Controls: Country Experiences with Their Use and Liberalization, IMF Occasional Paper No. 190 (Washington: International Monetary Fund).

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  • Baliño, T., and J. Canales-Kriljenko, 2001, “Competing Monetary Roles of the U.S. Dollar, the Euro, and the Japanese Yen in Developing Countries,” paper presented at the XIII Economic History Congress, Kassel, Germany.

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  • Canales-Kriljenko, J., forthcoming, “Foreign Exchange Market Organization in Selected Developing and Transition Economies: Results of a Survey,” IMF Working Paper (Washington: International Monetary Fund).

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  • Lyons, R., 2001, The Microstructure Approach to Exchange Rates (Cambridge, Massachusetts: MIT Press).


An independently floating regime, for example, is meaningful only in a foreign exchange system in which there is adequate scope for private parties to deal in foreign exchange and adequate competition among them.


A full description may be found in Canales-Kriljenko (forthcoming).


Foreign exchange brokers may be thought of as auctioneers. In fact, several electronic brokered systems can operate as continuous electronic auction markets.


In particular, the central bank may conduct one-sided auctions to sell the foreign exchange it obtains from the government, while permitting dealers to trade freely the foreign exchange they obtain from the central bank in a multiple-dealer decentralized market structure.


For example, transaction costs and bid-ask spreads have tended to be lower in countries with dealer markets.


Ninety percent of Survey respondents reported dealing through telephone lines, and about 75 percent through one of the Reuters dealing systems (these two methods of dealing are not mutually exclusive). It is not clear from the Survey, however, whether the Reuters systems were used for trading domestic currency or for trading foreign currencies abroad.


This approach followed the example of Mexico, which auctioned option contracts between August 1996 and June 2001.


In Colombia, the auctions in which the central bank buys foreign exchange took place every month, while those in which it sells foreign exchange were not on a regular schedule and took place only as required.


The central bank was the exclusive financial agent and foreign exchange dealer of the government in all of these countries except for Croatia.


Auctions may in some instances be used by the central bank to inject foreign exchange into a dealer market (much in the same way that other central bank operations introduce liquidity into the domestic money market). For example, Turkey is presently using such an auction as a transparent mechanism for providing the interbank market with foreign exchange derived from purchases under an IMF arrangement.


Taxes and subsidies can also indirectly affect the demand for and supply of foreign exchange through underlying transactions that must be settled in foreign currency.


Some respondents permitted such deposits and loans subject to quantitative limits or verification of an underlying legal current or capital transaction.


Multiple foreign exchange markets may, under certain conditions, give rise to multiple currency practices that are inconsistent with a country’s obligations under Article VIII, Section 3.


Over 70 percent of the respondents considered their spot markets to be developed, while only 20 percent considered their forward markets to be developed.


Flexible regimes include independent and managed floating, as well as crawling bands and pegs.


Other one-on-one online trading platforms used by developing and transition economies included Reuters 3000 Direct and Reuters 2002-2 Spot.


The central banks in some countries have experienced large losses from intervention through the forward foreign exchange market.


Limit orders instruct banks to buy or sell foreign exchange at a given price, if possible.