International Monetary Fund

Topics
Historical perspective on exchange rate
Gold Standard International Monetary Fund

Exchange Rate Regimes Fixed and Fluctuating

Euro and its evolution and current challenges

Exchange Rate Regimes Definition

The mechanism, procedures and institutional framework for determining exchange rates at a point in time and changes in them over time, including factors which induce the changes.

Gold Standard System

Gold Specie Standard Gold bullion Standard

Gold Exchange Standard

Mint Parity Exchange Rate Three rules under Gold Standard

Fix once & for all rate of conversion of paper money

Free flow of gold Money Supply
4

Gold Standard
Originated in the early stages of trade where countries used gold coins as medium of exchange of goods purchased.

As the volume of trade started increasing, shipping large quantities of gold became impractical. Countries adopted to exchange through paper currency

Gold Standard
Pegging currencies to gold and guaranteeing convertibility is known as the Gold Standard. By 1880, GB, Germany, Japan and US had adopted Gold Standard Value of currency was determined with respect to the gold For instance, US dollar was defined as 23.22 gms of fine pure gold Since 480 grains in an ounce, one ounce of gold cost was $20.67(480/23.22)
6

Gold Standard
The amount of currency required to buy one ounce of gold was referred to as gold par value. GB pound was defined as containing 113 grains of fine gold So exchange value of pound was 4.25 (480/113) From the gold values of pound and dollar we can compute exchange rate for converting pounds into dollars 1 pound = $4.87 (20.67/4.25)

Strength of the Gold Standard

Used as a balance of payments equilibrium US and Japan trade surplus and deficit gets corrected by inflow and outflow of gold The relationship among Gold flows, money supply and prices help automatic adjustment of deficit/surplus Gold Standard was in practice from 1870 till 1914 I World War in 1914 forced countries to print money for military expenses, and this increased price levels in US GB, France US returned to gold std in 1919, GB in 1925 and France in 1928 8

1918-1939
Inflation in UK made foreign holders of pounds losing confidence and government found difficult to satisfy demand for gold by depleting gold reserves and so suspended convertibility in 1931. US followed suit in 1933 but returned to Gold Std in 1934 by raising dollar price of gold from $20.67 per ounce to $35 per ounce. This effectively is devaluation of dollar Pound was $4.87 and became $8.24
9

1918-1939
Reducing price of US exports and increasing price of imports, US government boosted employment and output This prompted other countries to competitive devaluations and no country could win. This resulted in shattering confidence in the system and by 1939 this system was suspended by all the countries

IMF - constituted
The International Monetary Fundalso known as the IMF or the Fund was conceived at a United Nations conference convened in Bretton Woods, New Hampshire, U.S. in July 1944. The 45 governments represented at that conference sought to build a framework for economic cooperation that would avoid a repetition of the disastrous economic policies that had contributed to the Great Depression of the 1930s.
11

IMF - History and Background

Agreement for its creation came at the United Nationssponsored Monetary and Financial Conference in Bretton Woods, New Hampshire, United States, on July 22, 1944. The principle architects of the IMF at the Bretton Woods Conference were Fabian Society member John Maynard Keynes and the Assistant Secretary of the United States Treasury, Harry Dexter White. The Articles of the IMF Agreement came into force on December 27, 1945, the organization came into existence in May 1946, as part of a post-WWII reconstruction plan, and it began financial operations on March 1, 1947.
12

History and Background

It is sometimes referred to as a Bretton Woods institution", along with the Bank for International Settlements (BIS) and the World Bank, its twin organization. Together, these three institutions define the monetary policy shared by almost all countries with market economies. In order to gain access to IMF loans, BIS privilege, and strategic World Bank development loans, a country must normally agree to terms set forth by all three organizations.

13

The IMF describes itself as:

An organization of 184 countries, working to foster global monetary cooperation, secure financial stability, facilitate international trade, promote high employment and sustainable economic growth, and reduce poverty.

14

The IMF's Purposes

To promote international monetary cooperation To facilitate the expansion and balanced growth of international trade

To promote exchange stability To assist in the establishment of a multilateral system of payments in respect of current transactions
15

IMF Functions

To give confidence to members by making the general resources of the Fund temporarily available to them under adequate safeguards In accordance with the above, to shorten the duration and lessen the degree of disequilibrium in the international balances of payments of members.

The Bretton Wood System

US Govt. convert US $ freely into gold at a fixed parity of $35 per ounce
Other IMF member countries-Fix parities of currencies to US dollar with 1% variation Commitment not to use devaluation as a weapon of competitive trade policy
17

Typical IMF Structure

A typical IMF menu thus looks something like this: (1) budgetary austerity (bring fiscal deficit to certain % of GDP) (2) currency devaluation (to make exports more competitive; reduce imports) (3) trade liberalization (need to export) (4) privatization (state enterprises seen to be inefficient) (5) financial deregulation (no financial repression or directed credit; market interest rates) (6) price liberalization (7) deregulation of private business (8) openness to foreign capital (direct and portfolio)
18

The Functions of the IMF

Surveillance
Gathering data and assessing economic policies of countries

Technical Assistance
Strengthening human skills and institutional capacity of countries

Financial Assistance
Lending to countries to support reforms
19

The Functions of the IMF

Monitors economic and financial developments and policies, in member countries and at the global level, and gives policy advice to its members based on its more than fifty years of experience. Lends to member countries with balance of payments problems, not just to provide temporary financing but to support adjustment and reform policies aimed at correcting the underlying problems. Provides the governments and central banks of its member countries with technical assistance and training in its areas of expertise

The Functions of the IMF: Surveillance

Country Undertaking annual health check-ups of economies Regional Examining policies pursued under regional arrangements

Global Assessing the health of the world economy World Economic Outlook Assessing the stability of international financial markets Global Financial Stability Report

21

The Functions of the IMF: Technical Assistance

Design and implementation of fiscal and monetary policies Review of economic and financial legislation, regulations, and procedures Institution and capacity building Central banks Treasuries Tax and customs departments Statistical services Training for officials of member countries
22

Governance of the IMF

IMF is accountable to its member countries. Board of Governors: one Governor from each member country. Meets once a year. Day to day affairs are guided by the Executive Board: 24 Executive Directors. Managing Director of IMF is Chairman of the Executive Board.

23

The Functions of the IMF: Main Types of IMF Loans

Type of Loan Stand-by Arrangement (SBA)
Extended Fund Facility (EFF)

Purpose Medium-term assistance for temporary BOP difficulties

Longer-term assistance for longer-term BOP problems

Interest Rate Basic rate Plus surcharge for heavy borrowing

Basic rate Plus surcharge for heavy borrowing 0.5 % a year
24

Poverty Reduction Longer-term and Growth Facility assistance for BOP (PRGF) difficulties of a structural nature

IMF Resources

IMFs capital base consists of membership quotas, the financial contribution made by member countries. Total quotas amount to about US$300 billion.
A members quota is determined by its economic weight in the global economy. A members quota determines its voting power and size of loan it can borrow.

25

Special Drawing Rights (SDR)

SDRs per Currency unit (e.g. $ 1.00 = 0.67734 SDR) These rates are the official rates used by the Fund to conduct operations with member countries. The rates are derived from the currency's representative exchange rate, as reported by the issuing central bank, and the SDR value of the U.S. dollar rounded to six significant digits. Currency units per SDR (e.g. $ 1.47638 = 1 SDR) This rate, which are not used in Fund transactions, is the reciprocal of the SDR per currency unit rate, rounded to six significant digits.
26

Funding methods
Stand-By Arrangements Extended Fund Facility

Poverty Reduction and Growth Facility

Supplemental Reserve Facility. Emergency Assistance

27

Funding Facilities
Contingent Credit Lines The Compensatory Financing facility

Emergency assistance
The Emergency Financing Mechanism

Concessional Lending facility

28

Collapse of fixed exchange rate system

Fixed rate system worked well till 1960 The system collapsed in 1973 Dollar was reference point for all currencies and any pressure on dollar devalue could wreck havoc with the system Break up of fixed exchange could be traced with 1965-68 Vietnam war expenses and US welfare measures of Johnson resulted in budget deficit that was not financed by tax but be increase in money supply which resulted in inflation that was less than 4% in 1966 to 9% in 1968
29

Collapse of fixed exchange rate system

Increase in US inflation, worsening trade position led to speculation that dollar would be devalued In 1971 US trade figures showed it was importing more than what it is exporting This set off massive purchases of German mark by speculators that mark will be revalued against dollar.

Collapse of fixed exchange rate system

On May 4th , 1971, German central bank had to buy US$ 1 billion to hold dollar/DM exchange rate May 5th May again it had to buy another US$ 1 billion in the first hour of trading This forced the Bank to make its currency float

31

Collapse of fixed exchange rate system

Difficulty to devalue US $ Markets wanted dollar to devalue Since dollar was a reference currency under the Bretton Woods, for the dollar to devalue it requires all other currencies to simultaneously agree to revalue their currencies for which they did not agree They would lose out export competitiveness Vs US products

Finally..US Announces to float $

In August 1971, US President Nixon announced that dollar was no longer convertible into gold It also announce new 10% tax on imports till its trading partners agree to revalue With the discussions with trading partners, dollar was devalued by 8% and import tax was removed in December 1971
33

Prerequisites for success of the Fixed System

Two pre-requisites required for the system: US inflation to remain low US trade deficit under check Any strain led to speculative attack on the dollar; and collapse of the system

34

Floating Rates
January 1976, Jamaica Agreement, gold was abandoned as a reserve asset

IMF quotas were increased made available to 183 countries

Non-oil exporting, LDCs were given greater access to IMF funds

35

Flexible rates 1973

Exchange Rates Since 1973

1971 oil crisis OPEC raised oil prices four fold

US inflation 1977-78
In 1979 oil prices doubled

1980-85, unexpected rise in dollar despite deteriorating BOP

of US 1997 The Asian Crisis
37

Attributes of Ideal Exchange rate regime

Possesses three attributes, often referred to as the Impossible Trinity: Exchange rate stability Full financial integration Monetary independence The forces of economics do not allow the simultaneous achievement of all three.

The Impossibility Trinity

Fixed Exchange Rate

A nations choice as to which currency regime to follow reflects national priorities about all facets of the economy, including: inflation, unemployment, interest rate levels, trade balances, and economic growth. The choice between fixed and flexible rates may change over time as priorities change.

Fixed Vs Flexible Rates

Countries would prefer a fixed rate regime for the following reasons: stability in international prices. inherent anti-inflationary nature of fixed prices.
However, a fixed rate regime has the following problems: Need for central banks to maintain large quantities of hard currencies and gold to defend the fixed rate. Fixed rates can be maintained at rates that are inconsistent with economic fundamentals

Current Exchange Rate System

36 major currencies, such as the U.S. dollar, the Japanese yen, the Euro, and the British pound are determined largely by market forces. 50 countries, including the China, India, Russia, and Singapore, adopt some forms of Managed Floating system.

Current Exchange Rate System

41 countries do not have their own national currencies! 40 countries, including many islands in the Caribbean, many African nations, UAE and Venezuela, do have their own currencies, but they maintain a peg to another currency such as the U.S. dollar. The remaining countries have some mixture of fixed and floating exchange-rate regimes.

EMU
1979 1998: European Monetary System Objectives: To establish a zone of monetary stability in Europe. To coordinate exchange rate policies vis--vis non European currencies. To pave the way for the European Monetary Union.
EMU (1999-): A single currency for most of the European Union.

EMU
27 members of the European Union are: Austria, Belgium, Bulgaria, Czech, Cyprus, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, The Netherlands, Poland, Portugal, Romania, Slovakia, Slovenia, Spain, Sweden, and the United Kingdom.

EMU
Currently, twelve members of the EU have their currencies pegged against the Euro (Maastricht Treaty) beginning 1/1/99: Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, The Netherlands, Portugal, Spain.

EMU
Benefits for countries using the currency inside the Euro zone include: Cheaper transaction costs. Currency risks and costs related to exchange rate uncertainty are reduced. All consumers and businesses, both inside and outside of the euro zone enjoy price transparency and increased price-based competition. i.e., exchange rate stability, financial integration

EMU
Costs for countries using the currency include: Completely integrated and coordinated national monetary and fiscal policy rules: Nominal inflation should be no more than 1.5% above average for the three members of the EU with lowest inflation rates during previous year. Long-term interest rates should be no more than 2% above average for the three members of the EU with lowest interest rates.

EMU
Fiscal deficit should be no more than 3% of GDP.

Government debt should be no more than 60% of GDP.

European Central Bank (ECB) was established to promote price stability within the EU. i.e., no monetary independence!

Euro
Product of the desire to create a more integrated European economy. Eleven European countries adopted the Euro on January 1, 1999: Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, Netherlands, Portugal, and Spain. The following countries opted out initially: Denmark, Greece, Sweden, and the U.K. Euro notes and coins were introduced in 2002 Greece adopted the Euro in 2001 Slovenia adopted the Euro in 2007

Chronology of events

1944- Bretton Woods 1958 Birth of EEC

1963 US imposed Interest equalization tax

1963 voluntary credit restraints 1968 Mandatory controls on foreign investments 1970 SDRs created
51

Chronology of events
1971 US abandoned US$ gold convertibility (35 to 38) A snake (2.25%) with a tunnel (4.5%)

1973 US $ devalued from 38 to 42.22

1974 Oil price crisis

1976 Jamaica Agreement

1978 EMS replaced with joint currency
52

Chronology of events
1980 LA debt crisis 1985 Group of 5 countries Plaza Agreement 1987 Louvre Accord 1992 Tight monetary Policy in Germany UK withdrawn) 1993 Allowable deviation band around EMS 15%

53

Chronology of events
1993 EEC changed to EU 1994 Mexican Peso crisis 1997 Asian crisis 1999 Euro Jan 1 2002 Euro coins introduction 2008 US - sub prime crisis

2011-12 euro debt crisis

54

Current Scenario
Conventional Fixed peg arrangements Pegged Exchange Rates with Horizontal Bands Crawling Peg Crawling bands

Managed Floating with no pre-announced path for exchange

rate Independently Floating
55

Evolving Role of the IMF

Streamlining conditionality and building ownership Promoting transparency of IMF members policies and accountability Making the IMF more transparent Assessing the IMFs workthe Independent Evaluation Office

Listening and learning

56

Summary

Exchange rate systems IMF

Role and funding facilities

Tackling current global crisis

57