Abstract
THE GOLD AND FOREIGN EXCHANGE reserves of small or poor countries are often not large enough to make it easy to operate foreign exchange markets virtually free from quantitative restrictions.1 Furthermore, it may not be desirable on other grounds for such countries to invest a large proportion of their assets in foreign reserves, when there are other claims upon savings which deserve priority. There are, however, positive advantages for such countries in maintaining liberalized exchange markets, so that they have a direct interest in carrying out the international commitments into which they have entered, by joining the International Monetary Fund, to avoid the use of restrictions on the making of payments and transfers for current international payments. Many of them also wish to maintain certain controls to influence the rate of growth or the income distribution of their economies; and in these circumstances the maintenance of balance of payments equilibrium without recourse to exchange control measures requires a flexible, well-timed, and skillful management of monetary and/or fiscal controls of a kind for which the experience of more highly developed countries may not give adequate guidance.
THE GOLD AND FOREIGN EXCHANGE reserves of small or poor countries are often not large enough to make it easy to operate foreign exchange markets virtually free from quantitative restrictions.1 Furthermore, it may not be desirable on other grounds for such countries to invest a large proportion of their assets in foreign reserves, when there are other claims upon savings which deserve priority. There are, however, positive advantages for such countries in maintaining liberalized exchange markets, so that they have a direct interest in carrying out the international commitments into which they have entered, by joining the International Monetary Fund, to avoid the use of restrictions on the making of payments and transfers for current international payments. Many of them also wish to maintain certain controls to influence the rate of growth or the income distribution of their economies; and in these circumstances the maintenance of balance of payments equilibrium without recourse to exchange control measures requires a flexible, well-timed, and skillful management of monetary and/or fiscal controls of a kind for which the experience of more highly developed countries may not give adequate guidance.
Some countries have relied upon a floating exchange rate with the support of domestic measures to cope with any external disequilibrium; but if a floating rate is permitted, it is usually thought desirable to keep it as stable as possible. Thus, even with a floating rate, monetary and/or fiscal controls are still necessary to correct not very strong expansionary or contractionary movements.
In principle, a large number of instruments of monetary control are available for the use of central banks in underdeveloped countries; however, for a variety of reasons, many of them are not in fact, or cannot be, used. There may be serious doubts about their efficiency for the purposes for which they have been used in other countries. Deeply rooted popular prejudices and political opposition have to be taken into account. Open market operations, where the central bank sells securities in the market and thereby draws reserves away from the banking system, may be impossible because there is no organized money market or because suitable securities are not available in sufficient volume. The transfer of fiscal or public deposits between the commercial banks and the central bank, the effects of which may be similar to those of open market operations, may also be impossible because of institutional arrangements which are difficult to change. In these circumstances, several countries (e.g., Ecuador and Chile) have recently made use of compulsory payment of advance deposits on imports as an instrument for ensuring effective monetary control and helping to maintain balance of payments equilibrium.
If advance deposits are to be effective for these purposes, it is essential that they be maintained with the central bank and be sterilized by it. The payments may be made in a variety of ways; for example, they may be made in anticipation of payment of customs duties, consular fees, or other taxes. But irrespective of the way in which they are made, their effects should be the same. These effects may turn out to be similar to those of the more conventional instruments of policy, which may be difficult, or even impossible, to apply because of institutional factors or of certain disadvantages irrationally imputed to them. Advance deposits may have an even greater effect than conventional instruments upon the balance of payments equilibrium, which is the most important objective of the monetary policy that is being pursued.
A careful examination of the economic characteristics of a number of underdeveloped countries suggests that advance deposits on imports are likely to be a useful instrument of monetary management where the objective of external balance without resort to quantitative restrictions is being pursued under the following circumstances: the economy depends largely on foreign trade; the level of external reserves is rather low; the desire is to attain the objectives of economic policy mainly by indirect inducement; and the country faces the danger of, or is actually suffering from, a balance of payments disequilibrium which is not very severe.
General Characteristics
The requirement of advance deposits on imports means that the period for financing import inventories is lengthened and, therefore, the amount of capital tied up in this way is increased. Larger financial resources will be necessary—either as importers’ working capital or as bank credit advanced to importers—to finance a given volume of import inventories. The magnitude of the additional demand for financial resources will depend on the rate of import flow (the higher the rate, the larger will be the amount of financial resources tied up), the percentage of import values which the authorities require as advance deposits, and the period during which the volume of import financing has to be increased as a result of the advance deposit requirement. The significance of the first two of these three influences is obvious and requires no special discussion. The establishment of percentages even higher than 100 is conceivable, and the required percentages may be changed as frequently as desired in order to give adequate flexibility to the policy, the effectiveness of which will tend to vary proportionately with the magnitude of the percentage. The significance of the time factor needs closer examination, however.
The time factor is relevant because it determines the amount of financial resources which has to be tied up. Let us assume that imports are paid for upon delivery of the goods and that advance deposits have to be made before an import order is placed, say, 60 days before the arrival of the goods. If importers maintain inventories equivalent to 60 days’ imports, a 100 per cent advance deposit means that the financial resources needed to finance import trade will be doubled. If advance deposits have to be paid 30 days before the customary date of paying for imports, the financial resources needed for import financing will be increased by 50 per cent.
Apart from any interest cost involved in carrying a certain amount of advance deposits, the effects of their introduction or of any change in the amount required will be complete as soon as the financial resources needed to make the deposits have been accumulated or, if requirements are made less stringent, as soon as those resources have been released. If the required percentage is increased, it may take some time before all the new financial resources are accumulated, but thereafter the advance deposit requirement will be neutral with respect to the level of expenditures. Like most monetary and fiscal measures that influence the level of economic activity, advance deposit requirements may be used to offset expansionary or contractionary tendencies by suitable changes in either direction in the percentage of the import value that has to be deposited.
The maintenance of constant percentages does not mean that the financial resources needed to finance them will remain constant. The volume of these resources will also depend on changes in the volume of import demand or in the time period between advance deposits and normal payments for imports.
If it is assumed that inventories are maintained at a uniform proportion of imports, the total financial requirements for additional inventories and for additional advance deposits will change in the same proportion as the flow of imports. If the flow of imports increases, no new financing will be required after the amount of new resources has been tied up in inventories and advance deposits.
Any changes in the inventory requirements of importers will affect the volume of resources tied up in advance deposits in accordance with the way in which the new inventories are accumulated. Let us assume an annual rate of imports of 120 million and that inventories equal to two months’ imports are necessary, so that 20 million will be tied up in that form of investment. Let us assume also that advance deposits extend from two to three months the period for which the financing of inventories is required, thus increasing the financial resources required by 10 million. If importers then decide that they need inventories equivalent to four months’ instead of two months’ imports, 20 million of additional financial resources will be required. To build up the additional inventories, importers have either to increase their orders abroad or to reduce their sales at home. If the first procedure is followed, additional resources will be needed to finance advance deposits on the additional imports, until the new desired level of inventories is reached. If orders are then reduced to normal, the resources tied up in advance deposits for the extra imports will be released. The magnitude of the resources needed and the time during which they will be tied up will depend on the rate of inventory expansion. Changes in inventory requirements that are made effective by a reduction of sales at home will not affect resources tied up for advance deposits.
Inventories are a variable magnitude, and even if, for the sake of simplicity, we speak of “normal” inventories, the stocks actually in existence will seldom be “normal.” Any change in expectations about either domestic or foreign markets or in trade and exchange regulations will alter the “normal” standard. Any disappointment of expectations will cause undesired changes in inventories which will bring them to a level that is not “normal.” These changes may themselves be the result of changes in the orders placed by importers; in that event, the requirement of advance deposits will make the accumulation of new inventories more difficult because of the extra financing needed for the deposits. The existence of advance deposits will, however, facilitate the drawing down of inventories, for the financial resources then released will be greater than when no advance deposits are required.
Advance Deposits, Devaluation, and Multiple Exchange Rates
If the essential purpose of advance deposits is to increase the cost of imports, the question naturally arises whether there is any difference, from this point of view, between advance deposits, devaluation of the import exchange rate, and multiple exchange rates. An exhaustive examination of this question would extend this paper beyond reasonable limits. However, some general comments may be made here, which, it should be understood, have no policy implications.
A devaluation of the import exchange rate affects all international payments; advance deposits affect only payments for imports. But this difference is of little importance where payments for imports are by far the largest part of foreign payments. Changes in advance deposit requirements are usually easier to introduce or to alter than changes in the exchange rate or exchange rates. Devaluation, moreover, may appear to cast doubts on the soundness of the currency or of the exchange system; such doubts are less likely to arise when advance deposit requirements are imposed.
Devaluation of the import exchange rate by itself establishes an exchange margin or spread and creates profits for the government or the agency charged with the operation of the exchange system. Advance deposits imply the financing of new investments which in a “real” sense are unnecessary, and the extra cost of this financing accrues for the benefit of savers and financial middlemen.
Devaluation of the import rate has a contractionary effect on the general level of expenditure only if the proceeds arising from the creation of an exchange margin are sterilized. Likewise, a contractionary effect for advance deposits is assured only if the central bank sterilizes the funds and maintains a tight credit situation.
For many purposes, it is convenient to regard multiple currency practices as equivalent to a series of taxes and subsidies on international transactions. Although the establishment of advance deposits at different percentages for transactions of different types has effects which, in some respects, are similar to those of multiple currency practices, they are not comparable to taxes and subsidies.
Advance deposits cannot be used, as multiple currency practices may be, to encourage exports; to that extent they cannot be criticized in other countries, as multiple currency practices sometimes have been, as conferring upon exporters an unfair advantage. For the same reason, advance deposits offer no solution for the balance of payments problems that arise when buying rates are inadequate because of discrepancies between foreign and domestic prices; therefore, in this respect they cannot be compared with a general devaluation.
Balance of Payments Effects
A distinction should be made between the direct balance of payments effects of advance deposits, in the sense that they curtail import demand—and consequently tend to create or increase a surplus, or to reduce a deficit in the balance of payments—and their indirect balance of payments effects, which are related to the decline in money income produced by advance deposits through a reduction in the money supply and consequently in aggregate expenditures. An additional balance of payments effect may result from the impact of advance deposits upon interest rates and upon the flow of short-term capital which they may originate.
The direct effects on the balance of payments arise from the difficulty of importers in obtaining finance to provide the deposits and from the interest cost of maintaining the deposits. The difficulties of obtaining finance may be due to the reluctance of banks to shift credit from other customers to importers, and to the fact that importers cannot offer adequate collateral for additional loans. An obstacle to shifting credit to importers may exist if, because of legal restrictions or custom, the banks are unable or unwilling to charge the importers higher interest rates. The quantitative limitations on credit are most important in a period immediately following the imposition or increase of advance deposit requirements, or at a time when import demand is increasing. In the limiting case in which importers could not obtain additional credit, they would have to postpone import orders until they had built up their savings. The interest cost exists at all times, but it seems unlikely that in most cases it would be a powerful deterrent to imports. If the supply of bank credit is assumed to be perfectly elastic, the only deterrent to importers will be the interest charge on their additional borrowings from the banks. However, this will not generally be the case. The diagram of ordinary supply and demand curves, shown as Chart 1, illustrates the different situations that may arise. The amount of loanable funds of the banking system is measured along the horizontal axis and the price of borrowing, i.e., interest charges, on the vertical axis. The curves are assumed to be of a normal type, with more funds available for lending at higher rates and with a greater demand for loans at lower rates. When advance deposits are introduced or when the percentage of import value to be covered by advance deposits is changed, a shift in the demand curves from the position DD to D’D’ or to D”D” indicates the needs of importers for more credit.
Effects of Advance Deposits on Supply of and Demand for Bank Loans1
Citation: IMF Staff Papers 1958, 001; 10.5089/9781451949636.024.A003
1 For description of diagram, see text.Let us assume a supply of credit that is neither completely elastic nor completely inelastic, as illustrated by the curve SS. An increase in demand for credit will expand the amount of loans from Oa to Ob and raise the interest rate from Ot0 to Ot1. If the demand for credit rises to Oc as a consequence of advance deposit requirements, it will not be satisfied at the previous rate of interest. Part of the new demand will remain unsatisfied and part of it will be satisfied at a higher cost. The importance of each of those effects will depend on the elasticities of the demand for and the supply of bank credit.
If the banks are already fully loaned, the shift in demand will produce only an increase in interest charges, and the amount of lending will remain the same. The form in which available funds will be distributed between old and new uses (constituted by advance deposit requirements) will depend on the willingness of borrowers to accept the new interest burdens.
There may be cases where banks are fully loaned but interest charges do not, or cannot, change. There will then be an unsatisfied demand, equivalent to bd, which the banks will have to eliminate by rationing their funds. In rationing, the banks may be either more or less willing to deny financing to importers. Justification will be offered later for the view that banks in some cases may be less willing to finance advance deposits than to finance other kinds of transaction.
In summary, advance deposits introduce an additional cost for importers; the balance of payments effect will thus be the same as the effect of a devaluation of comparable magnitude on the import side of the exchange rate structure. The cost element is determined not only by the additional interest charges but also by the difficulties of finding any financing at all for at least part of the new funds required.
The problem may be examined in another way: Assume that at the time advance deposits are introduced the economy is in monetary equilibrium, in the sense that planned savings are equal to prospective investments and that any discrepancy between ex ante savings and investments is corrected through monetary and/or fiscal action. The introduction of advance deposits without any change in import demand or in the level of import inventories is then equivalent to a forced “investment,” which requires from the economy an equivalent amount of savings.
From the assumption that monetary stability will be preserved, implying that total expenditures will not exceed the supply of goods and services at current prices, it follows that room has to be made for the new “investments” by curtailing other expenditures. This requires an actual sacrifice, the magnitude of which is determined by the factors already discussed.
The same objective could be achieved through other measures. The advantage of advance deposits over most other kinds of fiscal or monetary action is that they not only affect the general level of expenditures but at the same time are more effective in specifically curtailing import demand.
Means of Financing Advance Deposits and Currency Required
From the standpoint of the economy as a whole, it is immaterial whether advance deposits are financed privately or by banks, as long as bank financing is not inflationary, i.e., the money-creating process is offset by savings. If importers do not get all the financing they expect, the establishment of advance deposits may mean that the difficulties of placing new import orders will increase and there may be a reduction in their scale of operations. If advance deposits are financed by a net expansion of bank credit made possible by the existence of excess reserves of the commercial banks, the imposition of the deposits will reduce the free reserves of the banking system and make the banks more amenable to control by the authorities. When the advance deposits are financed wholly out of excess reserves of the commercial banks, the expansion of bank loans will still not give rise to an increase in the money supply and a higher level of money income, since the credit expansion will be neutralized by the transfer of deposits to the central bank. As long as the advance deposits are not financed by a net increase in bank loans, their monetary effect is the same, regardless of whether they are provided by importers out of their own funds or by a shift of bank credit from other customers.
The possibility of obtaining foreign funds to finance advance deposits, although it may not be very great,2 should also receive consideration. If a capital inflow for this purpose does not affect the supply of long-term and short-term foreign capital for other purposes, the restrictive effects of advance deposits will be limited to the interest charges on the new financing. An inflow of short-term capital will relieve momentarily any pressure upon international reserves. If advance deposits are established in foreign currency or if the advance deposits in domestic currency are sterilized, the effect of the balance of payments surplus on the level of money income will be nil.
Importers will not seek external financing unless the internal cost of financing plus any other difficulties associated with it are greater than the external cost would be.
If advance deposits attract foreign funds which otherwise would have been forthcoming for other purposes, the effect of advance deposits upon reserves will be the same; but if it can be assumed that the advance deposit proceeds are not spent by the authorities, they will have a contractionary impact on money income.
If advance deposits are required in foreign currency and are also financed abroad, their effects will be the same as those outlined above for advance deposits expressed in domestic currency and financed abroad. In the case outlined above, however, the additional foreign reserves may accrue to any sector in the economy if transactions in foreign exchange are free, or to the authorized dealers if transactions are restricted, while if they are required in foreign currency, the foreign reserves corresponding to advance deposits borrowed abroad will accrue to the entity or entities entitled to receive advance deposits.
If advance deposits are required in foreign currency but there is no foreign financing, their effect will depend on the structure of the foreign exchange market. If exchange dealings can be carried out only through the authorities entitled to receive advance deposits, the situation will be the same as with advance deposits required in domestic currency. There will be no change in the holdings of foreign reserves, and the problem for the importers will be that of finding domestic financing. If, however, the authorities who receive advance deposits are not also dealers in foreign exchange, there will be a change in the holdings of foreign reserves, probably in the direction of ensuring that more foreign reserves accrue to the central authorities (central bank, etc.) and less to private banks, dealers, or individuals.
Advance Deposits as a Tool of Monetary Policy
Advance deposits may be conceived as an instrument of monetary policy similar to open market operations or transfers of fiscal or public funds between the commercial banks and the central bank. If the regulations establishing advance deposits require that they be held by private banks, so that lending capacity is unaltered, no use can be made of advance deposits as a monetary instrument, though all that has been said above about advance deposits in general remains valid. But if advance deposits have to be held in the central bank, there will be a net loss of reserves for the banking system and a decrease in its lending possibilities in just the same way as when the central bank sells securities in the open market or when deposits of the public sector are shifted from a commercial bank to the central bank.
The effectiveness of advance deposits as an instrument of credit regulation will depend on the amount of reserves which the banks lose as a result of the payment of advance deposits and the amount of excess reserves that they had before the deposit requirement was imposed. These are also the factors which determine the effectiveness of open market operations or of shifting fiscal deposits; and the limitations that apply to these monetary tools apply also to advance deposits held in the central bank. The reduction in the quantity of money attributable to advance deposits will tend to raise interest rates and to reduce the amount of investments and probably of consumption expenditures.
The effect of advance deposits on the balance of payments will then be threefold: import demand will be more difficult to satisfy because of increasing costs and financing difficulties; to the extent that advance deposits are actually made and funds shifted from the commercial banks to the central bank, there will be a reduction in money income, and consequently in import demand; and to the extent that interest rates are stiffened, more financing will take place abroad, and there will be an inflow of short-term capital with a favorable temporary effect upon the balance of payments and the level of foreign reserves.
When advance deposits affect the lending policies of the private banks, they may become an effective instrument for checking import demand. Bank loans to ordinary customers diminish reserves only by a fraction of the loans, i.e., by the amounts required to back the newly created deposits plus the part of the loans which the public draws from the banks and prefers to hold in the form of cash. But when the banks lend to importers to finance their advance deposits in the central bank, their reserves will diminish not by a fraction but by the full amount of the loans.
The difference between the effects upon bank reserves of loans for advance deposits and loans for other purposes may be indicated as follows:
Let
a=the legal or customary reserves expressed as a fraction of total deposits,
b=the fraction of new money which the public customarily holds in the form of cash,
A=the excess reserves of the banking system,
B=the amount of new lending by the banking system, and
C=the diminution of excess reserves.
If bank loans are increased by B, then
bB represents the amount of additional cash drawn by the public from the banks, and
(1–b) B represents the amount of new deposits created by the lending activities of the banks.
To back this increase in deposits, either law or custom will require additional reserves, equal to a (1–b)B. Excess reserves will be reduced by the public’s additional drawings of cash and by the additional reserves required by law or custom. Thus,
If new bank loans finance advance deposits, all of the new money created by the lending activities of the banks will go to the central bank and the net decline in excess reserves will be equal to B. Both a and b are positive fractions, neither of which can be greater than 1. If a = 1, it means that the banking system is required to hold 100 per cent reserves against deposits. If b = 1, it means that the new loans made are drawn entirely by the public in the form of banknotes. In either of these cases, the reserves of the banking system will diminish by the same amount, equivalent to the volume of new loans. Generally, neither a nor b is equal to 1. If a and b are between 0 and 1, excess reserves will decline by the amount expressed in the formula, which in general will be less than the amount of new loans.
In a realistic situation, we may assume that b = 0.5 and a = 0.12, i.e., half of the newly created money is held in the form of cash, and legal reserves are 12 per cent of deposits. New bank lending will then cause a decline in reserves of 56 per cent of the new loans. If legal reserves are 20 per cent of deposits, the loss will be 60 per cent of the new loans. Both cases can be compared with loans to importers for advance deposits, which will imply a decline in reserves equal to the total amount of the new loans.
If one or two banks have a large share of all the banking business of the community, the banking system may be expected to be more reluctant to finance advance deposits than to finance other kinds of enterprise. The banks will then be better aware that ordinary lending operations generally affect only part of their reserves, and will quickly realize that advance deposit financing takes from their reserves the whole of the financing permitted by them for that purpose. In those circumstances, banks may either reduce the amount of lending for advance deposits or increase the cost. In either case, importers will find it much more difficult to maintain the level of import orders that would be possible if the banks made no discrimination between different kinds of loan.
It may also be that the main disadvantage of financing advance deposits on imports—namely, greater losses of reserves—is entirely offset by the fact that a loan to an importer brings in a commission from the sale of exchange. This offsetting effect will be greater when there is a large number of banks, and individual banks do not understand the effects of such loans on their own reserves.
The existence of advance deposits strengthens the built-in stabilizers in the monetary system. An increase in money income will increase the demand for imports, and the contractionary effect of the outflow of exchange reserves will be intensified by the advance deposit requirement. On the other hand, a decrease in import demand will release advance deposits and will have an expansionary effect.
Selective Credit Control and Advance Deposits
In most underdeveloped countries, emphasis has been placed in recent years on the search for instruments of selective monetary control which may help in implementing government policies of economic development. So far, the results have not been very encouraging. Whatever its purpose may be, monetary policy undoubtedly tends to create a framework within which economic activity can take place, but its use to stimulate certain types of activity has rather limited possibilities.3
The mere establishment of advance deposits will reduce the financing of import trade generally and will therefore discriminate in favor of other types of economic activity. But if different percentages of advance deposits were established for different types of import, control might be applied more selectively. First, broad categories of imports could be established, such as cost of living items, essential raw materials and fuel for national industry, machinery and equipment for the development of new economic activities, less essential consumer goods, luxuries, etc. Then by the establishment of different percentages for different categories, the composition of imports could tend to be reshaped in accordance with the broad requirements of an economic development program.
One of the main problems of selective credit control is to ensure that the regulations are properly observed by the banks. This difficulty partly disappears when selective credit control is applied by using advance deposits as an instrument of monetary control. No elaborate machinery is required to check bank lending. Customs clearance requires that advance deposits be made in due time, and penalties can be imposed administratively on either importers or banks.
An Actual Experience—Ecuador
An examination of actual experience in Ecuador provides some empirical foundations for the analysis presented in this paper. However, the facts are not conclusive, because, on the one hand, there is lack of information on certain points and, on the other hand, the interpretation of the data is somewhat blurred because there were other relevant factors whose significance cannot be exactly measured.
In 1948, the Monetary Board of Ecuador was given the power to request advance deposits on imports. Very little use was made of this power except that a previous deposit of taxes for import licenses for certain commodities was required. In February 1951, this requirement was abolished at the request of the Chamber of Commerce of Quito and Guayaquil, which had maintained that postponing the payment of the tax would contribute to offsetting the restrictive tendencies in the means of payment.4 The figures available suggest that the relief afforded by this decision led to increased import demand, despite the fact that at the same time there was an economic contraction, as measured by changes in the money supply (Table 1 and Chart 2).
Import Permits Outstanding and Means of Payment in Ecuador, January-June 19511
Data as of end of month.
Import Permits Outstanding and Means of Payment in Ecuador, January-June 19511
| Import Permits | Money Supply | |
|---|---|---|
| (million U.S. dollars) | (thousand sucres) | |
| January | 23.7 | 892.9 |
| February | 25.1 | 882.9 |
| March | 26.6 | 864.8 |
| April | 27.7 | 869.0 |
| May | 25.9 | 855.2 |
| June | 29.7 | 848.1 |
Data as of end of month.
Import Permits Outstanding and Means of Payment in Ecuador, January-June 19511
| Import Permits | Money Supply | |
|---|---|---|
| (million U.S. dollars) | (thousand sucres) | |
| January | 23.7 | 892.9 |
| February | 25.1 | 882.9 |
| March | 26.6 | 864.8 |
| April | 27.7 | 869.0 |
| May | 25.9 | 855.2 |
| June | 29.7 | 848.1 |
Data as of end of month.
Indices of Import Permits Outstanding and Total Means of Payment in Ecuador, at End of Month, January-June, 19511
(January 1951 = 100)
Citation: IMF Staff Papers 1958, 001; 10.5089/9781451949636.024.A003
1 Based on data in Table 1.Subsequently, at the beginning of 1953, after considering a request from the Association of Textile Industrialists of Ecuador, the Monetary Board, using the powers granted under Articles 9 and 16 of the International Exchange Law, decided, as a measure of protection to the national textile industry, (1) to require that, prior to the granting of an import license, a deposit of 50 per cent of the value of the commodities included in certain paragraphs of the tariff law should be made, and (2) that all of the exchange tax of 33 per cent on the c.i.f. value of the same commodities should be paid before the import license was granted. In order to avoid an increase in import demand, the requirement of prior payment of all import taxes was extended in July to all commodities.
In 1954 and 1955, Ecuador made extensive use of changes in the percentages of advance deposits and prepayments of taxes in order to influence the balance of payments and the domestic credit situation. In April 1954, an arrangement was made for the gradual elimination of advance payments of customs duties. The subsequent increase in import demand led to the reimposition, in November 1954, of various advance deposits and prepayments of imports and customs duties: For List 1 imports (essential and semiessential goods), an advance cash deposit with the Central Bank of 50 per cent of the c.i.f. value of imports paid before delivery and of 15 per cent of the c.i.f. value of imports paid against sight or time drafts was required. To obtain an import permit for List 2 imports (nonessential and luxury goods), an advance deposit with the Central Bank of 40 per cent of the value of the customs duties to which the imports were liable was required, in addition to the advance deposit in foreign exchange of 100 per cent of the value of the imports; the advance deposit served as partial payment of customs duties.
The advance deposits imposed at the end of 1954, in combination with other factors, reduced the total of import permits from US$17.3 million in October 1954 to an average of US$6.4 million in January–February 1955. It is difficult to distinguish between the effects of advance deposits and the effects of the credit restrictions associated with a seasonal decline in exports. But the role of advance deposits was probably of considerable importance.
In February 1955 the 15 per cent advance deposit for certain List 1 imports was removed. However, in July of that year an advance deposit of 30 per cent was established for all List 1 imports, to cope with the serious payments problem confronting Ecuador at that time. The measure was relaxed somewhat at the end of September 1955, when a deposit of 15 per cent was required for some List 1 items and of 20 per cent for the others.
As a result of the elimination in February 1955 of the 15 per cent advance deposit, credit was relaxed. This reversed the import trend, as is shown by Table 2 and Chart 3. The table and chart also show the downturn of import permits in the third quarter of 1955. What part of this downturn can be attributed to advance deposits and what part to the other measures adopted by the authorities? In addition to establishing advance deposits, the authorities tried to redress the balance of payments by shifting certain import commodities from List 1 to List 2, and by extending the list of prohibited imports in September 1955. The second measure came into effect at a time when the demand for imports had been considerably reduced (Chart 3). In July and August 1955, import permits were below the average for January and February of that year. The prohibited list excluded imports which in 1954 had been worth US$1.3 million, and therefore relieved the pressure of imports at a monthly rate of less than US$110,000 per month. This figure does not appear to be significant in relation to fluctuations in import applications of the order of over US$8 million per month.
Import Permits in Ecuador, 1954–551
(In millions of U.S. dollars)
Based on data from Banco Central del Ecuador, Información Estadística (Quito).
Import Permits in Ecuador, 1954–551
(In millions of U.S. dollars)
| Change, | |||
|---|---|---|---|
| 1954 | 1955 | 1954–55 | |
| 1st quarter | 22.0 | 24.3 | +2.3 |
| 2nd quarter | 30.8 | 33.7 | +2.9 |
| 3rd quarter | 36.4 | 19.8 | −16.6 |
| October | 17.3 | 5.7 | −11.6 |
Based on data from Banco Central del Ecuador, Información Estadística (Quito).
Import Permits in Ecuador, 1954–551
(In millions of U.S. dollars)
| Change, | |||
|---|---|---|---|
| 1954 | 1955 | 1954–55 | |
| 1st quarter | 22.0 | 24.3 | +2.3 |
| 2nd quarter | 30.8 | 33.7 | +2.9 |
| 3rd quarter | 36.4 | 19.8 | −16.6 |
| October | 17.3 | 5.7 | −11.6 |
Based on data from Banco Central del Ecuador, Información Estadística (Quito).
Total New Credit Granted by Banking System and Value of Import Permits Granted in Ecuador, Monthly, August 1954-August 19551
Citation: IMF Staff Papers 1958, 001; 10.5089/9781451949636.024.A003
1 Data from Banco Central del Ecuador, Information Estadistica (Quito).By shifting imports from List 1 to List 2, the authorities undertook an effective depreciation of the exchange rate. During 1954, the value of imports of commodities that were thus shifted amounted to US$10.8 million. The shift changed the composition of imports roughly as follows: Before the shift, 88 per cent of imports came in at a rate of S/15 per U.S. dollar and 12 per cent at S/17.30 per U.S. dollar, making an effective average import rate of S/15.28 per dollar. After the shift, 76 per cent of imports came in at S/15 per U.S. dollar and 24 per cent at S/17.30 per U.S. dollar, making an effective average import rate of S/15.55 per dollar.
The sucre was thus effectively devalued by 1¾ per cent. This was a very small devaluation, if it was to be regarded as a measure for checking increased import demand that resulted from anticipatory buying in the expectation of a tariff revision and of a more drastic devaluation.
The shift of commodities also had the effect of increasing the required percentage of advance deposits. Imports in List 1 were subject to 30 per cent advance deposits and those in List 2 to 100 per cent.
The effects of advance deposits on the financing of Ecuador’s imports can be estimated on the assumption that goods imported at an annual rate of US$10 million were shifted from List 1 to List 2 and that imports in List 1 continued at nearly US$70 million per year. Since a period of six weeks usually elapses between import licensing and actual normal payment for goods, advance deposits amounting to about 12 per cent of the annual rate of imports are tied up throughout the year. To finance the advance deposits required for the goods shifted from List 1 to List 2, US$1.2 million was necessary; and to finance the deposits required for the goods remaining in List 1, US$2.5 million was needed.5 In all, the introduction of advance deposits required additional financing of US$3.7 million (S/ 54 million), one third of which was attributable to the shift of goods from List 1 to List 2. This calculation is based on the assumption that there was no change in the general level of import demand. Actually, import demand declined; the fact that by the end of October 1955 advance deposits of nearly S/ 40 million had been made suggests, moreover, that there may be an error in the assumption of a six-week period between licensing and actual payment.
Advance deposits had indeed been required in Ecuador for List 2 goods before July 1955. At that time, however, the average percentage of advance deposits was raised from 12.5 per cent of total imports to about 46 per cent. The cost of financing those new advance deposit requirements, at an interest rate of 10 per cent per annum, amounted to less than 2/5 of 1 per cent of the value of the imports. On the other hand, the absorption of bank reserves by advance deposit requirements was considerable.
Ordinary loans by private banks during the first three quarters of 1954 increased by S/101 million; in the same period of 1955, they increased by only S/ 15 million. Between the end of 1954 and October 1955, excess reserves dropped from S/ 40 million to S/ 30 million, which is the customary limit at which private banks cease to lend. The absorption of S/40 million in advance deposits more than offset other factors making for an increase of bank reserves during that period.
In countries like Ecuador, a tight credit situation is the best guarantee for stability of money incomes. Since the propensity to import is very high, even a mild monetary expansion sometimes has a large balance of payments effect. An import function based on only five observations suggests a marginal propensity to import in Ecuador of about 0.4. This estimate may be too high, but the correct measurement is not likely to be lower than 0.3. Any contraction in money income in Ecuador is therefore bound to produce a considerable effect on the demand for imports and the balance of payments. The evidence suggests that the advance deposit requirements introduced in Ecuador in the middle of 1955 played a decisive role in redressing the balance of payments disequilibrium of that country.
Mr. Jorge Marshall, Chief of the Latin American (South) Division, is a graduate of the University of Chile and of Harvard University. He was Professor of Political Economy in the University of Chile. Mr. Marshall left the service of the Fund in 1953 to become Professor of Money and Banking and Public Finance Statistics at the Inter-American Training Center for Economic and Financial Statistics, Santiago, Chile, and he rejoined the Fund staff in 1955.
This paper was presented to the Fifth Meeting of Technicians of Central Banks of the American Continent, held in Bogotá in November 1957.
However, the possibilities for many importers to obtain more financing abroad should not be disregarded.
See I. G. Patel, “Selective Credit Controls in Underdeveloped Economies,” Staff Papers, Vol. IV (1954–55), pp. 73-84, which examines the subject from the point of view of short-term stability and of long-term growth.
Banco Central del Ecuador, Memoria del Gerente General, 1951 (Quito, 1952), p. 44.
Six weeks’ imports of goods in List 1 would be US$8.4 million, and on these imports a deposit of 30 per cent was required.
