International business environment lesson 06

66 International Business Environment LESSON CONVERTIBILITY, EXCHANGE RESTRICTIONS AND INTERNATIONAL MONETARY SYSTEM CONTENTS 6.0 Aims and Objectives 6.1 Introduction 6.2 Exchange Rate Systems 6.2.1 Fixed Exchange Rate System 6.2.2 Flexible Exchange Rate System 6.3 Exchange Rates and Convertibility of the Rupee 6.4 6.5 6.3.1 Convertibility of Foreign Exchange 6.3.2 The Three Tasks 6.3.3 A Dozen Combinations 6.3.4 The Darling Pair 6.3.5 Impossible Trinity 6.3.6 Badge of Dishonour 6.3.7 Necessity is Mother Convertibility in India 6.4.1 Current Account Convertibility 6.4.2 Capital Account Convertibility 6.4.3 Tarapore Committee on Capital Account Convertibility (CAC) 6.4.4 Exchange Restrictions International Monetary Fund 6.5.1 Organization and Purpose 6.5.2 History of IMF 6.5.3 IMF Today 6.5.4 Data Dissemination Systems 6.5.5 Membership Qualifications 6.5.6 Members' Quotas and Voting Power, and Board of Governors 6.5.7 Assistance and Reforms 6.5.8 IMF/World Bank Support of Military Dictatorships 6.6 Let us Sum up 6.7 Lesson End Activity 6.8 Keywords 6.9 Questions for Discussion 6.10 Suggested Readings 6.0 AIMS AND OBJECTIVES After studying this lesson, you should be able to: • Understand the process of convertibility • Study the functions of International monetary fund • Know the exchange restrictions 6.1 INTRODUCTION Exchange control is one of the important means of achieving certain national objectives like an improvement in the balance of payments position, restriction of inessential imports and conspicuous consumption, facilitation of import of priority item, control of outflow of capital and maintains of the external value of the currency Under the exchange control, the whole foreign exchange resources of the nation, including those currently occurring to it, are usually brought directly under the control of the exchange control authority (the Central Bank, treasury or a specially constituted agency) Exporters have to surrender the foreign exchange earnings in exchange for home currency and the permission of the exchange control authority, on the basis of national priorities The allocation of foreign exchange is made by the exchange control authority, on the basis of national priorities Though the exchange control is administered by a central authority like the central bank, the day-today business of buying and selling foreign exchange is ordinarily handled by private exchange dealers, largely the exchange departments of commercial banks For example, in India there are authorized dealers and money changers, entitled to conduct foreign exchange business 6.2 EXCHANGE RATE SYSTEMS Broadly, there are two important exchange rate systems, namely the fixed exchange rate system and flexible exchange rate system 6.2.1 Fixed Exchange Rates System Countries following the fixed exchange rate (also known as stable exchange rate and pegged exchange rate) system agree to keep their currencies at a fixed, pegged rate and to change their value only at fairly infrequent intervals, when the economic situation forces them to so Under the gold standard, the values of currencies were fixed in terms of gold Until the breakdown of the Bretton Woods System in the early 1970, each member country of the IMF defined the value of its currency in terms of gold or the US dollar and agreed to maintain (to peg) the market value of its currency within per cent of the defined (par) values Following the breakdown of the Bretton wood system, some countries took to manage floating of their currencies while a number of countries still embraced the fixed exchanged rate system 6.2.2 Flexible Exchange Rate System The relative merits and demerits of the fixed and flexible exchange rate system have long been a topic for debate A number of arguments have been put forward for and against each system The important arguments supporting the stable exchange rate system are as follows: 67 Convertibility, Exchange Restrictions and International Monetary System 68 International Business Environment Exchange rate stability is necessary for orderly development and growth of foreign trade If exchange rate stability is not assured Exporters will be uncertain about the amount they will receive and imports will uncertain about the amount they will have to pay Such uncertainties and the associate’s risks Especially the developing countries, which have a persistent balance of payment deficits, should necessarily adopt the stable exchange rate system to prevent continuous depreciation of the external value of their currencies Exchanges rate stability is necessary to attract foreign capital investment, as foreigners will not be interested to invest in a country with an unstable currency Thus, exchange rate stability is necessary to augment resources and foster economic growth Unstable exchange rate stability is necessary to prevent its outflow A stable exchange rate system eliminates speculation in the foreign exchange market Check Your Progress 1 What are the objectives of exchange control? …………………………………………………………………………… …………………………………………………………………………… What you understand by fixed exchange rate? …………………………………………………………………………… …………………………………………………………………………… 6.3 EXCHANGE RATES AND CONVERTIBILITY OF THE RUPEE Free convertibility of a currency means that the currency can be exchanged for any other convertible currency, without any restriction, at the market determined exchange rates Convertibility of the rupee, thus means that the rupee can be freely converted into dollar, pound sterling, yen, Deutsche mark, etc and vice versa at the rates of exchange determined by the demand and supply forces After the collapse of the Bretton Woods System in 1971, the rupee was pegged to pound sterling for four years after which (since September 1975) it was linked to a basket of 14 and later currencies of India’s major trading partners This system continued through the 1980s, though the exchange rate was allowed to fluctuated in a wider margin and to depreciate modestly with a view to maintain competitiveness However, the need for adjusting exchange rate becomes precipitous in the face of the external payments crisis of 1991 As a part of the overall macroeconomic stabilization program, the exchange rate of the rupee was devalued in two stages by 18 per cent in terms of the US dollar in July 1991 As a part of the economic policy reforms, the rupee was made partially convertible since March 1992 The move towards convertibility of the rupee was in line with the worldwide trend towards currency convertibility According to the IMF, 70 countries accepted current account convertibility by 1990 while another 10 joined them in 1991 The opening up of capital account becomes very popular among the developing countries in the 1990s According to the system of partial convertibility of the rupees (Liberalized Exchange Rate Management System—LERMS) introduction in March 1992, 60 percent of all receipts under current transactions (merchandise exports and invisible receipts) could be converted at the free market exchange rate quoted by the authorized dealers The rate applicable for the remaining 40 percent was the official rate fixed by the reserve bank This 40 per cent of the total foreign exchange receipts under the current account was exclusively meant to cover government needs and to be made available to meet 40 per cent of the value of the advance licenses and special import licenses 6.3.1 Convertibility of Foreign Exchange Full convertibility is a necessity that can inject high-octane fuel into the economy It will secure the autonomy of the RBI in the management of monetary policy and interest rates The RBI and the Government have an onerous task ahead but it will vouchsafe India the trinity of equity, enterprise and economic growth, says G Ramachandran Full convertibility has become a necessity It is no longer negotiable Managing the rupee's dirty float within a system of limited convertibility and full interest rate autonomy has become a nightmare The Reserve Bank of India (RBI) has had a torrid time balancing capital inflows against the nation's policy on money supply, interest rates, inflation, price stability and growth Full convertibility and freely floating exchange rates are not joint policy issues But a combination of the two will restore India's full autonomy over money supply, interest rates and growth 6.3.2 The Three Tasks They have onerous tasks ahead First, full convertibility will require a system of monitoring and deterrence aimed at flows related to terrorism, crime and money laundering Second, the roadmap to convertibility will have to address how India will integrate itself into the global currency markets They will set the spot price of the rupee after reckoning with its supply and demand They will also set the rupee's forward price after reckoning with rupee interest rates The road map will have to address how the price of domestic credit will flow into the global currency markets Third, the road map to convertibility will have to address how India will put in place a fair and free market for domestic credit India has come a long way since July 1991 when it deregulated interest rates on corporate debentures But there is some more distance to go in the context of other borrowers 6.3.3 A Dozen Combinations Convertibility, interest rate autonomy and exchange rate systems are tightly related policy issues Convertibility or capital mobility offers two courses of action Interest rate policy offers two And exchange rate policy three There are in all a dozen theoretical combinations Many are sustainable; at least one is impossible First, India can choose to control convertibility or have no control Second, India can choose autonomous money supply and interest rates or slavishly allow these to be set by the central bank of a foreign country Third, India can choose to follow one of three types of exchange rate regimes for the rupee They are freely floating, fixed and pegged rates Fixed rates are not the same as pegged though many think they are Though floating and fixed rates appear to be dissimilar, they are members of the same family Pegged rates are the odd men out 6.3.4 The Darling Pair Floating and fixed rates are free-market mechanisms for international payments in the current and capital accounts With a floating rate, the RBI chooses monetary policy, but cedes control over the exchange rate policy The rupee is on autopilot As a desirable result, the RBI wholly determines India's monetary base and interest rates With a fixed rate, the RBI sets the exchange rate but has no monetary policy The monetary policy is on autopilot The monetary base is determined by the balance of payments When foreign exchange reserves increase, the monetary base expands 69 Convertibility, Exchange Restrictions and International Monetary System 70 International Business Environment Interest rates could fall; inflation could rise When reserves decrease, the monetary base contracts Interest rates could rise Growth could be undermined Growth is good for India That is not negotiable Price stability is good for India That too is not negotiable Therefore, it is wholly inadvisable to cede control over monetary policy and interest rates to the central bank of a foreign country So, full interest rate autonomy and freely floating exchange rates are possible, compatible and desirable Full interest rate autonomy and fixed exchange rates are impossible 6.3.5 Impossible Trinity India's economy and governance style, unlike China's, does not make pegging the rupee a viable choice (see Business Line, June 4, 2005) India has to work with fully floating exchange rates But they pose significant problems to exporters and importers Exporters may be very uncomfortable if the rupee strengthened from Rs 44 to 40 per US dollar in response to strong inflows of global capital Importers may be wrecked if the rupee weakened from Rs 44 to 48 per dollar in response to strong capital outflows This explains why nations abhor capital mobility They control convertibility in the capital account because capital mobility, freely floating exchange rates and full interest rate autonomy cannot coexist Any two — but not three — can coexist 6.3.6 Badge of Dishonour India's current account deficit is the result of growth Capital account surplus is necessary to fund this deficit It would be disastrous to staunch capital inflows It would be wholly foolish too because they bring technology and employment with them Hence, India has a seemingly respectable mixture of partial capital account convertibility, managed or dirty float of the rupee and bulging foreign exchange reserves The RBI creates foreign exchange reserves when capital inflows threaten to strengthen the rupee, say, from Rs 44 to 40 per dollar It involuntarily expands the domestic monetary base by injecting rupee funds to soak up capital inflows Exporters may reap rich rewards but bulging reserves are a badge of dishonour Bulging reserves suppress the purchasing power of ordinary Indians They make the rupee prices of imported crude oil, petrol, diesel, edible oils, metals and fertilisers costly They hurt growth (see Business Line, April 2, 2004) Hayek would have denounced this The RBI draws from the foreign exchange reserves when capital outflows threaten to weaken the rupee, say, from Rs 44 to 48 per dollar It involuntarily contracts the domestic monetary base by sucking out rupee funds and raising interest rates These hurt consumption, investments and growth Hayek would have denounced this too 6.3.7 Necessity is Mother India has been playing a dysfunctional game for long despite its earnest focus on growth This game has its worshippers who consider foreign exchange reserves a badge of honour and a source of resources (see Business Line, January 21, 2005) What these worshippers have not disclosed is that reserves are iniquitous and detrimental to future growth Full convertibility is a necessity that injects high-octane fuel into the economy It secures the autonomy of the RBI in monetary policy and interest rates but only when the rupee can float freely It pushes India into the possible trinity of equity, enterprise and economic growth 6.4 CONVERTIBILITY IN INDIA Convertibility of a currency implies that a currency can be transferred into another currency without any limitations or any control A currency is said to be fully convertible, if it can be converted into some other currency at the market price of that currency If currency has to be convertible, it shall not be subjected to these restrictions 6.4.1 Current Account Convertibility It refers to currency convertibility required in the case of transactions relating to exchange of goods and services, money transfers and all those transactions that are classified in the current account Budget for 1992-93 introduced partial convertibility of rupee Under this system, a dual exchange rate was fixed under which 40 per cent of foreign exchange earnings were to be surrendered at the official exchange rate while 60 percent were to be converted at a market determined rate Under the unified exchange rate regime adopted in the 1993-94 Budget, the 60:40 ratio was extended to 100 per cent conversion The 1993-94 Budget introduced full convertibility of on trade account Current account convertibility was finally achieved in August 1994 when the RBI further liberalized payments and accepted obligations under Article VIII of the IMF 6.4.2 Capital Account Convertibility It refers to convertibility required in the transactions of capital flows that are classified under the capital account of the balance of payments With growing strength of the balance of payments in the post-1991 reform period, in August 1994, by accepting obligations under Article VIII of the articles of agreement of the IMF, India made the Rupee convertible for current account transactions A Committee headed by Shri S.S.Tarapore in 1997 had chalked out a phased road map for making the capital account convertible The East Asian crisis intervened soon thereafter, leading to lack of popular enthusiasm for capital account convertibility With external sector remaining robust and gaining strength every year and the relative macro economic stability with high growth provides a conducive environment for relaxation in capital controls, RBI, in pursuance of the announcement by the Prime Minister, constituted a Committee (Chairman: S.S Tarapore) on March 20, 2006 for setting out a roadmap towards fuller capital account convertibility The Committee submitted its Report to the RBI on July 31,2006 Conscious of the risks in the movement towards fuller convertibility of the Rupee as emanating from cross country experiences in this regard, the Committee calibrated the liberalization roadmap to the specific contexts of preparedness – namely, a strong macroeconomic framework, sound financial systems and markets, and prudential regulatory and supervisory architecture After reviewing the existing capital controls, it detailed a broad five-year time frame for movement towards fuller convertibility in three phases: Phase I (2006-07); Phase II (2007-08 to 2008-09); and Phase III (200910 to 2010-11) It recommended the meeting of certain indicators/targets as a concomitant to the movement in: meeting FRBM targets; shifting from the present measure of fiscal deficit to a measure of the Public Sector Borrowing Requirement (PSBR); segregating Government debt management and monetary policy operations through the setting up of the Office of Public Debt independent of the RBI; imparting greater autonomy and transparency in the conduct of monetary policy; and slew of reforms in banking sector including a single banking legislation and reduction in the share 01 Government/RBI in the capital of public sector banks; keeping the current account deficit to GDP ratio under3 per cent; and evolving appropriate indicators of adequacy of reserves to cover not only import requirements, but also liquidity risks associated with present types of capital flows, short-term debt obligations and broader, measures including solvency 71 Convertibility, Exchange Restrictions and International Monetary System 72 International Business Environment Some of the significant measures, to be implemented in a sequenced manner as per the given roadmap include: raising the overall external commercial borrowing (ECB) ceiling as also the ceiling for automatic approval gradually; keeping ECBs of over 10year maturity in Phase I and over 7-year maturity in Phase II' outside the ceiling and removing end-use restriction in Phase I; monitoring import-linked short-term loans in a comprehensive manner and reviewing the per transaction limit of US$20 million; raising the limits for outflows on account of corporate investment abroad in phases from 200 per cent of net worth to 400 per cent of net worth; providing Exchange Earners Foreign Currency Account holders access to foreign currency current savings accounts with cheque facility and interest bearing term deposits; prohibiting FIIs from investing fresh money raised through Participatory Notes (PN), after providing existing PN-holders an exit route so as to phase them out completely within one year; allowing non-resident corporates (and non-residents) to invest in the Indian stock markets through SEBI-registered entities including mutual funds and portfolio management schemes who will be individually responsible for fulfilling know your customer (KYC) and Financial Action Task Force (FATF) norms; allowing institutions/corporates other than multilateral ones to raise Rupee bonds (with an option to convert into foreign exchange) subject to an overall ceiling which should be gradually raised; linking the limits for borrowing overseas to paid-up capital and free reserves, and not to unimpaired Tier I capital, as at present, raising it substantially to 50 per cent in Phase-I, 75 per cent in Phase II and 100 per cent in Phase III; abolishing the various stipulations on individual fund limits and the proportion in relation to net asset value; raising the overall ceilings from the present level of US$2 billion to US$3 billion in Phase I, to US$4 billion in Phase II and to US$5 billion in Phase III; raising the annual limit of remittance abroad by individuals from existing US$25,OOO per calendar year to US$50,OOO in Phase I, US$100,OOO in Phase II and US$200,000 in Phase III; allowing non-residents (other than NRls) access to foreign Currency Non-Resident (FCNR(B)) and Non-Resident (External) Rupee Account (NR(E)RA) schemes 6.4.3 Tarapore Committee on Capital Account Convertibility (CAC) At present, Indian rupee is partly convertible on current account In 1997, the Tarapore Committee on Capital Account Convertibility (CAC), constituted by the Reserve Bank, had indicated the preconditions for Capital Account Convertibility The three crucial preconditions were fiscal consolidation, a mandated inflation target and, strengthening of the financial system 6.4.4 Exchange Restrictions Convertibility can be related as the extent to which a country's regulations allow free flow of money into and outside the country For instance, in the case of India till 1990, one had to get permission from the Government or RBI as the case may be to procure foreign currency, say US Dollars, for any purpose Be it import of raw material, travel abroad, procuring books or paying fees for a ward who pursues higher studies abroad Similarly, any exporter who exports goods or services and brings foreign currency into the country has to surrender the foreign exchange to RBI and get it converted at a rate pre-determined by RBI After liberalization began in 1991, the government eased the movement of foreign currency on trade account, i.e exporters and importers were allowed to buy and sell foreign currency, as long as the items that they are exporting and importing were not in the banned list They need not get permission on a CASE-TO-CASE basis as was prevalent in the earlier regime This was the first concrete step the economy took towards making our currency convertible on trade account In the next two to three years, government liberalized the flow of foreign exchange to include items like amount of foreign currency that can be procured for purposes like travel abroad, studying abroad, engaging the services of foreign consultants etc This set the first step towards getting our currency convertible on the current account What it means is that people are allowed to have access to foreign currency for buying a whole range of consumable products and services These relaxations coincided with the liberalization on the industry and commerce front - which is why we have Honda City cars, Mars chocolate bars and Bacardi in India There was also simultaneous relaxation on the restriction on the funds that foreign investors can bring into India to invest in companies and the stock market in the country This step led to partial convertibility on the Capital Account "Capital Account convertibility in its entirety would mean that any individual, be it Indian or foreigner will be allowed to bring in any amount of foreign currency into the country and take any amount of foreign currency out of the country without any restriction." Indian companies were allowed to raise funds by way of equities (shares) or debts The fancy terms like Global Depository Receipts (GDRs), Euro Convertible Bonds (ECBs), Foreign currency syndicated loans became household jargons of Indian investors Listing in Nasdaq or NYSE became new found status symbols for Indian companies However, Indian companies or individuals still had to get permission on a case-to-case basis for investing abroad In 2000, the forex policy was further relaxed that allowed companies to acquire other companies abroad without having to go through the rigmarole of getting permission on a case to case basis Further, Indian debt based mutual funds were also allowed to invest in AAA rated government/corporate bonds abroad This got further relaxed with Indians being allowed to hold a portion of their foreign exchange earnings as foreign currency, subject to a limit in the recent monetary policy in October 2002 In general, restrictions on foreign currency movements are placed by developing countries which have faced foreign exchange problems in the past is to avoid sudden erosion of their foreign exchange reserves which are essential to maintain stability of trade balance and stability in their economy With India's forex reserves increasing steadily, it has slowly and steadily removed restrictions on movement of capital on many counts Forex Policy–2006-07 z Foreign exchange earners may retain up to 100 per cent of their foreign exchange earnings in their Exchange Earners’ Foreign Currency accounts z Borrowers eligible for accessing ECBs can avail of an additional US $ 250 million with average maturity of more than 10 years under the approval route Prepayment of ECB up to US $ 300 million without prior approval of the Reserve Bank z The existing limit of US $ billion on investments in Government securities by Foreign Institutional Investors (FIIS) to be enhanced in phases to US $ 3.2 billion by March 31, 2007 z The extant ceiling of overseas investment by mutual funds of US $ billion enhanced to US $ billion z Importers permitted to book forward contracts for their customs duty component of imports z FIIS allowed to rebook a part of the cancelled forward contracts 73 Convertibility, Exchange Restrictions and International Monetary System 74 International Business Environment z Forward contracts booked by exporters and importers in excess of 50 per cent of the eligible limit to be on deliverable basis and cannot be cancelled z Authorised dealer banks to be permitted to issue guarantees/letters of credit for import of services up to US $100,000 for securing a direct contractual liability arising out of a contract between a resident and a non-resident z Indian banks having presence outside India and foreign banks to migrate to the Basel II framework effective March 31, 2008 and other scheduled commercial banks to migrate in alignment but not later than March 31, 2009 z Prudential limit on credit and non-credit facilities to Indian Joint Ventures/Wholly Owned Subsidiaries abroad enhanced to 20 per cent of unimpaired capital funds 6.5 INTERNATIONAL MONETARY FUND International Monetary Fund Headquarters IMF member states in green Managing Director Washington, D.C., USA Central Bank of Dominique Strauss-Kahn Currency Special Drawing Rights ISO 4217 Code XDR Base borrowing rate 3.49% for SDRs Website www.imf.org The International Monetary Fund (IMF) is an international organization that oversees the global financial system by following the macroeconomic policies of its member countries, in particular those with an impact on exchange rates and the balance of payments It also offers financial and technical assistance to its members, making it an international lender of last resort Its headquarters are located in Washington, D.C., USA 6.5.1 Organization and Purpose Headquarters in Washington D.C The International Monetary Fund was created in 1944, with a goal to stabilize exchange rates and supervise the reconstruction of the world's international payment system Countries contributed to a pool which could be borrowed from, on a temporary basis, by countries with payment imbalances (Condon, 2007) The IMF describes itself as "an organization of 185 countries (Montenegro being the 185th, as of January 18, 2007), working to foster global monetary cooperation, secure financial stability, facilitate international trade, promote high employment and sustainable economic growth, and reduce poverty" With the exception of North Korea, Cuba, Andorra, Monaco, Liechtenstein, Tuvalu, and Nauru, all UN member states participate directly in the IMF Most are represented by other member states on a 24-member Executive Board but all member countries belong to the IMF's Board of Governors 6.5.2 History of IMF The International Monetary Fund was formally created in July 1944 during the United Nations Monetary and Financial Conference The representatives of 45 governments met in the Mount Washington Hotel in the area of Bretton Woods, New Hampshire, United States of America, with the delegates to the conference agreeing on a framework for international economic cooperation The IMF was formally organized on December 27, 1945, when the first 29 countries signed its Articles of Agreement The statutory purposes of the IMF today are the same as when they were formulated in 1944 6.5.3 IMF Today From the end of World War II until the late-1970s, the capitalist world experienced unprecedented growth in real incomes (Since then, the integration of China and Eastern and Central Europe into the capitalist system has added substantially to the growth of the system.) Within the capitalist system, the benefits of growth have not flowed equally to all (either within or among nations) but overall there has been an increase in accessable material wealth that contrasts with the conditions within capitalist countries during the interwar period In the decades since World War II, apart from rising material prosperity, the world economy and monetary system have undergone other major changes that have increased the importance and relevance of the purposes served by the IMF, but that has also required the IMF to adapt and reform Rapid advances in technology and communications have contributed to the increasing international integration of markets and to closer linkages among national economies As a result, financial crises, when they erupt, now tend to spread more rapidly among countries The IMF's influence in the global economy steadily increased as it accumulated more members The number of IMF member countries has more than quadrupled from the 44 states involved in its establishment, reflecting in particular the attainment of political independence by many developing countries and more recently the collapse of the Soviet bloc The expansion of the IMF's membership, together with the changes in the world economy, have required the IMF to adapt in a variety of ways to continue serving its purposes effectively In an apparent move to curb the sudden rise of gold prices, and to shore up the falling value of the US Dollar, The International Monetary Fund's executive board approved a broad financial overhaul plan that could lead to the eventual sale of a little over 400 tons of its substantial gold supplies IMF Managing Director Dominique Strauss-Kahn welcomed the board's decision April 7, 2008 to propose a new framework for the fund, designed to close a projected $400 million budget deficit over the next few years The budget proposal includes sharp spending cuts of $100 million until 2011 that will include up to 380 staff dismissals Check Your Progress State whether the following statements are true or false: A member's quota in the IMF determines the amount of its subscription, its voting weight Convertibility of a currency implies that a currency can be transferred into another currency without any limitations or any control Arguments in favor of the IMF say that economic stability is a precursor to democracy Capital account convertibility refers to convertibility required in the transactions of capital flows Current account convertibility does not refer to currency convertibility required in the case of transactions relating to exchange of goods and services 75 Convertibility, Exchange Restrictions and International Monetary System 76 International Business Environment 6.5.4 Data Dissemination Systems IMF Data Dissemination Systems participants: IMF member using SDDS IMF member, using GDDS IMF member, not using any of the DDSystems non-IMF entity using SDDS non-IMF entity using GDDS no interaction with the IMF In 1995, the International Monetary Fund began work on data dissemination standards with the view of guiding IMF member countries to disseminate their economic and financial data to the public The International Monetary and Financial Committee (IMFC) endorsed the guidelines for the dissemination standards and they were split into two tiers: The General Data Dissemination System (GDDS) and the Special Data Dissemination Standard (SDDS) The International Monetary Fund executive board approved the SDDS and GDDS in 1996 and 1997 respectively and subsequent amendments were published in a revised “Guide to the General Data Dissemination System” The system is aimed primarily at statisticians and aims to improve many aspects of statistical systems in a country It is also part of the World Bank Millennium Development Goals and Poverty Reduction Strategic Papers The IMF established a system and standard to guide members in the dissemination to the public of their economic and financial data Currently there are two such systems: General Data Dissemination System (GDDS) and its superset Special Data Dissemination System (SDDS), for those member countries having or seeking access to international capital markets The primary objective of the GDDS is to encourage IMF member countries to build a framework to improve data quality and increase statistical capacity building This will involve the preparation of metadata describing current statistical collection practices and setting improvement plans Upon building a framework, a country can evaluate statistical needs, set priorities in improving the timeliness, transparency, reliability and accessibility of financial and economic data Some countries initially used the GDDS, but lately upgraded to SDDS Some entities that are not themselves IMF members also contribute statistical data to the systems: z Palestinian Authority – GDDS z Hong Kong – SDDS z European Union institutions: ™ the European Central Bank for the Eurozone – SDDS ™ Eurostat for the whole EU – SDDS, thus providing data from Cyprus (not using any DDSystem on its own) and Malta (using only GDDS on its own) 6.5.5 Membership Qualifications Any country may apply for membership to the IMF The application will be considered first by the IMF's Executive Board After its consideration, the Executive Board will submit a report to the Board of Governors of the IMF with recommendations in the form of a "Membership Resolution." These recommendations cover the amount of quota in the IMF, the form of payment of the subscription, and other customary terms and conditions of membership After the Board of Governors has adopted the "Membership Resolution," the applicant state needs to take the legal steps required under its own law to enable it to sign the IMF's Articles of Agreement and to fulfil the obligations of IMF membership Similarly, any member country can withdraw from the Fund, although that is rare For example, in April 2007, the president of Ecuador Rafael Correa announced the expulsion of the World Bank representative in the country A few days later, at the end of April, Venezuelan president Hugo Chavez announced that the country would withdraw from the IMF and the World Bank Chavez dubbed both organizations as “the tools of the empire” that “serve the interests of the North” As of April 2008, both countries remain as members of both organizations Venezuela was forced to back down because a withdrawal would have triggered default clauses in the country's sovereign bonds A member's quota in the IMF determines the amount of its subscription, its voting weight, its access to IMF financing, and its allocation of Special Drawing Rights (SDRs) A member state cannot unilaterally increase its quota — increases must be approved by the Executive Board and are linked to formulas that include many variables such as the size of a country in the world economy For example, in 2001, China was prevented from increasing its quota as high as it wished, ensuring it remained at the level of the smallest G7 economy (Canada) In September 2005, the IMF's member countries agreed to the first round of ad hoc quota increases for four countries, including China On March 28, 2008, the IMF's Executive Board ended a period of extensive discussion and negotiation over a major package of reforms to enhance the institution's governance that would shift quota and voting shares from advanced to emerging markets and developing countries The Fund's Board of Governors must vote on these reforms by April 28, 2008 Examples of press coverage of the discussions regarding changes to the voting formula to increase equity: IMF Seeks Role in Shifting Global Economy 6.5.6 Members' Quotas and Voting Power, and Board of Governors Table showing the top 21 member countries in terms of voting power: Table 6.1 IMF Member Country Quota: Millions of Quota: Percentage of SDRs Alternate Governor Total Governor Votes: Votes: Percentage of Number Total Australia 3236.4 1.49 Wayne Swan Ken Henry 32614 1.47 Belgium 4605.2 2.12 Jezreel Pattaguan Jean-Pierre Arnoldi 46302 2.09 Brazil 3036.1 1.4 Guido Mantega Henrique de 30611 Campos Meirelles 1.38 Canada 6369.2 2.93 Jim Flaherty David A Dodge 63942 2.89 China 8090.1 3.72 ZHOU Xiaochuan HU Xiaolian 81151 3.66 France 10738.5 4.94 Christine Lagarde Christian Noyer 107635 4.86 Germany 13008.2 5.99 Peer Steinbrück 130332 5.88 India 4158.2 1.91 P Chidambaram Yaga V Reddy 41832 1.89 Italy 7055.5 3.25 Giulio Tremonti Mario Draghi 70805 3.2 Japan 13312.8 6.13 Koji Omi Toshihiko Fukui 133378 6.02 Korea 2927.3 1.35 Okyu Kwon Seong Tae Lee 29523 1.33 3152.8 1.45 Agustín Carstens Guillermo Ortiz 31778 1.43 Mexico Contd… 77 Convertibility, Exchange Restrictions and International Monetary System 78 International Business Environment Netherlands 5162.4 2.38 A.H.E.M Wellink Russian Federation 5945.4 2.74 Aleksei Kudrin Sergey Ignatiev Saudi Arabia 6985.5 3.21 Ibrahim A AlHamad Al-Sayari 70105 Assaf 3.17 Spain 3048.9 1.4 Pedro Solbes Miguel Fernández 30739 Ordóđez 1.39 Sweden 2395.5 1.1 Stefan Ingves Per Jansson 24205 1.09 Switzerland 3458.5 1.59 Jean-Pierre Roth Hans-Rudolf Merz 34835 1.57 United Kingdom 10738.5 4.94 Alistair Darling Mervyn King 107635 4.86 United States 37149.3 17.09 Henry Paulson Ben Bernanke 371743 16.79 Venezuela 2659.1 1.22 Gastón Parra Luzardo Rodrigo Cabeza Morales 26841 1.21 29.14 respective respective 637067 28.78 remaining 165 60081.4 countries L.B.J van Geest 51874 59704 2.34 2.7 Source: www.imf.org 6.5.7 Assistance and Reforms The primary mission of the IMF is to provide financial assistance to countries that experience serious financial and economic difficulties using funds deposited with the IMF from the institution's 185 member countries Member states with balance of payments problems, which often arise from these difficulties, may request loans to help fill gaps between what countries earn and/or are able to borrow from other official lenders and what countries must spend to operate, including to cover the cost of importing basic goods and services In return, countries are usually required to launch certain reforms, which have often been dubbed the "Washington Consensus" These reforms are generally required because countries with fixed exchange rate policies can engage in fiscal, monetary, and political practices which may lead to the crisis itself For example, nations with severe budget deficits, rampant inflation, strict price controls, or significantly over-valued or under-valued currencies run the risk of facing balance of payment crises Thus, the structural adjustment programs are at least ostensibly intended to ensure that the IMF is actually helping to prevent financial crises rather than merely funding financial recklessness 6.5.8 IMF/World Bank Support of Military Dictatorships The role of the Bretton Woods institutions has been controversial since the late Cold War period, as the IMF policy makers supported military dictatorships friendly to American and European corporations Critics also claim that the IMF is generally apathetic or hostile to their views of democracy, human rights, and labor rights The controversy has helped spark the anti-globalization movement Arguments in favor of the IMF say that economic stability is a precursor to democracy, however critics highlight various examples in which democratized countries fell after receiving IMF loans Countries that were or are under a Military dictatorship whilst being members of the IMF/World Bank (support from various sources in $ Billion): Table 6.2 Country indebted to IMF/Worl Dictator d In In debts at start of Debts at end of power power Dictatorship(1) Dictatorship(2) from to Country Debts in 1996 Dictator debts generated $ billion Dictator generated debt % of total debt Bank Argentina Bolivia Brazil Chile El Salvador Ethiopia Haiti Indonesia Kenya Liberia Malawi Nigeria Pakistan Paraguay Philippines Somalia South Africa Sudan Military dictatorship Military dictatorship Military dictatorship Augusto Pinochet Military dictatorship Mengistu Haile Mariam Jean-Claude Duvalier Suharto Moi Doe Banda Buhari/Abac Zia-ul Haq Stroessner Marcos Siad Barre 1976 1983 9.3 48.9 93.8 39.6 42.00% 1962 1980 2.7 5.2 2.7 52.00% 1964 1984 5.1 105.1 179 100 56.00% 1973 1989 5.2 18 27.4 12.8 47.00% 1979 1994 0.9 2.2 2.2 1.3 59.00% 1977 1991 0.5 4.2 10 3.7 37.00% 1971 1986 0.7 0.9 0.7 78.00% 1998 2002 1990 1994 2.7 0.6 0.1 129 6.9 1.9 129 6.9 2.1 2.3 126 4.2 1.3 1.9 98.00% 61.00% 62.00% 83.00% 1984 1998 17.8 31.4 31.4 13.6 43.00% 7.6 0.1 1.5 17 2.4 28.3 2.4 2.1 41.2 2.6 2.3 26.8 2.4 96.00% 65.00% 92.00% 18.7 23.6 18.7 79.00% 0.3 17 17 16.7 98.00% 0.2 21.4 21.4 21.2 99.00% 1967 1979 1979 1964 1977 1954 1965 1969 apartheid Nimeiry/alMahdi 1988 1989 1986 1991 1992 presen t presen 1970 t 1969 Syria Assad Thailand Military dictatorship 1950 1983 13.9 90.8 13.9 15.00% Zaire/Cong o Mobutu 1965 1997 0.3 12.8 12.8 12.5 98.00% Source: www.IMF.Org Notes: Debt at takeover by dictatorship; earliest data published by the World Bank is for 1970 Debt at end of dictatorship (or 1996, most recent date for World Bank data) 6.6 LET US SUM UP Free convertibility of a currency means that the currency can be exchanged for any other convertible currency, without any restriction, at the market determined exchange rates Convertibility of the rupee, thus means that the rupee can be freely converted into dollar, pound sterling, yen, Deutsche mark, etc and vice versa at the rates of exchange determined by the demand and supply forces The International Monetary Fund was formally created in July 1944 during the United Nations Monetary and Financial Conference The IMF established a system and standard to guide members in the dissemination to the public of their economic and financial data The primary mission of the IMF is to provide financial assistance to countries that experience serious financial and economic difficulties using funds deposited with the IMF from the institution's 185 member countries Thus, the structural adjustment programs are at least ostensibly intended to ensure that the IMF is actually helping to prevent financial crises rather than merely funding financial recklessness 79 Convertibility, Exchange Restrictions and International Monetary System 80 International Business Environment 6.7 LESSON END ACTIVITY Prepare a study note on the international monetary system 6.8 KEYWORDS Current account convertibility: It refers to currency convertibility required in the case of transactions relating to exchange of goods and services, money transfers and all those transactions that are classified in the current account Capital account convertibility: It refers to convertibility required in the transactions of capital flows that are classified under the capital account of the balance of payments 6.9 QUESTIONS FOR DISCUSSION What is exchange rate system? Explain the procedure of convertibility of foreign exchange Write about the functions of IMF Check Your Progress: Model Answers CYP 1 Exchange Control: Exchange control is one of the important means of achieving certain national objectives like an improvement in the balance of payments position, restriction of inessential imports and conspicuous consumption, facilitation of import of priority item, control of outflow of capital and maintains of the external value of the currency Fixed Exchange Rate System: Countries following the fixed exchange rate (also known as stable exchange rate and pegged exchange rate) system agree to keep their currencies at a fixed, pegged rate and to change their value only at fairly infrequent intervals, when the economic situation forces them to so CYP T, T, T, T, F 6.10 SUGGESTED READINGS Daniels, D and Radebangh H., “International Business”, Pearson Education Asia, New Delhi, 2002 Griffin and Pustay, “International Business”, Pearson Education Asia, New Delhi, 2002 Subba Rao, “International Business”, Himalaya, Mumbai, 2001 Schaffer, “International Business Law and its Environment”, Thomson, 2002 Onkwist and,Shaw, “International Marketing” Philip R Careora, “International Marketing”  ... Convertibility, Exchange Restrictions and International Monetary System 80 International Business Environment 6.7 LESSON END ACTIVITY Prepare a study note on the international monetary system 6.8 KEYWORDS... Radebangh H., ? ?International Business? ??, Pearson Education Asia, New Delhi, 2002 Griffin and Pustay, ? ?International Business? ??, Pearson Education Asia, New Delhi, 2002 Subba Rao, ? ?International Business? ??,... Himalaya, Mumbai, 2001 Schaffer, ? ?International Business Law and its Environment? ??, Thomson, 2002 Onkwist and,Shaw, ? ?International Marketing” Philip R Careora, ? ?International Marketing”