Fund Transactions and Reserve Creation
  • 1 https://isni.org/isni/0000000404811396, International Monetary Fund

This paper describes the effects of Fund transactions on members’ external reserves, estimates the net reserve creation or absorption by the Fund in the 1980s, and compares the role of the Fund in this respect with that of other sources of international reserves.

Abstract

This paper describes the effects of Fund transactions on members’ external reserves, estimates the net reserve creation or absorption by the Fund in the 1980s, and compares the role of the Fund in this respect with that of other sources of international reserves.

I. Introduction

International reserves, which are the resources held and used by national monetary authorities to finance foreign exchange market intervention and imbalances in international payments, comprise gold and foreign exchange, as well as certain Fund-created reserve assets. The latter category of assets consists of SDRs and reserve positions in the Fund. A country’s reserve position in the Fund, in turn, is the sum of its reserve tranche (creditor) position and any loan claims it may hold on the Fund.

Many Fund transactions and operations result in the creation or absorption by the Fund of reserve assets in the form of foreign exchange and Fund-generated reserves. Sales of members’ currencies and SDRs by the Fund—mainly in purchase transactions—allocations of SDRs, and borrowing by the Fund from members in their own currencies generally result in increases in the level of international reserves held by monetary authorities. Conversely, repurchases by members of their outstanding obligations to the Fund in currencies and SDRs, and repayments of Fund borrowing in the creditor’s own currency, tend to have a contractionary effect on the level of members’ reserves. Additional effects on the stock of international reserves held by members result when some of the currencies or SDRs provided by the Fund in purchases or used for repurchases of outstanding obligations to the Fund are converted into other currencies or are acquired from other members. These conversions, which are arranged by the Fund, usually take place when the currency provided in a purchase or required for a repurchase is not a freely usable one. A Fund transaction often involves a number of elements affecting more than one member, so that a transaction as a whole may exert divergent effects on the reserves of different members. The impact of a Fund transaction on countries’ reserves is viewed here in terms of its overall or net effect on the world stock of reserves.

The organization of the paper is as follows: The concept of reserve creation or absorption by the Fund, and the factors relevant to an assessment of the impact on reserves of Fund transactions are examined in Section II; the effects on international reserves of specific Fund transactions are described in Section III; and estimates of the net creation or absorption of reserves by the Fund in the 1980s, and a comparison of the resulting changes in Fund-generated reserves with other changes in the stock of nongold reserves are given in Section IV.

In comparison with an earlier paper on the same subject, 1/ the present study attempts to illustrate both the immediate and overall effects of each separate Fund transaction on the reserves of the members involved taking into account in each case the media used and the members’ positions in the Fund. It also provides—to the extent possible—a comprehensive estimate of reserves created or absorbed by the Fund in the 1980s. The paper concludes that changes in net reserves created by the Fund were negatively correlated with changes in other international reserves for most of the 1980s, which contrasts with the finding of the earlier study that no close correlation existed in the period 1951-72 between changes in Fund-created reserves and changes in the stock of reserve assets. 2/

II. General Considerations Bearing on Reserve Creation by the Fund

1. Fund-created reserves

The Fund contributes to international reserves by creating reserve assets through its provision of conditional financial assistance. Access limits on the use of the Fund’s resources, which are expressed in terms of quota, constrain the amounts a member can draw, and hence the amount of conditional liquidity available to it through the Fund. In responding to requests for the use of its financial resources, the Fund assesses both the need for such financing as well as the adequacy of the measures to be taken by the prospective borrowing country to correct its external imbalance. Fund resources are made available to members through a number of policies and facilities, which differ mainly in the type of balance of payments need they seek to address and in the degree of conditionality attached to them. All purchases from the Fund, however, have the common feature of exchanging the borrower’s currency for the currencies of other members or SDRs. Once a member makes a purchase from the Fund, it is free to use the proceeds in any way it sees fit.

Reflecting the revolving character of Fund resources, outstanding purchases from the Fund, other than purchases of reserve tranche positions, are to be repurchased within a prescribed period or sooner if the purchaser’s external position improves. The discharge of financial obligations to the Fund involves a reduction in the member’s holdings of foreign exchange or SDRs, in exchange for its own currency received from the Fund. 3/

The Fund also creates unconditional reserve assets in the form of reserve tranche positions, loan claims on the Fund, and SDR allocations. The sale of the currencies of members with strong balance of payments and reserve positions to finance purchases from the Fund gives rise to claims on the Fund, in the form of reserve tranche positions, 4/ by the creditor members whose currencies have been sold. Reserve tranche positions can also be created by using members’ currencies in Fund operations, for instance, in the payment of the Fund’s administrative expenditures. Reserve tranche positions in the Fund are freely available for use by members, with the only requirement being representation of balance of payments need. Loan claims on the Fund can be encashed, sold, or transferred to other holders, with such transactions taking place either freely or under certain conditions agreed in advance with the Fund. In using a reserve tranche position or loan claim on the Fund, the holder’s representation of balance of payments need is not challenged by the Fund. The SDR is the third category of unconditional reserve asset created by the Fund. Since the first Amendment of the Fund’s Articles of Agreement in 1969, SDR 21.4 billion has been allocated by the Fund to its members. SDRs are freely usable in transactions by agreement among members, and in transactions with the Fund. The use of SDRs with designation, which was conducted up to July 1987, when the expansion of transactions by agreement made such use unnecessary, was subject to balance of payments need. 5/

An operational budget is prepared and approved by the Executive Board each quarter specifying the amounts of SDRs and national currencies that the Fund may provide to finance purchases and other operations, and those that it may receive in repurchases and other operations during the relevant budget period. Although several currencies are used in the operational budget, the bulk of the Fund’s holdings of usable currencies has been the five freely usable currencies, which are those most widely used in making payments for international transactions and traded in major foreign exchange markets, i.e., the deutsche mark, the French franc, the Japanese yen, the pound sterling, and the U.S. dollar.

Procedures have been established for the conversion of any usable currency, other than the five freely usable ones, by its issuing monetary authority. This makes it possible for the purchasing member to obtain the specific currency it wants “at equal value” (with the value date and exchange rate determined by the Fund), and for a repurchasing member to acquire, at equal value, a usable currency specified by the Fund for a transaction in exchange for a freely usable currency the member holds. A monetary authority issuing a freely usable currency is not required to exchange it for other currencies at equal value; a member wishing to exchange a freely usable currency received from the Fund in a purchase for another currency has to make arrangements directly with the central bank issuing that currency, at terms agreeable between them, unless that central bank has notified the Fund that it agrees to exchange its currency used in Fund purchases or needed for use in repurchases of Fund obligations for other currencies, as requested by purchasers and repurchasers. Such a notification has been made by the Bank of England.

2. General considerations bearing on reserve creation

In considering the effects of a Fund transaction on international reserves, the primary focus is on the combined or net addition to or absorption of the total gross international reserves held by the monetary authorities of all the members involved in the transaction. For example, a purchase under a stand-by arrangement of a currency whose issuer is not indebted to the Fund leads in the first instance to an addition of twice the amount of the purchase to the stock of international reserves. This comprises the foreign exchange obtained by the purchaser and an increase of a similar amount in the reserve tranche position of the provider of the currency used in the purchase, as the Fund’s holdings of this currency decline. However, if the purchase is made in a non-freely usable currency that is converted, at the request of the purchaser, into an equivalent amount of a freely usable currency, then the central bank of the member whose currency is provided by the Fund buys back its currency and transfers to the purchaser a freely usable currency that is already part of the existing stock of international reserves. Following this conversion, in which the reserves of the member buying back its own currency are reduced by an amount equal to the purchase, the overall impact on reserves of the purchase and the exchange is limited to the amount of the purchase, rather than twice that amount, as was the case before the exchange took place. If the original purchase were made in SDRs, on the other hand, and then converted into a freely usable currency through a transaction by agreement with the central bank issuing that currency, then an amount equal to twice the purchase is added to total gross reserves; the conversion of SDRs into currency entails the provision by the issuing central bank of a currency that was not part of the stock of international reserves against the acquisition of SDRs.

These examples underline the following points:

a. International reserves are generally defined as gross reserve assets held by monetary authorities. There are two implications of this definition for Fund-related assets: First, while resources transferred by the Fund or from members to it—in the form of SDRs and usable currencies—in Fund transactions are reflected in changes in members’ international reserves, the Fund’s holdings of reserve assets are not counted as part of international reserves. Second, because the definition of international reserves focuses on a gross concept, changes in indebtedness to the Fund are not taken into account in assessing the impact of Fund transactions on international reserves.

b. Most Fund transactions have more than one element, e.g., a simple purchase of another member’s currency entails at least two elements: the receipt of foreign exchange by the purchasing member and the reduction in the Fund’s holdings of the currency of the member whose currency is used, which increases its reserve tranche position in the Fund. While each element of a transaction needs to be considered, it is the effects of all the elements taken together that determine the overall impact of the transaction on the creation or absorption of the stock of international reserves of all the member countries involved in the transaction.

c. Fund transactions are conducted in members’ currencies and in SDRs. and the impact on international reserves is dependent on the media used. The use of SDRs in purchases adds the amount of the purchase to the reserve assets of the purchaser. The use of currency creates additional reserves in the form of a reserve tranche position for the issuer of the currency if it is not indebted to the Fund. If that currency were not a freely usable one, however, its exchange for a freely usable currency would result, as explained above, in an overall increase in reserves equal to the amount of the purchase only.

d. The impact of a transaction on international reserves depends on the positions in the Fund of the different members involved in the transaction. A member may have a creditor position (reserve tranche position), a debtor position (use of Fund credit), or both. 6/ It may also be in a neutral position with no reserve tranche or use of Fund credit, i.e., the Fund’s holdings of its currency are equivalent to the amount of its quota. A purchase in the reserve tranche of the currency of a member not indebted to the Fund adds the amount of the purchase to international reserves, reflecting the increase in the reserve tranche position of the member whose currency is used; the composition, and not the total, of the reserve holdings of the purchaser changes. No reserve creation results when the member whose currency is purchased is indebted to the Fund, as the reduction in the Fund holdings of its currency is attributed to reducing its liabilities to the Fund. If the purchaser were, however, using Fund credit—instead of making a reserve tranche drawing—then international reserves would, in addition to the above-mentioned effects, increase by the amount of the purchase.

e. The widespread convertibility of currencies since 1958 and the subsequent requirement of the Second Amendment of the Fund’s Articles of Agreement that members make arrangements with the Fund to convert their currencies sold by the Fund into freely usable currencies have led to a substantial increase in the number of currencies used in Fund transactions. 7/ The use of a variety of currencies in these transactions sometimes creates a need for the purchaser to convert the particular currency obtained from the Fund into an equivalent amount of other currencies (freely usable ones) acceptable to the purchaser’s creditors or usable in interventions. Similarly, a member making a repurchase may not have among its foreign exchange holdings the currency specified by the Fund for this purpose and therefore needs to acquire the currency from the central bank issuing it. Such currency conversions have effects on international reserves additional to those emanating directly from a purchase or repurchase, as explained earlier. Additional effects also arise from the conversion of SDRs into currency and vice versa when such conversion takes place at the central bank issuing the currency, as this currency is added to foreign exchange reserves in the first case and is absorbed by the central bank in the second one.

III. Effects on Gross Reserves of Specific Fund Transactions

The total amounts of selected Fund transactions in 1980-89 classified by transaction media (SDRs/currencies) are presented in Table 1. As can be seen, transactions related to purchases by members using Fund resources and their repurchase are the largest category. Associated with these transactions are the charges paid by members indebted to the Fund on their use of Fund resources, and the remuneration paid by the Fund on creditor positions created mainly by the sale of members’ currencies to finance other members’ purchases.

Table 1.

Total Amounts of Fund Transactions, 1980-89

(In billions of SDRs)

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Other major groups of transactions relate to the resources provided to the Fund in the form of reserve asset payments for initial quota subscriptions by new members and for quota increases under general reviews by the whole membership, as well as borrowing by the Fund, repayment of this borrowing, and the payment of interest thereon.Sources: Data on purchases, repurchases, and SDR transactions among members are from the Fund’s Economic Information System; other data are from the Treasurer’s Department database.

Payments of the reserve asset portion of initial quota subscriptions and quota increases.

Includes repayment of borrowing under the General Arrangements to Borrow and the oil facilities totaling SDR 3.6 billion.

Equivalent amounts of currencies are used in the exchanges.

A further major category of transactions comprises the allocation of SDRs by the Fund, and SDR transactions among members by agreement and with designation. SDR transactions among members are arranged by the Fund and are closely related to the Fund’s financial activities; hence, their impact on members’ international reserves needs to be taken into account in estimating reserve creation by the Fund.

The effects of the above types of transactions on the total international reserves of the countries involved are discussed in the following paragraphs.

1. Payments for initial quota subscriptions by new members and for quota increases under general reviews

Payments by new members for their initial quota subscriptions and by the membership at large for quota increases under general reviews are effected partly (normally approximately 25 percent) in reserve assets 8/ and the remainder in the domestic currency of the paying member. Since the Seventh General Review of Quotas, the reserve asset payment has been made mostly in SDRs and partly in the currencies of other members acceptable to the Fund. A subscription payment in SDRs reduces the paying member’s SDR holdings but increases its reserve tranche position in the Fund or establishes such a position if the member had already drawn its reserve, tranche prior to the quota increase. The only effect, therefore, of this payment on the member’s reserves is a change in the composition, rather than the total, of reserves. A subscription payment made in the currency of another member—which requires the concurrence of the latter member—has the same effect on the paying country’s reserves, i.e., a change in composition only, but also affects the reserve tranche position of the member whose currency is used, which is reduced by the amount of the payment because the Fund’s holdings of its currency are increased in relation to the member’s quota. As a result, gross international reserves are unchanged when the reserve asset portion of quota subscriptions is paid in SDRs and decline when such payments are made in other members’ currencies.

Apart from the above direct effects, additional effects on international reserves result from payments for quota subscriptions if the paying member does not have in its holdings adequate SDRs or the currency required to make the payment and needs, therefore, to acquire them from another country in exchange for foreign exchange. If SDRs are acquired from the country issuing the currency used in the exchange, then this country absorbs its own currency and SDRs already included in the existing stock of reserves are shifted from one country to another, with the result that total reserves decline, If the reserve asset payment is to be made in a currency that the member does not have in its holdings, it obtains that currency from the central bank of the country issuing it in exchange for another currency it already holds. This increases the reserves of the country providing the currency. In either case, the level of reserves of the paying country is not affected because the exchange of SDRs for currency or one currency for another only changes the composition of its reserves. In case a member has inadequate reserves to make the reserve asset payment, the Fund arranges for the member to borrow SDRs from other members and simultaneously to repay the borrowing by drawing the reserve tranche position created by the reserve asset payment. These transactions are all made in SDRs and their impact on international reserves is neutral, entailing no gain or loss of reserves by the borrower or the lender.

Illustrations of the direct and overall effects on gross international reserves of payments for initial quota subscriptions and for quota increases according to the media of payment are presented in Section 1 of Appendix Table 1.

2. Fund borrowing, repayments, and interest payments

Fund borrowing has provided an important supplement to usable quota resources, which are the basic source of financing of the Fund’s activities. Borrowing helps the Fund meet temporary increases in the demand for its financial resources that could not be met from its ordinary resources. The Fund has borrowed currencies partly from the members issuing them and to a larger extent from other members with the concurrence of the issuing country. Borrowing by the Fund results in a loan claim of the lending country on the Fund. The borrowing of members’ currencies and the repayment by the Fund of such borrowing do not have an impact on the level of the Fund’s holdings of these members’ currencies, as the amounts borrowed are passed through to users of Fund resources in purchases, and repurchases by indebted members are passed through to lenders in repayments. 9/

A borrowing by the Fund of a currency other than that of the lending member 10/ has no impact on the lender’s gross reserves, as the reduction in its holdings of foreign exchange is matched by the creation of a claim on the Fund for the same amount. However, if the Fund borrows a lender’s own currency, the level of reserves increases by the amount of the claim on the Fund.

Conversely, repayments of borrowing by the Fund, if they are made in the lender’s own currency, result in a reduction in the lender’s international reserves, as the lender’s claim on the Fund is partly or fully encashed. Repayments in other currencies or in SDRs have no impact on the level of reserves, as they entail only a change in the composition of the lender’s reserves.

Payment by the Fund of interest on its borrowing increases a lender’s reserves by the amount of interest received, irrespective of the media of payment; payments in SDRs or in other currencies add these reserve assets to the lender’s reserve holdings, whereas a payment in the lender’s own currency increases its reserve tranche position in the Fund. In case of a payment made in the currency of another member, the reserve tranche position of that latter member also increases.

Illustrations of the effects on members’ reserves of borrowings, repayments, and payments of interest by the Fund—depending on the media used—represented in Section 2 of Appendix Table 1.

3. Purchases, repurchases, and related transactions

The Fund transactions having the largest impact on international reserves are the provision of financial support by the Fund to its members through purchases and the subsequent discharge of the related obligations to the Fund by indebted members through repurchases. When a member country uses Fund resources, it obtains SDRs or the currency of another member in exchange for its own currency, and when it repurchases these drawings the reverse takes place. The direct effect of these transactions on gross international reserves varies according to the media used in the purchase/repurchase (SDRs or currency), and also depending on whether the purchaser/repurchaser and the member whose currency is used in the transaction are in creditor or debtor positions with the Fund. There are also additional effects resulting from the conversion of the media used in the purchase/repurchase. The direct and additional effects of purchases and repurchases are explained in the following paragraphs.

A purchase in SDRs of a member’s reserve tranche has no effect on the level of its international reserves and merely alters the composition of its reserves. If the purchaser, were using Fund credit instead, then the amount of the purchase is added to international reserves; its counterpart, the increase in indebtedness to the Fund, does not affect gross reserves.

A purchase in currency has no impact on international reserves if the purchaser is using its reserve tranche, and hence simply changing the composition of its reserves, and if the issuer of the currency used is indebted to the Fund and has no reserve tranche position, so that its obligation to the Fund declines as a result of the sale of its currency with no impact on its gross reserves. 11/ International reserves increase by the amount of the purchase if both the purchaser and the country whose currency is used have reserve tranche positions in the Fund because the latter member’s claim on the Fund would rise as a result of the sale of its currency whereas the decline in the purchaser’s reserve tranche position is offset by the amount of the foreign exchange it receives from the Fund, or if both are indebted to the Fund with no outstanding reserve tranche position. The combined reserves of both members increase by twice the amount of the purchase if the purchaser of the currency is and the issuer of the currency is not indebted to the Fund; in this case, the reserve tranche position of the latter member increases by the amount of the purchase, and the use of Fund credit by the purchaser increases its gross reserves by the same amount.

If the SDRs acquired in a purchase are converted by the purchasing member into a currency at the central bank issuing that currency, an increase in international reserves equal to the amount of the purchase results. Conversely, an exchange of the currency provided by the Fund in a purchase for another currency at the central bank issuing the currency provided reduces gross reserves because of the absorption by the latter central bank of its own currency.

Repurchases have the opposite direct effects on countries’ reserves from those generated by purchases: A repurchase in SDRs or in the currency of a member indebted to the Fund reduces international reserves by the amount of the repurchase, whereas reserves decline by twice the amount of the repurchase if the repurchase is made in the currency of a member which has a reserve tranche position in the Fund. When SDRs are acquired for currency, international reserves are additionally reduced by an amount equivalent to that of the repurchase. When a currency exchange precedes the repurchase, its additional effect would be to increase the reserves of the country whose currency is needed for the repurchase by the amount of the foreign exchange received in the exchange. This offsets the reduction in its reserve tranche position when the Fund’s holdings of its currency increase following the receipt of that currency in the repurchase.

Illustrations of the effects on reserves of purchases and repurchases—depending of the media used—are presented in Sections 3 and 4 of Appendix Table 1.

The payment of charges by members using Fund resources is required to be made in SDRs. Such payments reduce the gross reserves of paying members. If a member with an obligation to pay charges does not have adequate holdings of SDRs and, therefore, acquires the needed SDRs from another member in exchange for that member’s currency, the additional effect on reserves is negative, i.e., a decline, as the latter member buys back its currency. The same would occur if the debtor obtained the needed SDRs from the Fund, as the receipt of the currency by the Fund would raise the Fund’s holdings of it and, hence, reduce the issuing member’s reserve tranche position in the Fund. If SDRs were acquired instead against a third currency held by the debtor, the additional effect on reserves would be neutral; a simple exchange of one reserve asset for another.

Remuneration payments by the Fund to members with creditor positions are made mostly in SDRs and to a very limited extent in the recipients’ own currencies. The recipients’ reserves increase by the amount of such payments, irrespective of the media of payment. Remuneration payments in SDRs add this asset to the reserves of the recipient member, and payments in the member’s own currency increase its reserve tranche position in the Fund.

Illustrations of the effects on international reserves of charges and remuneration payments are presented in Sections 5 and 6 of Appendix Table 1.

4. SDR transactions

SDR allocations by the Fund are direct supplements to members’ international reserves (see Section 7 of Appendix Table 1). SDRs are used in transactions between members and the Fund, as well as among members in transactions by agreement and with designation. The impact on international reserves of transactions involving transfers between members and the Fund has been discussed above in the context of explaining the effects of the different Fund transactions conducted in SDRs.

With regard to SDR uses among members, countries with a balance of payments need can exchange the SDRs they hold for foreign exchange in a transaction with designation, i.e., one in which another member is designated by the Fund to provide a freely usable currency in exchange for SDRs. 12/ The Fund may designate members to provide currency in exchange for SDRs on the basis of the strength of their balance of payments and reserve positions. Fund members also use SDRs in a variety of voluntary transfers in transactions by agreement, whose use is not predicated on balance of payments need. In these transactions, the Fund acts as an agent to promote the smooth functioning of the market in SDRs, primarily by bringing together participants that are ready to buy or sell SDRs, either under standing arrangements or on an ad hoc basis.

Transactions among members are closely related to Fund activities and are arranged by the Fund. They enable members receiving SDRs in purchases from the Fund to convert them into the currencies needed for balance of payments settlements. Transactions by agreement also enable members indebted to the Fund to acquire SDRs needed to pay charges and to repurchase their currencies from the Fund.

The effects on gross reserves of exchanges of SDRs for currency or currency for SDRs among members can be summarized as follows. The reserves of the member initiating the exchange and of the member with which the exchange is made, if other than the country issuing the currency used, are not affected as the result is the substitution of one reserve asset for another. If the exchange is made with the country issuing the currency used in the transaction, however, total reserves increase (decline) as a result of the latter country providing, (buying back) its own domestic currency for SDRs (see Section 8 of Appendix Table 1).

IV. Estimates of Reserve Creation by the Fund, 1980-89

The discussion has focused so far on demonstrating the direct and overall effects of specific Fund transactions on the gross reserves of the countries involved. This section attempts to measure the aggregate reserves created or absorbed annually by the Fund in the 1980s as a consequence of the totality of its transactions, and to compare these Fund-generated changes in members’ reserves with the changes in nongold reserves emanating from other sources. The demand for Fund resources could be expected to rise when international liquidity is tight—reflecting the need for additional sources of external financing—and to fall when international liquidity is more ample. A comparison of changes in reserves resulting from Fund transactions with those in other international reserves would provide interesting evidence with respect to this hypothesis.

1. Fund transactions in currencies

The measurement of the effects on gross reserves of Fund transactions in members’ currencies is made in two stages. First, the effect of Fund transactions on members’ reserve positions in the Fund is examined. Then, additions to or absorptions of foreign exchange reserves resulting from purchases and repurchases and from currency/SDR conversions are taken into account.

a. Effects on reserve positions in the Fund

Fund transactions conducted in members’ currencies change the Fund’s holdings of these currencies. As indicated earlier, the excess of a member’s quota over the Fund’s holdings of its currency, excluding those related to the use of Fund credit, is equivalent to its reserve tranche position in the Fund.

These positions in the Fund cannot fully be counted as reserves created by the Fund because the Fund often absorbs reserve assets from its members, e.g., in payments for quota increases, in the process of creating members’ positions in the Fund. Gross reserves created by the Fund, in the form of reserve tranche positions, need therefore to be reduced by the amount of reserve absorption by the Fund from its members, in the form of SDR holdings (gold holdings before the Second Amendment) received from members and not added back to their reserves in one form or another, to obtain the net amount of reserves created or absorbed by the Fund.

All transactions conducted in currencies between the Fund and its members—whether related to quota payments, purchases, repurchases, remuneration payments on creditor positions, or interest payments on Fund borrowing—are reflected in the Fund’s holdings of the currencies of the members involved in these transactions, and hence are already taken into account in their reserve tranche positions. The first step in determining reserve creation is thus: 13/

NRC=RTPSDRGRA(1)

where NRC is net reserve creation or absorption by the Fund in a period, RTP is reserve tranche positions in the Fund, and SDRGRA represents holdings of SDRs by the Fund’s General Resources Account (GRA).

Taking account of transactions related to Fund borrowing net of the repayment of that borrowing, the equation becomes:

NRC=RPFSDRGRA(2)

where RPF is reserve tranche positions plus loan claims on the Fund.

b. Effects on foreign exchange reserves

Account needs to be taken now of the effects of purchases and repurchases in members’ currencies on foreign exchange reserves, 14/ adjusted to include changes in these reserves resulting from currency exchanges at equal value by member countries using Fund resources to obtain the specific currencies they need in place of those provided to them, and by countries discharging obligations to the Fund to acquire the currencies required for repurchases if not already held by them.

A large majority of purchases and repurchases are made in freely usable currencies. In the period 1980-89, the share of freely usable currencies in total purchases (repurchases) in currencies averaged 72 percent (also 72 percent), of which the average share of the U.S. dollar was 52 percent (43 percent), the pound sterling 2 percent (5 percent), and the combined share of the deutsche mark, the French franc, and the Japanese yen 18 percent (24 percent). The remainder of the purchases and repurchases was made in non-freely usable currencies. 15/

As indicated earlier, the Fund arranges with the central bank issuing a non-freely usable currency provided in a purchase or needed for a repurchase for that currency to be converted in the first case into a freely usable currency at equal value (with value dates and at exchange rates determined by the Fund), and in the second case for the currency needed to be provided at equal value to the member making the repurchase in exchange for a freely usable currency. These currency exchanges offset the initial increase in foreign exchange reserves of the purchaser, and also the initial decline in the reserves of the repurchaser so that no change occurs in members’ foreign exchange holdings. 16/

In the case of freely usable currencies, the issuing central banks are not required to exchange these currencies for other currencies at equal value. Except for the pound sterling, which the Bank of England exchanges for other currencies at equal value, any exchanges of other freely usable currencies are arranged directly by a member using Fund resources or repaying obligations to the Fund with the issuing central bank at terms agreed between them. These latter transactions are outside the scope of this paper. 17/ Hence, purchases (repurchases) in freely usable currencies, other than the pound sterling, are fully reflected in increases (declines) in members’ foreign exchange holdings. In the case of the pound sterling, only that portion of purchases (repurchases) that has not been converted into other currencies (acquired against other currencies) is counted as a change in foreign exchange reserves. Data on such exchanges involving the pound sterling were not readily available until recently, however. In 1990-91, the average portion of purchases in sterling not converted into another currency and of repurchases in sterling provided to the Fund from the repurchasers’ own holdings was of the order of 15 percent of total pound sterling purchases and repurchases. These shares have been used to estimate the changes in earlier years in members’ foreign exchange reserves emanating from purchases and repurchases in sterling that were not exchanged for other currencies. The remainder of these transactions, which are estimated to have been subject to currency exchanges, 18/ did not have an effect on members’ reserves.

Data on purchases and repurchases in U.S. dollars, derived from the Fund’s Economic Information System, include the bulk of those financed from borrowed resources provided by lenders other than the United States, which have no effect on members’ foreign exchange holdings (see Section III.2 above). However, data from the Fund’s operational budget on transfers and receipts of U.S. dollars by the Fund relate mainly to purchases and repurchases in that currency financed from ordinary resources, and have, therefore, been used in estimating the reserve assets created or absorbed by the Fund as a result of these transactions. The budget data exclude most purchases and repurchases financed through borrowing arrangements; the exceptions relate mainly to cases of mismatches of currencies between those used in repayments to lenders, normally the U.S. dollar, and those received by the Fund in repurchases, e.g., SDRs, in which event the transfer side of the budget (representing currency sales) includes the U.S. dollars paid to lenders. Although the use of currencies in such mismatches is already reflected in members’ reserve positions in the Fund, data are not readily available on the amount of U.S. dollars used in these mismatches in 1980-89, in order to exclude them from budget transfers in that currency.

In light of the foregoing, our equation will need to include purchases (P5) and repurchases (R5) in the five freely usable currencies, adjusted in the case of those in U.S. dollars and pounds sterling as indicated above:

NRC=RPFSDRGRA+P5R5(3)

2. Fund transactions in SDRs

The impact on members’ reserves of transactions conducted in SDRs is examined below. First, the effects on total reserves of SDR transfers between the Fund (General Resources Account) and its members are taken into account. Then, additional effects on foreign exchange holdings of transfers between members involving the conversion of SDRs received in purchases into currencies and the acquisition of the SDRs needed for repurchases in exchange for currencies are accounted for.

a. Effects of transfers between members and the Fund

Transfers of SDRs from the Fund to members—in allocations, purchases, remuneration payments, repayments of borrowing, and interest payments on Fund borrowing—increase total reserves in the form of SDR holdings. Similarly, SDR transfers to the Fund from members—in repurchases and payments of charges on the use of Fund resources as well as the yield received by the Fund on its SDR holdings (from net users of SDRs beyond their allocations)—reduce the stock of SDRs held by the membership. Apart from allocations of SDRs, transfers between members and the Fund are reflected in the changes in the SDR holdings of the General Resources Account, which were discussed above. New allocations of SDRs (SDRALC) must be added to our formula for calculating reserve creation by the Fund. Hence:

NRC=RPFSDRGRA+P5R5+SDRALC(4)

b. Effects of transfers between members

Members using Fund resources convert the bulk of the purchases they receive in SDRs into currencies. Countries indebted to the Fund also acquire SDRs from other members in order to pay charges and to repay obligations to the Fund. To the extent that the currencies involved in these transactions are provided (received) by the issuing central bank, there are effects on the foreign exchange reserves of the countries involved additional to those emanating directly from the use of Fund resources or the servicing of obligations to the Fund, If the currencies are provided (received) instead by other central banks, then only the composition of reserves changes, with no effect on total reserves.

Members using Fund resources made purchases from the Fund in SDRs totaling SDR 18.6 billion in 1980-87 (July), 19/ and converted SDR 15.5 billion of this amount into other members’ currencies in transactions with designation; 20/ the remainder was either used directly in settlements or retained by the purchaser as part of its reserves. The U.S. dollar was the currency into which the majority of these SDRs were converted (97.5 percent), followed by the French franc (2.1 percent). The average combined share of the acquisitions by the United States and France in the SDRs used with designation during this period was only 22 percent, which suggests that the majority of U.S. dollars and French francs provided against SDRs came from central banks other than those of the United States and France, with no additional effects on members’ total gross reserves. The expansionary impact on gross reserves of the provision of U.S. dollars by the Federal Reserve, French francs by the Bank of France, and other freely usable currencies by their issuing central banks was taken to equal the amounts of SDRs acquired annually by each of these countries in transactions with designation to the extent that these acquisitions did not exceed the amount of the respective currencies provided in such transactions; otherwise the estimates were based on the amounts of currencies provided.

Transactions by agreement between members totaled SDR 32.3 billion in 1980-89. Through these transactions, the non-oil developing countries acquired SDRs amounting to SDR 23.0 billion from other members mainly to make payments to the Fund for charges on the use of its resources and for repurchases of outstanding obligations. 21/ The U.S. dollar was the main currency provided by members acquiring SDRs in transactions by agreement (82 percent), followed by the deutsche mark and the Japanese yen with a share of 8 percent each. The sale of SDRs by the United States, Germany, and Japan was, however, only a fraction (27 percent on average) of the total SDRs sold by agreement in 1980-89, reflecting the fact that these currencies were mostly provided by other countries. Such SDR sales for currency by non-issuing central banks have no effect on members’ reserves, as indicated above. The contractionary impact on reserves of the absorption of U.S. dollars by the Federal Reserve, the deutsche mark by the Bundesbank, the Japanese yen by the Bank of Japan, and other freely usable currencies by their issuing central banks was estimated as equivalent to the amounts of SDRs sold annually by each of these countries in transactions by agreement to the extent that they did not exceed the amounts of currencies received in such transactions; otherwise the estimates were based on the amounts of currencies received.

Taking account of SDRs converted into currency and those acquired for currency in transfers between members, 22/ our final formula for the derivation of net reserve creation by the Fund becomes:

NRC=RPFSDRGRA+P5R5+SDRALC+SDRCONSDRAQR(5)

where SDRCON are SDRs converted into currencies at the central banks issuing them, and SDRAQR are acquisitions of SDRs for currencies from the issuing central banks.

3. Estimating reserves created and absorbed by the Fund in 1980-89

Estimates of reserves created or absorbed by the Fund in each of the years 1980-89, based on formula (5) above, are presented in Table 2 (column 8). It can be seen from the table that there was net reserve creation by the Fund in 1980-84 and net reserve absorption in 1985-89. Increases in reserves attributed to Fund transactions in the former period averaged SDR 8.8 billion a year, and emanated from the expansion in members’ reserve positions in the Fund (by SDR 6.0 billion a year on average), an excess of purchases over repurchases in freely usable currencies (SDR 1.8 billion), net SDR conversions into currency (SDR 0.3 billion), and SDR allocations in 1980 and 1981 (which averaged SDR 1.6 billion a year). These additions to international reserves were offset in part by the absorption by the Fund of SDRs in transactions with members (SDR 0.8 billion).

Table 2.

Reserves Created or Absorbed by the Fund Compared with Changes in Other World Nongold Reserves, 1980-89

(In millions of SDRs)

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Sources: Data are from the Fund’s Economic Information System supplemented in the case of columns (3) and (4) with data derived from the operational budget or transfers and receipts of U.S. dollars and from TRE’s records on purchases and repurchases in pounds sterling not exchanged for other currencies, and in the case of columns (6) and (7) with data from TRE’s records on SDR transactions.

Gold absorption by the Fund is taken into account because reserve tranche positions in the 1980s were partly created in earlier years when gold was the medium of payment to the Fund. Fund holdings of gold remained unchanged during 1981-89; its inclusion in the analysis therefore has no bearing on the estimates of reserves created by the Fund except in 1980, when there was a slight reduction in gold holdings compared with 1979.

Comprising transactions with designation that involved a conversion into currency at the issuing central bank.

Comprising SDRs acquired by agreement from the central banks issuing the currencies used.

Col. (8) - Cols. (1 + 3 + 5 + 6) - (2 + 4 + 7).

Declines in international reserves in 1985-89 resulting from Fund transactions averaged SDR 4.6 billion annually, and derived from the contraction in members’ reserve positions in the Fund (averaging SDR 3.2 billion annually), repurchases by members of outstanding obligations in excess of new purchases made in freely usable currencies (SDR 1.2 billion), and the net acquisition of SDRs in exchange for currency to pay charges and to discharge obligations to the Fund (SDR 1.0 billion). These declines were offset in part by net transfers of SDRs from the Fund to members (SDR 0.8 billion).

Large use of Fund resources is generally made when external payments disequilibria intensify—as evidenced by declines in world liquidity (with international reserves used as a proxy)—and small or negative 23/ use is made when current account deficits narrow and international liquidity is built up. 24/ Hence, a negative relationship would be expected between reserves created or absorbed by the Fund and changes in world reserves emanating from other sources.

Table 2 also contains a comparison between reserve assets created or absorbed by the Fund and changes in other world nongold reserves. As can be seen, movements of Fund-related reserves tended to compensate for changes in other world nongold reserves during most of the 1980s. This is consistent with the view that reserves created or absorbed by the Fund would be expected to be negatively correlated with changes in other international reserves. This is because an intensification of international payments disequilibria, which may be reflected by a tightening of international liquidity and reserve positions, is likely to trigger an increase in the demand for Fund financial support by member countries. The major exceptions to this turn of events occurred in 1983 and 1985. In 1983, there was a sudden turnaround in other international reserves which rose sharply, while the Fund continued to create reserves at a rapid pace in the process of providing financial support to major borrowers following the 1982 debt crisis. In 1985, a slowdown in the use of Fund resources and an increase in the discharge of outstanding obligations led to reserve absorption by the Fund, at the same time as other international reserves also fell slightly.