## ppea2019015 ## Source details **Canonical URL:** [ppea2019015](https://www.imf.org/-/media/files/publications/pp/2019/ppea2019015.pdf) ## Other formats - [Markdown version](/-/media/files/publications/pp/2019/ppea2019015.pdf.md) - [Structured JSON version](/-/media/files/publications/pp/2019/ppea2019015.pdf.json) --- ### Overview and purpose - Reviews the Fund’s policy on multiple currency practices (MCPs); last comprehensive review was in 1981. - Date on document: August 1, 2018. - Aim: make the policy and its application more effective by (i) not discouraging good FX market practices, (ii) better aligning with other Fund policies, and (iii) ensuring continued coverage of objectionable official actions. ### Rationale for retaining an MCP policy - MCPs can be distortionary, create unfair competitive advantage, and hamper trade. - Core principle retained: “official action” should not cause unreasonable deviations in FX spreads compared to normal commercial costs and risks. ### Key empirical incidence and duration statistics - Total MCPs reported in staff reports since 1980: 506. - Approved measures: 108 (21 percent). - Approved only for part of duration: 79 (16 percent). - Never approved: 285 (56 percent). - Rest did not require approval (e.g., under Article XIV). - At end-2017: 45 MCPs in 28 member countries (down from 102 MCPs in 55 countries in 1986). - Average MCP duration = 4.4 years. - Median MCP duration = 3 years. - Mode MCP duration = 1 year. - More than 20 percent of MCPs eliminated within a year of identification. - Distribution of MCPs by region: generally confined to lower-middle and low-income countries, particularly in Africa and Middle-eastern regions. - Share of countries with MCPs in international trade: declined from about 12 percent in 1982 to about four percent in 2016 (share in international trade and GDP reported for period 1982–2017 in background material). - Parallel market MCPs as of end-2017: 9 MCPs. ### Econometric and regression findings (selected) - Logit-model factors associated with higher probability of maintaining MCPs (Table 2 summary): - High inflation: coefficient 0.019, z-statistic 2.480 (** p < 0.05). - ∆ Real effective exchange rate: coefficient -0.012, z-statistic -1.770. - ∆ Reserves: coefficient -0.038, z-statistic -1.740. - ∆ Terms of Trade: coefficient -0.698, z-statistic -1.640. - Trade openness: coefficient -0.021, z-statistic -2.520. - GDP per capita: coefficient -0.447, z-statistic -2.020. - Observations: 3040 (columns (1) and (3)) and 2199 (columns (2) and (4)). - Number of countries: 126 (cols (1),(3)) and 117 (cols (2),(4)). - Advanced economies excluded. - Linear regressions (Table 3 summary): Countries with MCPs tend to experience lower growth and higher inflation after introduction; potentiality-based MCPs do not have a significant impact on growth and inflation. ### Main proposed reforms (summary) - Clarify concept of “official action” to focus on measures that segment FX markets; this would: - Exclude certain practices from MCP coverage (FX auctions designed in accordance with best practice, illegal parallel markets, and the use of official exchange rates based on the market exchange rate of the previous day — “1-day lagged official exchange rates”). - Retain exchange taxes under MCP policy. - Eliminate “potentiality”: an MCP would only arise if official action resulted in an actual exchange rate spread on the member’s territory that exceeded the permissible margin. - Replace the “two-percent” rule with a country-specific market-based H/L norm plus a tolerance margin applied uniformly across membership. - Proposed tolerance margin = +/- 2 percent around the midpoint of H/L (empirical support: "95 percent of the deviations are less than two percent"). - H/L = intraday HIGH (most depreciated) and LOW (most appreciated) in the wholesale market; midpoint M_H/L = HIGH+LOW 2. - Box 3 condition (as presented): Min{LOW ; M_H/L − 2%} ≤ R ≤ Max{HIGH ; M_H/L + 2%} where R is the exchange rate arising from official action. - Adjust approval policy: - Align MCP and exchange restriction approval policies. - Remove approval for non-BOP reasons (rare historically). - Approval only if MCP is maintained for BOP reasons, is temporary, and does not give unfair competitive advantage or discriminate among members. - Revisit link with capital transactions: staff’s longstanding position that MCP policy applies to capital transactions is revisited; Board guidance requested. - Consider merits of a remedial framework with escalating measures (censure/noncooperation up to sanctions), while weighing cooperation-based alternatives (surveillance, TA, conditionality). ### Treatment of specific practices under proposed reforms - FX auctions: - An FX auction (including multi-price) would not give rise to an MCP if it does not segment the market (i.e., open access to all intermediaries; bid exchange rate is sole allotment criterion; no constraints on range/level of bids). - Auctions failing screening (access or allotment criteria) would be assessed: R = weighted average of successful bids; test against H/L and +/-2% margin. - Preliminary screening of 33 auctions with available regulations: 14 met criteria, 19 did not; among the 19, 17 failed allotment criterion, 2 failed access criterion. - Applying the proposal reduces auction-based MCP findings from current counts to 2 (from 8 based on potentiality in tests). - Parallel (illegal) markets: - Exclude parallel markets that are legally prohibited from MCP analysis; treat such cases under exchange restrictions policy focusing on formal-market restrictions that create parallel market pressure. - Lagged official exchange rates: - Elimination of potentiality reduces MCPs from lagged rates. - Proposed carve-out: official rates based on market rates with a maximum one-day lag, computed as a weighted average of transactions between intermediaries (or intermediaries and clients), would not give rise to an MCP. - Exchange taxes: - Proposed approach: deem tax levied on the midpoint of H/L and compare with +/-2% margin; in practice this implies exchange taxes up to two percent would not be considered MCPs under the proposed methodology. - Note consistency issue: current practice has occasioned findings of exchange restrictions for negligible exchange taxes under exchange-restrictions policy; staff suggests harmonizing treatment so a tax that does not give rise to an MCP would also not be treated as an exchange restriction under revised policy. - Measures increasing cost of FX transactions (import deposits, margin requirements, guarantee schemes): - Effective exchange rate R includes interest forgone and is tested against H/L and +/-2% margin. - Formula for margin-deposit effective cost (Appendix III): R = DC * (i_k − i_g) * G * T (definitions preserved from source). - Numerical examples show some margin requirements would generate MCPs under the proposed test while others would not depending on parameters. ### Market-data methodology and operational design - Market-data sources proposed: - Primary: Thomson Reuters DataStream (World Markets/Reuters — WMR). - Secondary: Bloomberg (BFIX/BGN). - For 14 members not covered by DataStream, Bloomberg to be used; five exceptions without standard benchmarks: Iran, South Sudan, Sudan, Syria, and Tajikistan (information for all except Syria could be obtained from other sources). - H/L benchmark rationale: - H/L captures intraday extremes and is less likely to generate false findings due to timing differences than bid/ask or close rates. - Preferred over bid/ask because published bid/ask are averages and do not define intraday maximum deviations; official rates are 3.5 times more likely to deviate from bid/ask than from H/L in staff analysis. - Non-spot transactions: - Apply analogous H/L and +/-2% tolerance to wholesale non-spot markets (forwards, swaps, options). - If forward H/L unavailable, use theoretical forward (spot plus interest differential) with same tolerance test. - Option pricing: - Where option market benchmarks are unavailable, use theoretical option pricing calculators (Reuters FXOC default; Bloomberg OVML as backup) with locally adjusted parameters where appropriate. - Data access and implementation resources: - Fund subscription to Thomson Reuters DataStream and Bloomberg provides intraday H/L, bid/ask, mid-rates. - Current subscription through IMF Library (CFS) covers sufficient licenses; approved budget proposal to add licenses to expand access. - Staff would monitor deviations continuously once official action is identified. ### Empirical application of proposed methodology (preliminary results) - Staff applied methodology to available data (April–October 2017 window) and preliminary jurisdictional tests: - Of 12 countries with MCPs from official exchange rates, 13 instances of official rates deviating from H/L were identified; 4 deviated from midpoint by more than +/-2% and would remain MCPs under new methodology (a decrease by two thirds). - For members using lagged official rates: 12 members had official rates outside H/L; of these, 6 deviated from midpoint by more than +/-2%. - Dual/multiple markets: of 32 identified members with dual/multiple markets, methodology applied to 10 with legal or undetermined legal status; 8 current MCPs arise from dual/multiple markets, 5 of which arise from illegal markets and would be excluded under proposed revision; systematic review revealed secondary market rates in five countries outside H/L and permissible margins. - Auctions: of 33 members with auction regulations reviewed, 19 appear to result in segmentation; applying H/L + +/-2% reduces auction-based MCP findings to 2 (from 8 based on potentiality). - Measures increasing FX costs: cases decline to 3 from 7 when applying the methodology; two members with taxes >2 percent are captured by new methodology; deposit requirements produced mixed outcomes depending on parameters. - Aggregate: H/L norm and revised official-action definition would reduce number of findings to 33; with the +/-2 percent tolerance margin number of MCPs would decrease to 14. ### Legal, institutional, and approval framework points - Current Decision No. 6790-(81/43) (March 20, 1981) remains the legal basis; its “two percent” rule and “potentiality” application have driven historical practice. - Approval practice: - Approval generally granted for one year to allow regular Executive Board review in Article IV context; 1998 amendment allows longer approval where practice maintained only for existing arrangements and for a specified period. - Approval is granted sparingly; historically BOP reasons accounted for less than 10 percent of approvals but became more common recently for potentiality-based MCPs. - Article XIV transitional arrangements allow pre-membership MCPs to be maintained subject to expected elimination; as of the paper many Article XIV members no longer maintain MCPs; South Sudan noted as maintaining an MCP under Article XIV at the time. - Interaction with Article VIII, Section 2(a) (exchange restrictions): MCPs can overlap with exchange restrictions; exchange restrictions primarily target outward payments for current transactions and have no de minimis rule, creating harmonization issues for taxes and other measures. - Capital-account MCPs: longstanding staff position that Article VIII, Section 3 applies to capital transactions is revisited; historical lack of Board endorsement leaves ambiguity; Institutional View (IV) does not alter legal obligations under the Articles. ### Remedial framework and alternatives - Proposal considered: escalating remedial measures for unapproved MCPs (declaration of censure/noncooperation, culminating in sanctions). - Arguments for remedial framework: consistency with focusing on objectionable practices under revised policy. - Arguments against: preference for cooperative approach via surveillance, technical assistance, and conditionality; operational constraints and legal considerations noted. - Design of remedial framework is outside scope of paper. ### Implementation, guidance, and transitional arrangements - Next steps: informal staff briefing, formal Board meeting, then formal proposal with draft decisions. - Management would issue a published guidance note detailing implementation, including data provision modalities under Article VIII, Section 5 and procedures for finding, eliminating, and approving MCPs. - Transitional arrangements would be provided to avoid disruption and to protect countries adversely affected by new framework. - Staff will review the revised MCP policy within 5 years of implementation. ### Operational and practical challenges highlighted - Potential manipulation of H/L via wash trades is a concern; benchmark providers’ robustness checks mitigate this risk. - Use of third-party data raises reliability, integrity, continuity, budget, and staff-access issues (addressed by existing subscriptions and planned license expansions). - Detecting formal-market exchange restrictions can be difficult where access is determined by moral suasion rather than explicit regulation; staff rely on market interviews and evidence like payment arrears. *REVIEW OF POLICY ON MULTIPLE CURRENCY PRACTICES: INITIAL CONSIDERATIONS — INTERNATIONAL MONETARY FUND* ### EXECUTIVE SUMMARY ### EXECUTIVE SUMMARY ### Overview - This paper reviews the Fund’s policy on multiple currency practices (MCPs). - The policy is a cornerstone of the Fund’s legal and policy framework for exchange rates and has not been comprehensively reviewed since 1981. - Significant changes in foreign exchange (FX) markets—including greater experience with flexible exchange rates, substantial deepening and standardization, and the development of hedging products—provide an opportunity for a sweeping review. - The review also aims to address operational issues that have arisen in the implementation of the policy. - Date on document: August 1, 2018. ### Rationale for retaining an MCP policy - There remain strong economic and legal reasons to retain a policy on MCPs. - While MCPs have been approved by the Fund in particular circumstances, broader use remains objectionable because MCPs can be distortionary, create unfair competitive advantage among countries, and hamper trade. - The core principle of the current policy remains appropriate: “official action” should not cause unreasonable deviations in FX spreads compared to normal commercial costs and risks. ### Over-arching aim and objectives of the review - Over-arching aim: make the policy and its application more effective. - Objectives: adjust the policy so that it does not discourage good practices established in FX markets, better align it with the Fund’s other policies, and ensure it continues to address policy actions that are objectionable. - Any changes would be designed to make the MCP policy more relevant and understandable. ### Initial considerations and proposed reforms (summarized) - Clarify the concept of “official action” to focus on measures that segment FX markets. This clarification would: - Exclude from the coverage of the MCP policy certain practices, such as FX auctions designed in accordance with best practice, illegal parallel markets, and the use of official exchange rates based on the market exchange rate of the previous day (1-day lagged official exchange rates). - Retain exchange taxes under the purview of the MCP policy. - Eliminate “potentiality.” An MCP would only arise if official action resulted in an actual exchange rate spread on the member’s territory that exceeded the permissible margin. This would re-focus the policy on economically more meaningful developments and promote a more constructive dialogue with the membership. - Update the threshold for permissible FX spreads: - Replace the “two-percent” rule for permissible spreads for spot FX transactions with a country-specific market-based norm, including a tolerance margin, that would apply uniformly across the membership. - Apply an analogous treatment for non-spot transactions. - Adjust approval policies: - Align policies for approval of MCPs and exchange restrictions. - Remove approval of MCPs for non-BOP reasons (approval of MCPs for non-BOP reasons has become rare over time). - Approval would only be granted if the MCP is maintained for BOP reasons, is temporary, and does not give the member an unfair competitive advantage over other members or discriminate among members. - Review links with capital transactions: - Staff’s longstanding position has been that the MCP policy also applies to capital transactions; historically the IMF Board has not endorsed this interpretation of the Fund’s jurisdiction. - The paper revisits the debate and, in the event the Board retains its view, clarifies the link between the MCP policy and the Institutional View (IV). - Consider the merits of a remedial framework: - It would be possible for the Fund to establish a framework under which members in breach of their obligations under the MCP policy would be subject to escalating remedial measures, although the merits of introducing such a framework would need to be carefully weighed. ### Notable specific policy elements and thresholds in current practice - Under the current policy, for an MCP to arise the following conditions must be met: - Official action by the authorities that relates to an “exchange transaction.” Official action may be direct or indirect (e.g., an FX regulation) and may include exchange taxes or informal guidance. - The exchange transaction must take place on the member’s territory (including other territories of the member). - The official action, of itself, must give rise to a spread in exchange rates beyond what is considered “commercially reasonable.” Specifically: - For spot transactions, the action must give rise to a spread of more than 2 percent between any buying rate and selling rate on the member’s territory (the “two percent” rule). - For non-spot transactions (e.g., forwards), the action must give rise to deviations between buying and selling rates for these other transactions against spot transactions, beyond what is representative of the additional costs and exchange risks for these other transactions (not explicitly quantified in the current policy). - An MCP also arises where official action results in “broken cross-rates”: midpoint spot exchange rates for other members’ currencies against its own currency differing by more than 1 percent from the midpoint spot exchange rates for these currencies in their principal markets and persisting for more than one week. - Two application features of the current policy: - The “two percent rule” has been applied in effect as a “de minimis” standard: official action that of itself leads to spreads of less than 2 percent is not prohibited. - Application evolved to include “potentiality”: official action that could potentially give rise to a spread exceeding thresholds has been treated as an MCP unless there is a mechanism in place to keep the spread within the permissible range. ### Implementation and next steps - The Executive Board will have an opportunity to discuss the paper initially during an informal staff level briefing covering technical aspects and then at a formal meeting. - Based on guidance from that meeting, a formal proposal for reform, with draft decisions, will be presented to the Board. - Following adoption of a new policy, a guidance note for staff would be issued with details on how to implement it. *Prepared by a staff team from the Legal Department (LEG), Monetary and Capital Markets Department (MCM), and Strategy, Policy, and Review Department (SPR), in collaboration with the Research Department (RES). Approved by Tobias Adrian, Ross Leckow, and Martin Mühleisen.* ### Box 1. Exchange Measures that Give Rise to MCPs ### Box 1. Exchange Measures that Give Rise to MCPs ### Measures typically considered to give rise to MCPs - Different rates for different transactions: - Authorities set different exchange rates for different categories of transactions which result in spreads of more than two percent between these rates, or against market rates. - Example: an official exchange rate for governmental transactions (e.g., servicing external debt, other government operations) that differs by more than two percent from prevailing market rates or other official rates. - Surrender requirements: certain market participants (e.g., exporters) must sell FX proceeds at a special rate which differs by more than two percent from the market rate or other official rates. - Dual or multiple FX markets: - Separate exchange markets where the rates at which exchange transactions are conducted by participants in the two markets exceed the permissible spreads. - Exchange taxes: - A tax payable on exchange transactions is considered part of the effective exchange rate by increasing the cost of the exchange transaction. - If such costs imposed by the authorities exceed two percent, an MCP will arise. - Bilateral payments agreements (BPAs): - Agreements under which two central banks settle current transactions on pre-defined dates at specific exchange rates that differ by more than two percent from those prevailing in the FX markets. - Exchange guarantee schemes: - Schemes to cover exchange risks of certain market participants (e.g., exporters); depending on features, compensation for exchange losses is considered part of the effective exchange rate that can give rise to an MCP. - A system for covering exchange risks managed by a member or its fiscal agencies does not give rise to an MCP if it is self-financed (premia paid by beneficiaries are sufficient to cover operating costs). - FX auctions: - Authorities allocate FX outside the auction at a different exchange rate than the auction rate, or the auction rate differs from the market exchange rate, and these rates differ by more than two percent. - Multi-price auctions give rise to an MCP if rates at which successful bidders are sold FX at the same auction differ by more than two percent. - Import deposit requirements: - Requirement of an import deposit before a letter of credit is opened or FX purchased. If the interest rate on the deposits is lower than the prevailing market interest rate, this is considered an additional cost of the FX transaction that can give rise to an MCP. ### Legal status, Fund treatment, and operational implications - MCPs are a breach of obligation under the Articles and may result in the imposition of sanctions. - Members may maintain MCPs under two conditions: - Transitional arrangements: Article XIV, Section 2 allows members to maintain MCPs that were in effect on the date the country became a member, without Fund approval; the member is expected to eliminate these measures over time as its balance of payments (BOP) improves. - Approval: MCPs not covered under transitional arrangements may be maintained temporarily with Fund approval if they are introduced or maintained for BOP reasons, are temporary, and do not give the member an unfair competitive advantage or discriminate among members. Approval may also be granted for MCPs maintained primarily for non-BOP reasons if they do not materially impede the member’s BOP adjustment, do not harm the interests of other members, and do not discriminate among members. Approval is generally granted for one year to allow regular review by the Executive Board in the context of Article IV consultations. - Conditionality under Fund arrangements: - Since 1980, Extended Fund Facility and Stand-by Arrangements have included a standard continuous performance criterion prohibiting the introduction or modification of MCPs during the period of the arrangement; this has been extended to other Fund arrangements and non-financing instruments. - Introduction or modification of an MCP during Fund arrangements requires a waiver for nonobservance for financial resources to be disbursed. - Relationship to Article IV and Article VIII, Section 2(a): - Article IV: members have substantial freedom in choosing exchange arrangements but must collaborate with the Fund and other members to ensure orderly exchange arrangements, refrain from manipulating exchange rates to prevent BOP adjustment or gain unfair advantage; in implementing exchange rate policies under Article IV, members are prohibited from engaging in MCPs. - Article VIII, Section 2(a): Fund policy prohibits members from imposing, without Fund approval, restrictions on the making of payments or transfers for current international transactions. Exchange measures can give rise to both MCPs and exchange restrictions; MCP policy is broader because an MCP can arise from any purchase or sale of FX related to either outflow or inflow of a current international payment, while exchange restrictions policy deals only with restrictions on outward payments and transfers for current international transactions. - Interaction with WTO: - MCPs arising from export subsidies or exchange taxes are generally prohibited under the WTO legal framework. - If an MCP is maintained in accordance with IMF Articles of Agreement (temporarily approved by the Fund under Article VIII or maintained under Article XIV transitional arrangements), it would not be subject to discipline under the WTO legal framework. ### Rationale for the MCP policy and economic effects - Historical rationale: - Prohibition of MCPs was part of efforts to eliminate restrictions on current international payments and transfers after the trade wars of the 1930s, when differentiated exchange rates and BPAs distorted trade and stimulated destructive spillovers and retaliation. - Purposes for which MCPs have been used: - Mitigate BOP pressures. - Achieve non-BOP objectives (e.g., revenue mobilization, allocation of resources to specific entities or sectors) without resorting to direct taxes or subsidies; MCPs have often been implemented by executive order or central bank regulation rather than legislation. - Short-term effects: - MCPs have had partial short-term success in stabilizing the BOP position and temporarily mitigating BOP pressures, including those associated with capital flow volatility. - MCPs have temporarily helped reduce pressure to tighten monetary policy while protecting the BOP during financial distress and have at times improved government revenue-raising powers in the short term. - Medium- and long-term effects: - MCPs typically do not address fundamental causes of BOP imbalances and only delay the impact of BOP pressures. - When used for non-BOP purposes, MCPs tend to introduce unintended inefficiency in resource allocation and are less transparent than direct taxes or budgetary subsidies; they can invite rent-seeking behavior. - MCPs distort relative prices and domestic resource allocation, especially if permanent; examples include acting as a tax on exports and a subsidy on basic imports, undermining exports and encouraging inefficient import-substituting industries, leading to resource misallocation and loss of growth and job creation. - MCPs have generally been associated with lower GDP growth, higher inflation, and lower trade volumes; they can distort the current account because of asymmetric effects on imports and exports. - MCPs may be considered a discriminatory trade practice, acting de facto as a differentiated tariff, creating unfair competitive advantage, hampering international trade, and generating retaliatory measures; some MCPs (e.g., taxes on purchase of FX for remittance of profits) may deter foreign investment. - Policy importance: - The MCP policy provides a strong deterrent against the emergence of distortive exchange practices; the policy has contributed to a substantial decline in MCPs over recent decades, especially among large countries, and without it there would be less protection against re-emergence of exchange practices that undermine trade and investment. ### Incidence, composition, and duration of MCPs in practice - Historical incidence: - MCPs were frequent in the Fund’s early history; in the mid-1950s, about two-thirds of members maintained MCPs. - By the early 1980s, about 30 percent of the membership maintained MCPs. - Reliance among EMDCs temporarily increased in the early 1980s, with about a third maintaining MCPs in 1986, but declined thereafter. - Recent trends and counts: - The downward trend continued over the past three decades, with many EMDCs opening up and liberalizing exchange systems in the 1990s and early-2000s. - After the global financial crisis there was a small uptick in MCPs reflecting BOP difficulties and FX shortages. - At end-2017, 45 MCPs were in place in 28 member countries, down from 102 MCPs in 55 countries in 1986. - Among countries with MCPs, the average number of MCPs ranges between 1 and 2. - Distribution and share in world trade/GDP: - In recent years, MCPs have been generally confined to lower-middle and low-income countries, particularly in Africa and Middle-eastern regions. - The share of countries with MCPs in international trade declined from about 12 percent in 1982 to about four percent in 2016. - The decline is even more evident among EMDCs; the share in world GDP of EMDCs with MCPs has also declined. - Composition changes: - Use of the FX system to discriminate against certain transactions (e.g., exchange subsidies, guarantees) and taxes on conversion of FX has declined. - Types of MCPs such as margin requirements, unremunerated advance import deposit requirements, and BPAs have decreased in the last three decades; broken cross-rates have virtually disappeared. - The share of MCPs arising from parallel markets has increased (9 MCPs as of end-2017); these tend to be highly distortionary and typically arise due to FX shortages and rationing in the official market. - Potentiality-based findings: - Increasingly, MCPs have been found on the basis of potentiality; about one third of recent MCP findings have fallen in this category. - The two most frequent potentiality-based MCPs arise from FX multi-price auctions and the lagged calculation of official exchange rates (e.g., calculating the exchange rate for governmental transactions based on previous days’ market exchange rates). - Duration and elimination: - On average, MCPs have lasted for about 4.4 years. - More than 20 percent of MCPs were eliminated within a year of their identification. - Certain MCP types have taken longer to eliminate, e.g., exchange taxes (largest group of MCPs lasting more than 10 years), exchange rate guarantee schemes, and BPAs. *International Monetary Fund — Review of Policy on Multiple Currency Practices: Initial Considerations (Box 1).* ### 26. The Fund has only sparingly approved MCPs. Only a third of MCPs were approved for at ### ppea2019015 - 26. The Fund has only sparingly approved MCPs. Only a third of MCPs were approved for at ### Approval and incidence of MCPs - Among a total of 506 MCPs reported in staff reports since 1980, only 108 measures (21 percent) were approved. - 79 measures (16 percent) were approved only for a part of their duration. - 285 measures (56 percent) were never approved. - The rest did not require approval by the IMF (e.g., MCPs maintained under Article XIV). - BOP reasons accounted for less than 10 percent historically but became more common recently for potentiality-based MCPs. - In the majority of cases, approval was not granted because the MCP was not considered temporary. - More than a half of parallel market MCPs and MCPs from different rates for different transactions were not approved. - MCPs from multi-price auctions, which were typically based on potentiality, were more readily approved. ### Duration statistics - Average = 4.4 years - Median = 3 years - Mode = 1 year - Most MCPs are eliminated within 2-3 years, but there are some exceptions (e.g., among the current MCPs, 2 have been in place for more than 25 years). - Note: IMF staff reports do not necessarily mention MCPs that were introduced and removed between two consecutive staff reports, so the actual number of MCPs that were eliminated shortly after their introduction may be larger. ### Types of MCPs (listed in source) - Different rates for different transactions: Armenia (3), Burundi (12), Ghana (6), Guinea (13), Iran (3)**, Kyrgyz (7), Maldives (2), Mongolia (9), Nigeria (1), Papua New Guinea (2), Sudan (5), Trinidad and Tobago (2), Ukraine (6) - Spread with parallel market: Eritrea (15), Iran (4)**, Iraq (5), Maldives (9), Nigeria (2), South Sudan (4)***, Sudan (5), Syria (14), Venezuela (14) - FX auctions (multiple price): Angola (11), Honduras (2)**, Jamaica (1)**, Mongolia (9), Myanmar (5)** - FX auctions (spread with the market rate): Angola (2), Honduras (2)**, Ukraine (3) - Exchange taxes: Angola (11), Brazil (3), Eritrea (10), Ukraine (6) - Import deposit requirements: Pakistan (1)*, Sudan (11), Syria (34) - Exchange guarantee schemes: Tunisia (30) - Bilateral payments agreements: Congo, DR (15) - Other: Eritrea (13), Iran (15)**, Mauritius (1)**, Papua New Guinea (2), Trinidad and Tobago (2), Uzbekistan (8) - Total 45 (countries listed) ### Challenges with current MCP policy - The MCP policy has increasingly captured measures that may not result from official action or involve relatively minimal deviations in exchange rates with little harm. - Lack of clarity on key policy aspects has complicated implementation. - Any revision should ensure the Fund’s framework continues to facilitate FX systems that: - promote a stable system of exchange rates, - are free of restrictions on payments and transfers for current international transactions, - are based on unitary exchange rates. - Effective policy needs rules that: - reflect market realities in member countries, - can be applied uniformly across the Fund’s membership, - are simple and easily understood by stakeholders. ### Clarifying the concept of official action — taxonomy - Official action can be conceptually divided into three categories: - Authorities directly engage in FX transactions that give rise to multiplicity of exchange rates that exceed permissible spread (including when the spread between buying and selling rates the authorities offer exceeds two percent for spot transactions). - Authorities do not engage in FX transactions themselves but take action (e.g., an FX regulation) to require or bring about multiplicity of exchange rates in other parties’ transactions that exceed permissible spread (market segmentation via separate FX markets is typical). - Authorities directly impose costs on FX transactions (e.g., exchange taxes) that increase spreads and, if applied only to certain transactions, cause segmentation. ### FX auctions and official FX intervention — problem statement - Current policy can find an MCP where authorities offer FX at rates beyond permissible margins even in the absence of market segmentation. - This approach is inappropriate where authorities offer rates to the entire market for all purposes because market participants can choose other counterparties; multiplicity then stems from participants’ economic choices. - Both single and multi-price exchange auctions have been found to give rise to MCPs under current practice: - Multi-price auctions: where auction rules allow successful bids to deviate by more than two percent, considered to give rise to an MCP due to simultaneous settlements at differing rates. - An MCP may also arise from deviation of more than two percent between auction rate(s) and prevailing market rates outside the auction. - Well-designed FX auctions are used for official intervention, transparency, price discovery, and market development; labeling common auction practices inconsistent with Article obligations (unless temporarily approved) creates reputational risks and tension with authorities. ### FX auctions — possible solution proposed - An FX auction (including a multi-price auction) would not give rise to an MCP in the absence of segmentation. - An MCP should arise only where the authorities restrict access to the auction to a limited group of market participants or for a limited set of purposes. - Rationale: if all market participants can access the auction (directly or via intermediaries), multiplicity of rates results from participants’ economic choices, not from official action. - This approach aligns with the Fund’s treatment of other FX intervention that offers to purchase or sell FX on one side of the market at a particular rate to all market participants; such intervention does not give rise to an MCP if open to all participants. - Auction design should follow best practices to avoid segmentation, including: - grant access to all intermediaries in the country’s wholesale FX market so they can make purchases for themselves and on behalf of clients; - ensure the bid exchange rate submitted is the only criterion to determine successful bids; - not set constraints on the range or level of exchange rates that can be submitted. - Such auctions would not result in MCPs even if the difference between the auction rate(s) and the market rate exceed permissible margins. ### Parallel markets — problem statement - Treatment of parallel markets under the MCP policy is unclear and creates implementation challenges. - Parallel markets generally emerge in two situations: - to service illegal transactions only (e.g., drug sales); - because FX demand for certain legitimate transactions is not being met in the legal market (e.g., due to exchange restrictions, rationing, or prioritization). - Parallel markets should not be confused with dual markets (dual markets involve two or more separate legal markets). - Conceptually difficult to treat spreads in illegal parallel markets as resulting from official action because authorities prohibit transactions in those markets. - Fund staff have used concepts like “toleration”, “relegating”, or “channeling” and examined whether authorities are actively “cracking-down” (prosecuting illegal FX dealers) — these tests have proven difficult to apply and can lead to inconsistent treatment. ### Parallel markets — possible solution proposed - Exclude parallel markets from MCP analysis whenever they are legally prohibited, because exchange rates in them are not the result of official action. - Such cases could instead be addressed under the Fund’s policy on exchange restrictions. - Where spreads arise because access to FX in the formal market is restricted or limited (e.g., rationing and/or prioritization), the Fund’s jurisdictional analysis should focus on authorities’ action in the formal market to restrict availability of FX, rather than on the spread in the parallel market. - Consequence: these cases would no longer give rise to an MCP but would still be considered an exchange restriction. - Note: the exchange restrictions policy focuses on outward payments and transfers and would not cover exchange practices related to inward payments and transfers (e.g., requirement for exporters to surrender FX proceeds at an off-market rate). However, surrender requirements at an off-market exchange rate could still be captured under the MCP policy if legal FX markets (e.g., interbank market) exist. ### Potentiality — problem statement - The concept of potentiality has evolved to find MCPs arising not only from actual spreads but also from potential spreads. - Potentiality has been particularly relevant for FX auctions: even if deviations do not exceed two percent, the possibility that spreads exceeding the permissible margin may emerge leads to an MCP finding unless a mechanism exists to prevent such spreads. - Potentiality has also applied in cases involving official exchange rates: an MCP has been found unless there is a mechanism to prevent spreads of more than two percent from arising between official and prevailing market rates. *Italic line from source: REVIEW OF POLICY ON MULTIPLE CURRENCY PRACTICES: INITIAL CONSIDERATIONS — INTERNATIONAL MONETARY FUND* ### 41. Potentiality raises a number of issues. While it has facilitated policy application in some ### ppea2019015 - 41. Potentiality raises a number of issues. While it has facilitated policy application in some ### Potentiality: issues identified - The concept of potentiality is "not well grounded in the 1981 Decision" and has been "difficult to explain to national authorities" who maintain MCPs even when excessive spreads have not actually emerged. - MCP findings based on potentiality may lead to sub-optimal economic solutions (example: rules to limit deviations between winning bids in multi-price auctions may undermine price discovery and harm market development). - Reliance on potentiality minimizes the need for staff to continuously monitor spreads in FX markets to determine whether MCPs have arisen. (Footnote: "Reliance on potentiality minimizes the need for staff to continuously monitor spreads in FX markets to determine whether MCPs have arisen.") - Practical challenges in detecting exchange restrictions in formal markets: access to FX may be determined through moral suasion rather than regulations; staff typically interview market participants or consider external payment arrears as evidence. (Footnote references: moral suasion and external payment arrears.) ### Possible solution: eliminate potentiality - Rationale: - Difficult to reconcile potentiality with the kind of official action MCP policy aims to capture. - If MCP policy should capture multiplicity of exchange rates arising from official action, official action should be relevant only when it causes an actual multiplicity of exchange rates. - Proposed change: - Eliminate potentiality. An MCP would arise only if official action resulted in an actual FX spread emerging on the member’s territory that exceeded the permissible threshold under the policy. - Focusing on official action that results in actual FX spreads would capture the economically meaningful effect of official action and facilitate more coherent policy application. ### Box 2: Finding and Eliminating MCPs Based on Actual Spreads (summary) - An MCP would arise whenever official action results in an actual FX spread beyond what is permitted under the policy. Upon confirmation that a single deviation from the permissible spread resulted from official action, an MCP would be found. - MCP elimination mechanisms: - Elimination when authorities remove the official action that gave rise to the MCP (e.g., abolition of an off-market official exchange rate). Approval of the MCP could be granted while necessary steps are being taken. - If authorities keep the official action, the MCP could be considered eliminated in certain circumstances if credible measures are taken to ensure such action will not in future give rise to spreads outside permissible margins. If an impermissible spread arose again, a new MCP would be found. - If an actual deviation occurs but does not reemerge, an MCP could be eliminated if the member demonstrates over a specified "observation period" (e.g., 12 months) after the emergence of the spread that an impermissible spread had not recurred. The MCP would remain in place during the observation period and be noted in Article IV staff reports. The reemergence of an impermissible spread during this period would "reset the clock", and the observation period would start again. - Note: staff considered an alternative requiring the permissible spread to be exceeded for a certain number of consecutive days or within a defined period, but rejected it because it could miss sporadic but significant deviations (examples: periodic government purchases at a special rate, BPAs that settle periodically, exchange rate guarantee schemes, intermittent exchange auctions earmarked to sectors). ### Revisiting permissible spreads: problems with the two percent rule - Historical context: - The two percent rule stems from a 1979/1981 basis: a survey of actual transaction costs in twelve FX markets and operational work in 1979/1981. - Difficulties with the two percent rule: - Does not reflect market realities of individual members: reasonable costs for spot transactions in most markets are significantly less than two percent, though in some cases may be more. - Temporary market circumstances can push spreads beyond two percent even in well-functioning markets. - Unclear how to compare exchange rates under the rule (e.g., simultaneous rates vs. closing rate). - The test comparing "spot" and "other transactions" is hard to apply: two percent applies to spot telegraphic transfers while "commercial reasonableness" is used for other spot and non-spot transactions, creating conceptual problems. - Staff alternatives considered (and dismissed or qualified): - Updating two percent based on current data (uniformly or country-specific) — poses operational and equity problems. - Focusing only on "macrocritical" deviations — not operationally feasible and risks subjectivity. - Staff suggests replacing the two percent rule with a market-based formula applied uniformly across membership. ### Market-based formula and data sources - Proposal: - Use market rates within a member’s principal exchange market to determine a permissible range that changes on a daily basis. - Although the range will be different for each country, the methodology would be uniform across membership. - Feasibility: - Modern availability of independently computed market exchange rates and deepened FX markets support this approach. - Exchange rate benchmarks (bid/ask, high/low, open/close) are prepared and published daily by professional international benchmark administrators for all but five IMF members. - The five exceptions: Iran, South Sudan, Sudan, Syria, and Tajikistan. (Information for all countries except Syria could be obtained by staff from other sources.) - Primary data sources: - Staff suggest using Thomson Reuters DataStream as the primary source for market rates due to most extensive coverage. - For 14 members not covered through Thomson Reuters DataStream, data would be sourced from Bloomberg. - Both companies provide accurate real-time data and methodologies subject to independent assessment for compliance with the international standard for computation of international benchmarks of the International Organization of Securities Commission. - Alternative data sources could be used in certain cases (see Background paper III). ### H/L benchmark, three-step methodology, and tolerance margin - H/L definition and rationale: - The range between the highest and lowest exchange rates (H/L) in the wholesale market on a given day is proposed as the benchmark reflecting commercial reasonableness. - HIGH = most depreciated exchange in the FX market during the trading day; LOW = most appreciated exchange of the day. - The H/L indicates "market boundaries"; as H/L widens in exceptional circumstances, no MCP would arise if the official action exchange rate remains within the H/L range. - An MCP would occur if an exchange rate arising from official action falls outside the H/L range or a fixed margin on either side of the mid-point of this range, whichever is larger. The margin is a tolerance buffer to avoid capturing minor deviations. - Three-step assessment for MCP existence: - First: ascertain whether an exchange rate has arisen from official action. - Second: check whether the rate arising from official action is within the market-determined H/L range of the day. If within the range, it would not constitute an MCP. If beyond the H/L range, proceed to step three. - Third: apply a tolerance margin (buffer) defined as a percentage of the average of the H/L (i.e., the midpoint of the H/L) for that day, added on either side of the midpoint. No MCP arises when the official-action rate remains within this margin even if outside the H/L range. A single deviation from the norm as a result of official action would be considered an MCP. - Practical notes: - The market rate reference is the inter-dealer market for spot (settled at up to 2 days) and non-spot (settled at more than 2 days) transactions respectively. Any rate arising from official action in the spot market will be assessed with reference to the interdealer spot market, and any rate arising from official action in the non-spot market will be assessed with reference to the interdealer non-spot market rate, or a calculated non-spot rate if the former is not available. - Staff preferred H/L over bid/ask because published bid and ask rates are averages and do not define a maximum limit for deviations during the day; FX market expert confirmation supported H/L as most representative. ### Box 3: Assessing the Existence of an MCP (formula and variables as presented) - Condition for exchange rate R (arising from official action): - Min{LOW ; M_H/L - 2%} ≤ R ≤ Max{HIGH ; M_H/L + 2%} - Where: - R is the exchange rate arising from official action - HIGH is the intraday high, i.e. the most depreciated exchange rate of the day; - LOW is the intraday low, i.e. the most appreciated exchange rate of the day, and - M_H/L = HIGH+LOW 2 - If the exchange rate falls outside of the range defined above, an MCP would be found. ### Justification for the +/-2 percent tolerance margin - Staff studied the distribution of the H/L and deviations between the average of the H/L and available official rates in the membership to gauge insignificance thresholds. - Typical distribution thresholds for tail events are reached for a two percent margin: "95 percent of the deviations are less than two percent." - The margin is intended to ensure the policy focuses on egregious cases involving significantly large spreads arising from official action. - Differences from the current two percent rule: - The two percent rule was originally a proxy for commercial reasonableness; under the new methodology commercial reasonableness is represented by the country-specific H/L range. - The current two percent rule applies to buy/sell, buy/buy, and sell/sell spreads between official rates; the proposed margin compares both buying and selling rates caused by official action with the H/L midpoint rate. In practice, where H/L is wide this could allow spreads larger than two percent between buying and selling rates (buy/sell). *International Monetary Fund — REVIEW OF POLICY ON MULTIPLE CURRENCY PRACTICES: INITIAL CONSIDERATIONS (excerpts provided in the content unit)* ### Box 4. Exchange Taxes and Lagged Calculation of Official Exchange Rates ### Box 4. Exchange Taxes and Lagged Calculation of Official Exchange Rates ### Exchange taxes - Challenges in applying the methodology to exchange taxes: - Official action (tax) may affect all exchange rates and as such the H/L as well, making comparison with market rates difficult. - Using a country-specific H/L as a measure of permissible exchange taxes may result in a wide range of tax rates deemed acceptable under the MCP policy. - Even negligible taxes could cause market rates situated near the boundaries of the H/L or the +/- 2 percent margin to trigger MCP findings. - Historical and policy context: - Historically the MCP policy has allowed members to impose minor taxes on exchange transactions without giving rise to an MCP. - Under the current policy, exchange taxes will not give rise to MCPs if they are equal to or less than two percent. - Proposed approach to preserve flexibility for minor taxes: - Deem the tax to be levied on the midpoint of the H/L and compare with the +/- 2 percent permissible margin. - In practice, assuming no other governmental costs imposed on exchange transactions, this would imply that exchange taxes up to two percent would not be considered MCPs. - This approach would allow countries that have built the two percent in their exchange regimes to continue using this practice. - Caveat from historical cases and alignment issue: - While exchange taxes below two percent do not currently give rise to MCPs, in a few cases the Fund has found an exchange restriction to arise when the exchange tax targets the making of payments and transfers for current international transactions. - Due to the absence of a de minimis rule for exchange restrictions, this has resulted in findings of exchange restrictions even for negligible exchange taxes below two percent. - It would not appear appropriate to allow a member to impose a two percent exchange tax under the MCP policy, and at the same time consider such tax, or a substantially similar tax, to be an exchange restriction. - The Second Amendment papers suggest that the treatment of exchange taxes under the policies on MCPs and exchange restrictions should be harmonized; it would therefore be important to address this inconsistency and clarify that, under a revised MCP policy, if an exchange tax does not give rise to an MCP, it would also not give rise to an exchange restriction. ### Use of official exchange rates with lagged calculation - Issue: - Official exchange rates calculated with a lag (occasionally based on market exchange rates of the previous day) can diverge from contemporaneous market rates, and in times of high volatility the divergence may randomly exceed the threshold permitted under the MCP policy. - Proposed mitigation: - Elimination of potentiality should greatly reduce MCPs from lagged official rates, but to further minimize MCP findings it is proposed that exchange rates used by the authorities for certain official transactions which are based on market exchange rates with a maximum of one-day lag would not give rise to an MCP. - The official rate would need to be computed as a weighted average of transaction exchange rates between wholesale intermediaries, or between intermediaries and their clients. - Operational detail and reference: - Official exchange rates are occasionally calculated based on market exchange rates of the previous day. - See Background Paper III for related discussion. *Source: Box 4. Exchange Taxes and Lagged Calculation of Official Exchange Rates.* ### 65. Consideration could be given to establishing a remedial framework to address cases of ### Consideration could be given to establishing a remedial framework to address cases of unapproved MCPs or exchange restrictions ### Remedial framework proposal - In principle, the Fund could establish a policy framework under which members in breach of their obligations respecting MCPs or exchange restrictions would be subject to escalating remedial measures such as: - a declaration of censure or noncooperation (similar to the procedure for breaches of obligation under Article VIII, Section 5) - culminating in the imposition of sanctions. - The remedial framework could also address cases of long-standing MCPs or exchange restrictions maintained under Article XIV, where the Fund considers that the member is ready to eliminate them. - Design of such a remedial framework is outside the scope of this paper. ### Pros and cons of establishing a remedial framework - Arguments in favor: - Possible revisions to the MCP policy seek to focus application on practices that are objectionable; under such a revised approach, it may appear appropriate for the Fund to have a remedial framework for dealing with such practices. - Arguments against / alternatives: - From a policy perspective it may be desirable to retain a cooperative approach. - The Fund and member countries could continue to cooperate on the elimination of unapproved MCPs via: - surveillance and technical assistance (TA) - monitoring of exchange measures via standard conditionality in Fund arrangements. - Operational constraint noted: - Introduction of MCPs or exchange restrictions during a Fund-supported program requires a waiver for nonobservance of the relevant performance criterion for financial resources to be disbursed. ### Operational issues if MCP policy is reformed - Guidance and data provision: - Members would need guidance on their obligation to provide data on exchange rates to the Fund. - Article VIII, Section 5 provides that members are required to furnish to the Fund information on “buying and selling rates for foreign currencies”, but no further guidance is provided on the modalities for providing this information to the Fund (e.g., it is unclear whether these modalities are covered by any general understandings with members on data provision under Article VIII, Section 5). - Third-party data considerations: - The new methodology would be based on data compiled by third parties, raising issues of reliability, integrity, and continuity of data. - The new system may have implications in terms of budget and staff resources. - Area Departments would need to have access to FX data for each member. - Management guidance and publication: - Management would need to issue a guidance note on application of the MCP policy, which would be published. - The guidance note would describe in detail the most common types of MCPs and procedures for finding, eliminating and approving MCPs. - Guidance could be provided on issues including: - overlap between MCPs and exchange restrictions - in what circumstances auctions would give rise to MCPs - criteria for approval, including better guidance on how to assess the temporariness of a measure. - Purpose: increase transparency of the MCP policy for staff and the membership, and help ensure uniform understanding and consistent application. - Market data availability (operational footnote details preserved): - Market data is available through the Fund’s subscription to Thomson Reuters DataStream and Bloomberg. - The current subscription of the Fund through IMF Library (CFS) covers sufficient licenses to Thomson Reuters DataStream and Bloomberg. - These licenses are accessible to various users throughout the IMF in area departments and other functional areas. - There is a budget proposal approved to add licenses during the coming fiscal year, whereby almost all research officers in country teams would have access to the required market data. - The current service agreement provides both close of day and intraday data for exchange rates covering bid/ask, mid-rates, and intraday H/L. ### Transitional arrangements - To avoid unnecessary disruptions, transitional arrangements would be put in place as part of any new policy, particularly to protect countries that may be adversely affected by the new framework. - A transitional period could be envisaged to provide time for members to adjust their policies, after which the revised MCP policy would become operational. - Review clause: - Staff will review the revised MCP policy within a period of 5 years, once sufficient experience with its application has been accumulated. ### Issues for discussion (as listed) - Do Directors agree that MCPs can lead to domestic distortions and externalities, and that the Fund needs a policy to address them? - Do Directors concur that developments in FX markets and operational issues with the implementation of the current policy warrant a reconsideration of the MCP policy? - Do Directors support the revisions to the MCP policy proposed by staff? - Do Directors agree that MCPs applying solely to the capital account should fall under the Fund’s jurisdiction? - Do Directors see the need for developing a remedial framework for MCPs? *Source: REVIEW OF POLICY ON MULTIPLE CURRENCY PRACTICES: INITIAL CONSIDERATIONS (selected excerpts).* ### Box 1. The 1947 Memorandum ### Box 1. The 1947 Memorandum ### Recognition of MCPs and their restrictive nature - The 1947 Memorandum recognized MCPs as systems of multiple rates and exchange restrictions. - The memorandum noted that MCPs, “besides being in most cases restrictive practices, also constitute systems of exchange rates”. - The memorandum also observed that MCPs often represented “both systems of exchange rates and restrictions on payments and transfers for current international transactions”. - The memorandum treated Article VIII, Section 2(a) (exchange restrictions) and Article VIII, Section 3 (MCPs) as closely related, both “seeking to eliminate restrictive exchange measures.” ### Relationship between MCPs and exchange stability (Article IV) - The memorandum emphasized an intrinsic relationship between Article VIII, Section 3, and Article IV, Section 4(a), focusing on exchange rate stability. - It recalled that Article IV originally dealt with “Par Values of Currencies”, and Section 4 referred to members’ “Obligations Regarding Exchange Stability”. - The memorandum stated that “since exchange stability depends on effective rates, the general purposes of the Fund and the members’ undertakings of Article IV, Section 4(a) ‘to collaborate with the Fund to promote exchange stability, to maintain orderly exchange arrangements with other members, and to avoid competitive exchange alterations’ are fundamental considerations in an interpretation of the rights and obligations of members under (...) Article VIII, Section 3”. ### First MCP definition and the one percent parity margin - The 1947 Memorandum articulated the first MCP definition. - It concluded that an effective buying or selling rate which differed from parity by more than one percent constituted an MCP. - Therefore, the 1947 Memorandum linked the MCP definition to the parity margins of one percent prescribed in Article IV, Section 3(i). - The memorandum’s basic concept of an MCP “would remain essentially unchanged for the next three decades.” ### Fund jurisdiction over exchange taxes - The 1947 Memorandum articulated for the first time the Fund’s jurisdiction over exchange taxes. - It stated: “When a tax affects an obligation undertaken by the members of the Fund, the relationship between the tax and the obligation is of direct concern to the Fund and subject to its jurisdiction. Whenever exchange taxes are used to modify par values, create multiple currency practices, or introduce restrictive exchange controls, they are subject to the Fund’s jurisdiction. The Fund has authority to deal with these exchange matters irrespective of the official device or procedure involved.” *Statement to Members transmitting Fund’s Decisions on Multiple Currency Practices, Appendix to Decision No. 237-2, adopted December 18, 1947.* ### 21. The proposals discussed in the period from 1979 to 1981 were reflected in Decision ### FUND POLICY ON APPROVAL OF MULTIPLE CURRENCY PRACTICES ### Decision No. 6790-(81/43) (March 20, 1981) - Decision No. 6790-(81/43), adopted on March 20, 1981, reflects proposals discussed in the period from 1979 to 1981. - Key prohibitions under Decision No. 6790: - Official action that of itself gives rise to a spread of more than two percent between buying and selling rates for spot exchange transactions between the member’s currency and any other member’s currency. - Official action causing deviations between the buying and selling rates for spot transactions and for other transactions, unless they represent the additional costs and exchange risks for these other transactions. - Official action which results in midpoint spot exchange rates of other members’ currencies against its own currency in a relationship which differs by more than one percent from the midpoint spot exchange rates for these currencies in their principal markets, if the one percent differentials persist for more than one week (broken cross-rates). - Decision No. 6790 states that exchange spreads arising without official action would not give rise to an MCP. ### Application of the MCP policy and the “potentiality” concept - Since the early 1980s, the MCP policy has been applied to find MCPs whenever an official action creates a situation where a spread of more than two percent may arise, even if such a deviation has not actually emerged in practice, unless the authorities have in place a mechanism which prevents such spreads from arising. - The “potentiality” concept has given rise to a number of MCP findings over several decades, particularly in the context of: - multi-price FX auctions; and - lagged calculation of official exchange rates. - One minor change to the MCP policy occurred in 1998 to allow a longer approval period “where the practice is maintained only for existing arrangements and for a specified period of time”. ### Relationship between Article VIII, Section 3 and other Articles - Article VIII, Section 3 is linked to: - Article VIII, Section 2(a) on exchange restrictions; - Article IV, which governs exchange rate policies and surveillance; and - Article XIV, which outlines transitional provisions for members who join the Fund with MCPs or exchange restrictions in place. - Article I purposes related to these provisions: - Article I(iii): the promotion of exchange stability and orderly exchange arrangements; - Article I(iv): the elimination of exchange restrictions which hamper growth of world trade. ### Multiple Currency Practices versus Exchange Restrictions - Exchange restrictions and MCPs are distinct legal concepts under the Articles: - Article VIII, Section 3 prevents members from engaging in MCPs. - Article VIII, Section 2(a) prohibits imposing restrictions on the making of payments or transfers for current international transactions, unless authorized under the Articles. - Logic connecting MCPs and exchange restrictions: - MCPs typically involve some market participants accessing FX at more favorable rates than others; the additional cost borne by disadvantaged participants may be viewed as an impediment to their access to FX for current payments and thus an “exchange restriction”. - Measures that impose an additional cost on all market participants (e.g., an exchange tax in excess of 2 percent) may be both an MCP and an exchange restriction. ### Exchange Restrictions Under Article VIII, Section 2(a) (overview) - Article VIII, Section 2(a) prohibits restrictions on the “making” of payments and transfers; the obligation primarily extends to outward payments and transfers and does not extend to restrictions on inward receipts. - The Executive Board’s guiding principle: “[t]he guiding principle in ascertaining whether a measure is a restriction on payments and transfers for current transactions under Article VIII, Section 2, is whether it involves a direct governmental limitation on the availability or use of exchange as such.” (Decision No. 1034-(60/27), adopted June 1, 1960). - Examples of measures that can give rise to exchange restrictions include, but are not limited to: - imposition of priority lists for access to foreign exchange; - imposition of absolute limits on the amount of foreign exchange that can be purchased (e.g. allowances); - exchange taxes; - administrative practices causing undue delays in availability or use of foreign exchange for current international payments and transfers. - Payments for “current” transactions are defined in Article XXX(d); these include payments relating to trade, services, interest on loans and income, and certain payments that may be characterized as capital for reporting purposes (e.g., moderate amounts for amortization of loans or for depreciation of direct investment). - “International” current transactions generally mean transactions between countries; specific territorial examples are noted in the provision. - Article VIII, Section 2(a) targets restrictions “imposed” by a member; exchange restrictions that do not result from governmental acts are not subject to the Fund’s jurisdiction. ### Multiple Currency Practices Maintained Under Article XIV - Article XIV provides transitional arrangements allowing a member to maintain MCPs or exchange restrictions that were in effect on the date it became a Fund member, with an obligation to consult with the Fund annually regarding their removal. - Any measures introduced by authorities after joining the Fund are not protected by Article XIV, Section 2 and will give rise to a breach of Article VIII, Section 3 unless approved by the Fund. - Article XIV, Section 2 expects members to withdraw such measures as soon as they are satisfied they can settle their balance of payments without undue encumbrance to access to the Fund’s general resources; in exceptional circumstances the Fund may make representations to a member that the circumstances are ripe for removal of such measures (Article XIV, Section 3). - Persistent failure to remove such measures may lead to ineligibility to use the Fund’s general resources under Article XXVI, Section 2(a). - The Fund has used tools to facilitate removal of measures maintained under Article XIV, including Fund-supported programs, surveillance and technical assistance (TA). Fund-supported programs have, in certain cases, included structural conditionality requiring members to accept the obligations of Article VIII, Sections 2, 3 and 4 or to remove specific exchange measures maintained under Article XIV. - Countries noted as still relying on the transitional arrangements under Article XIV as of the date of the paper: Afghanistan, Angola, Bhutan, Bosnia and Herzegovina, Burundi, Eritrea, Ethiopia, Iraq, Liberia, Maldives, Myanmar, Nigeria, Sao Tome and Principe, Somalia, Syrian Arab Republic and Turkmenistan. The text notes that many of these countries no longer maintain any MCPs or exchange restrictions under Article XIV. ### MCPs and Fund Surveillance (Article IV linkages and consultations) - Article VIII, Section 3 and Article IV are closely related; under Article IV Fund members undertake to collaborate with the Fund and other members to assure orderly exchange arrangements and to promote a stable system of exchange rates, and the Fund is required to exercise surveillance over each member’s policies. - ISD and predecessors recognize indicators that may suggest the need for additional consultations to ensure compliance with Article IV obligations; MCPs are designed to help further surveillance objectives. - Specific linkages and implications: - Members have the freedom to determine their exchange rate arrangements, but this freedom does not permit engaging in MCPs. - If substantial spreads arise in the market but do not give rise to MCPs (e.g., because they do not arise as a result of official action), the Fund may call on a member to consult with it under Article IV. - MCPs may be considered in assessing indicators that signal the need for additional discussion of compliance with the Principles for the Guidance of Members’ Policies under the ISD. - Approval criteria for MCPs echo Article IV, Section 1(iii) prohibiting manipulation of exchange rates to gain an unfair competitive advantage. - Consultation and reporting requirements: - In principle, both MCPs and exchange restrictions must be covered in Article IV consultations; as part of Article IV staff work, staff must determine whether a member has introduced or continues to maintain MCPs or exchange restrictions that require Fund approval or are covered under Article XIV. - MCPs and exchange restrictions are required to be identified in the staff report, and the staff appraisal should make a recommendation concerning Board approval. Staff should inform members that failure to notify and seek Fund approval would be a breach of their obligation under the Articles. - Modalities for concluding consultations (per Box 4): - Article IV consultations are typically concluded by way of a summing up, rather than a formal Board decision. - Article VIII: where approval of an exchange restriction or MCP is not being sought, no formal Board decision is taken; the Board makes a finding in the summing up when it endorses staff conclusions. Where staff recommends approval and the Board agrees, a formal Board decision is taken. - Article XIV: a formal Board decision is required to conclude the consultation. - Relevant decisions and guidance referenced: - Decision No. 15203-(12/72), adopted July 18, 2012 (Integrated Surveillance Decision). - Decision No. 1034-(60/27), adopted June 1, 1960 (guiding principle on restrictions). *Source: ppea2019015 - Historical Development and Legal Framework of the MCP Policy (excerpts).* ### 31. While the Fund has consistently discouraged members from using MCPs, it may ### 31. While the Fund has consistently discouraged members from using MCPs, it may ### Approval policy for multiple currency practices (MCPs) - The Fund is prepared to grant approval for MCPs introduced or maintained for balance of payments if: - the measures are temporary; - they are being applied while the member is endeavoring to eliminate its balance of payments problems; - and they do not give the member an unfair competitive advantage over other members or discriminate among members. - For MCPs imposed for non-balance of payments reasons, approval may be granted if: - the practices do not materially impede the member’s BOP adjustment; - they do not harm the interest of other members; - and they do not discriminate among members. - Where an exchange measure gives rise both to an MCP and an exchange restriction, approval can currently only be granted if it is introduced or maintained for balance of payments reasons because the approval policy for exchange restrictions does not allow approval for non-balance of payments reasons. - The approval policy and other approval criteria are set out in Decision No. 6790-(81/43), adopted March 20, 1981, as amended. ### Duration of approval and amendments to Decision No. 6790 - Approval for MCPs is generally granted for a one-year period to allow for regular Executive Board review in the context of Article IV consultations. - In 1998 a minor amendment was proposed and paragraph 5 of Decision No. 6790 was amended to allow a longer approval period “where the practice is maintained only for existing arrangements and for a specified period of time” to address cases where legal commitments remain after formal elimination of a scheme. - This amendment is noted as the only amendment to Decision No. 6790 since 1981. ### Legal consequences and enforcement practice - An unapproved MCP is a breach of a member’s obligations under the Articles and could lead to sanctions under Article XXVI, Section 2(a), including ultimately compulsory withdrawal. - In practice: - many Fund members have maintained MCPs that would have required approval and have either not requested approval or the Fund has not approved maintenance, placing them in breach of the Articles; - rather than imposing Article XXVI, Section 2(a) sanctions, the Fund has pursued a collaborative approach and refrained from applying those sanctions to date. - Management has not issued a “complaint” to the Executive Board alleging breach of Article VIII, Section 3 obligations; under Rule H-2 another member could bring such a complaint. ### MCPs and Fund conditionality - Since 1980, Fund arrangements have included a standard continuous performance criterion prohibiting the introduction or modification of MCPs during the arrangement period. - This performance criterion has since been extended to other Fund arrangements and non-financing instruments. - The introduction or modification of an MCP during a Fund arrangement blocks a member’s right to make purchases or request a disbursement unless the Executive Board grants a waiver of non-observance. ### MCPs and capital transactions: scope and long-standing debate - Article VIII, Section 3 prohibits members from maintaining unapproved MCPs but does not specify whether the obligation applies only to current transactions or also to capital transactions; Article VIII, Section 2 explicitly addresses current international transactions, creating ambiguity. - Staff position (first articulated in 1955): - Article VIII, Section 3 prohibits discriminatory currency arrangements and MCPs that relate solely to capital transactions unless authorized under the Articles. - This view rests on the idea that obligations under Article VIII, Section 3 form part of obligations concerning exchange rates and exchange stability in Article IV, which are not limited to current transactions. - Distinguishing current and capital transactions can be complex because Article XXX(d) treats several transactions that are economically capital in nature as current for Fund purposes. - Executive Board and Committee on Interpretation positions: - In 1956, the Committee on Interpretation rejected staff’s position that Article VIII, Section 3 restricted MCPs applicable solely to capital transactions, finding the issue complex and related to the relationship with “the provisions of the Fund Agreement with regard to rates.” - The Committee concluded to “keep this aspect of the problem under consideration.” - Subsequent Board discussions in 1979, 1984, and 1985 did not produce consensus. - As a result: - while staff identifies MCPs applicable to capital transactions in Article IV consultation reports, no finding of a breach of obligation is made and such MCPs are not subject to Fund approval. ### Institutional developments and the Institutional View (IV) - In the late 1990s, an amendment to the Articles was discussed that would have: - given the Fund an explicit purpose to promote liberalization of capital movements; and - established Fund jurisdiction over the capital account, prohibiting restrictions or MCPs on certain international capital movements without IMF approval. - The amendment proposal lost support after the Asian crisis in 1997 and did not materialize. - In 2012 the Fund adopted its Institutional View on liberalization and management of capital flows (IV): - The IV does not change members’ rights and obligations under the Articles and has the status of policy advice. - The IV acknowledges potential overlap with Article VIII, Sections 2 and 3 and states it does not alter the Fund’s jurisdiction or policies under Article VIII, Section 2(a) and 3. - The IV did not expressly resolve the Fund’s jurisdiction over MCPs related solely to capital transactions. ### MCPs and the WTO framework - MCPs can be considered discriminatory trade practices and are relevant under the WTO legal framework; MCPs arising from export subsidies or exchange taxes are generally prohibited under WTO rules. - MCPs maintained by countries in accordance with IMF Articles (i.e., temporarily approved by the Fund under Article VIII or maintained under Article XIV transitional arrangements) are not subject to WTO discipline. - WTO instruments defer to the Fund’s determination on consistency with the Fund’s Articles: - GATT Article XV, 9(a) provides that use of “exchange controls or exchange restrictions” in accordance with the Fund’s Articles does not violate the GATT; the WTO understands this term to extend to MCPs. - GATT Article XVI (Ad Article XVI) and GATT Article VIII (Ad Article VIII) allow certain multiple rates or multiple currency exchange fees “in accordance with” or “for balance of payments reasons” if consistent with the Fund’s Articles. - GATS Article XI, paragraph 2 states nothing in the GATS can “affect the rights and obligations” of Fund members under the Fund’s Articles, including exchange actions “in conformity” with the Fund’s Articles; this is understood to ensure MCPs approved by the Fund are consistent with GATS obligations. - The 1996 Cooperation Agreement formalizes close cooperation and consultation between the Fund and the WTO to achieve greater coherence in global economic policymaking. *Review of the Fund’s Policy on Multiple Currency Practices: Initial Considerations—Economic Context and Experiences—Background Paper II (excerpt).* ### 1. Survey Questionnaire ____________________________________________________________ 26 ### 1. Survey Questionnaire ____________________________________________________________ 26 ### Figures - 1. Costa Rica MCP (1980-83) ________________________________________________________ 9 - 2. Incidence of MCPs in Fund Membership _________________________________________ 12 - 3. Incidence of Multiple Currency Practices by Region _____________________________ 13 - 4. Type of MCPs ____________________________________________________________________ 14 - 5. Composition of MCPs ____________________________________________________________ 16 - 6. Approval of MCPs ________________________________________________________________ 19 - 7. MCPs and Article VIII Acceptance ________________________________________________ 20 ### Tables - 1. MCP Episodes: Selected Country Case Studies ___________________________________ 10 - 2. Logit Analysis: Causes of MCPs, 1980-2016 ______________________________________ 22 - 3. Regression Analysis: Macroeconomic Impacts of MCPs, 1980-2016 ______________ 23 - 4. Recent MCPs: Selected Experiences ______________________________________________ 27 *ppea2019015 - 1. Survey Questionnaire ____________________________________________________________ 26* ### References _________________________________________________________________________ 28 ### ppea2019015 - References ### REVIEW OF LITERATURE AND COUNTRY CASES: 1925–1983 - MCPs have been used for two main purposes: (i) stabilization of short-term BOP pressures; and (ii) revenue mobilization or resource allocation. - Short-term: MCPs have had partial success stabilizing BOP position and capital flows. - Medium/long-term: MCPs have been associated with adverse effects, especially when persistent. - Country case studies surveyed: Argentina (1981 and 1982), Costa Rica (1980–83), Cuba (1925–50s), Honduras (late 1930s–50), Indonesia (1950s and 1960s), Jamaica (1977–80), Mexico (1982), the Philippines (1951–65), Romania (late 1970s–80), Turkey (late 1970s-80), Venezuela (early 1960s). - Note: Not all surveyed countries were necessarily identified by the IMF as having had an MCP. ### WHY AND HOW HAVE COUNTRIES IMPOSED MCPS? - Primary motivations: - Mitigate BOP pressures and/or capital flow volatility (de la Torre and Ize 2013; IMF 1984a; Kiguel and O’Connell 1994). - Revenue mobilization or special resource allocation objectives (IMF 1984a; Sherwood 1956). - Typical context: introduced after a large negative external shock, often with underlying vulnerabilities (expansionary fiscal policies and/or rapid domestic credit expansion under a fixed exchange rate). - Examples: Jamaica (1977–80) and Venezuela (early 1960s) imposed MCPs following deterioration in terms of trade. - Revenue rationale: - Administration of multiple rates easier than direct taxation under weak state capacity (Fleming 1974; Dornbusch 1986). - Revenue collection via MCPs can be sizable in the near term. - Tax revenue obtained from MCPs was 4.6, 20.5, and 5.2 percent of total revenue in Cuba, the Philippines, and Venezuela, respectively, over the years 1951–54. - Exchange taxes, export taxes/subsidies, and import surcharges gave rise to MCPs in various countries (examples: Honduras, the Philippines, Nicaragua, Indonesia). - Market structure and segmentation due to exchange controls explain emergence/persistence (IMF 1984b); example: Jamaica’s split “basic” market and a depreciated second market. ### NEAR-TERM CORRECTIVE EFFECTS OF MCPS - Theoretical channel: raising effective import prices relative to export prices, ceteris paribus, should improve trade/current account balances primarily through import reduction (Dornbusch 1986). - Empirical examples: - Costa Rica (1980–83): sharp decline in import volumes and stable export volumes after tightening trade and exchange systems including MCPs (IMF 1984b). - Venezuela (early 1960s): acute BOP difficulties mitigated at least temporarily under MCPs and exchange controls (Woodley 1964). - Mexico (1982): MCPs insulated the economy from unsustainable capital flows and prevented further capital flight (IMF 1984a, 1984b). - Macroeconomic trade-off management: - MCPs can partially insulate domestic prices from foreign shocks in the short term (Ghei and Kiguel 1992). - Argentina and Mexico (1981–82) and Venezuela (early 1960s) used MCPs to reduce pressure to tighten monetary policy while protecting the BOP. - Revenue-raising: even small exchange taxes or spreads can generate sizable revenue relative to other tax sources. - Parallel FX market: can provide limited short-term insulation (Ghei and Kiguel 1992). ### DISTORTIVE EFFECTS OF MCPS - Macro growth impact: - IMF (1984b) finds real output growth lower in three out of four years and inflation higher in all four years for MCP countries (1979–82); both export and import volumes were lower, leading to a lower ratio of current account deficit to exports of goods and services. - Export sector distortions: - Exchange rate spread acts as an implicit tax on exports and subsidy on basic imports, undermining exporting and import-substituting industries (Dornbusch 1986; Kiguel and O’Connell 1994; Woodley 1964). - Representative episodes: Argentina and Mexico (early 1980s), Venezuela (early 1960s). - Rent-seeking and illegal leakage: - Exchange rate spreads create wedges between private and social interests, incentivizing rent-seeking (de la Torre and Ize 2013). - Different rates create opportunities for illegal leakage (over-invoicing imports, under-invoicing exports) weakening effectiveness (Fan 2004). - Incidence on consumers and investors: - Exchange-conversion taxes shift incidence to domestic consumers through higher prices or reduced receipts; may deter foreign investment (Sherwood 1956). - Difficulties of removal and postponement of adjustment: - MCPs often became long-lasting devices delaying fiscal/monetary adjustment (Venezuela early 1960s; Cuba; Philippines). - IMF (1984) findings: - From 1970 to 1983, 12 members had multiple exchange rates continuously; for 61 members maintaining explicit MCPs at some time over this period, average duration was five years. - Systems implemented using complex mechanisms subject to numerous modifications; partial free market mechanisms sometimes contributed to capital outflows and instability (examples: Argentina 1981–82; Costa Rica 1980). - Frequent changes generated uncertainty, disrupting foreign trade and creating speculative trade activities (anticipation of depreciation led exporters to withhold shipments and repatriation; importers to stockpile and over-invoice). ### CROSS-BORDER SPILLOVERS - MCPs can adversely affect other countries via trade and investment channels: - Differentiation among trade partners (transfer payment burden to non-preferred partners) can distort trade and generate retaliatory measures (Romania late 1970s–80). - Taxes on remittances deter foreign investment (Philippines). - Conceptual parallels: MCP effects comparable to direct and indirect tax/subsidy policies that change relative prices (Dornbusch 1986); taxes/subsidies on capital transactions under exchange controls resemble MCPs (Fleming 1974). ### BALANCING CORRECTIVE AND DISTORTIVE EFFECTS - Consensus from literature and experience: MCPs likely have partial short-term success but negative long-term effects. - Fund policy stance suggested: - Continue to discourage members from using MCPs. - Accept limited, temporary MCPs only as a partial step toward exchange rate adjustment or market development completion. - Reiterate desirability of avoiding reliance on multiple exchange rates or establishing concrete plans for elimination where they existed. ### RECENT EXPERIENCE WITH MCPS: 1980–2017 — EVOLUTION AND MACRO DRIVERS - Historical trend: - MCPs frequent in early Fund history; use dropped significantly by early 1980s. - Early 1980s: about 30 percent of Fund members maintained MCPs. - Peak incidence: 1986, with about a third of EMDCs maintaining MCPs. - Decline thereafter as global economy recovered and U.S. dollar depreciated after the Plaza Accord in 1984. - Share of countries with MCPs in international trade and GDP (1982 to 2017): - Share in international trade: from about 12 percent in 1982 to about 4 percent by 2017. - Share of world GDP: from 14 percent to 5 percent. - Share of EMDC GDP: from 56 percent to 13 percent. - Post-Global Financial Crisis (GFC): - Number of countries with MCPs increased marginally; at end-2017 there were 45 MCPs maintained by 28 countries. - Recent MCPs concentrated in lower-middle and low-income countries, particularly Africa and Middle East. - Many recent MCPs (particularly potentiality-based) arose from efforts to move toward more liberalized FX markets (e.g., FX auctions, computation of official rates under a floating regime). - MCPs have become more prevalent among countries with more flexible exchange rate arrangements. ### CHARACTERISTICS AND FREQUENCY OF MCPS - Total MCPs: declined from a peak of 102 in 1986 to a trough of 29 in 2006; has risen recently. - Typical country: maintains more than one MCP; average number per country ranges between 1 and 2. - Composition changes since 1980s: - Decline in MCPs used to discriminate against certain transactions (subsidies, tax, guarantees). - Spread-based MCPs (formal vs parallel market) remain sizable (9 MCPs as of end-2017). - Increase in “potentiality-based” MCPs (about one third of total MCP findings recently). - Potentiality-based MCPs: - Arise when official exchange rate calculation (e.g., lagged based on previous day’s transactions) can deviate by two percent or more from market rates. - Multiple price FX auctions create potential spreads unless mechanisms keep accepted bids within 2 percent; since 2000, 15 countries found to have MCPs from multiple price auctions. - Declining MCP types: - Taxes on FX conversion/transfer, subsidies, guarantees have declined over time. - Tax-related MCPs: 67 MCPs from exchange taxes in last 35 years; about one third targeted invisible transactions. - Subsidy-related MCPs: only one current subsidy-related MCP (legacy schemes); historical examples mostly disappeared by 2000. - Guarantees: currently only one MCP (Tunisia). - Parallel market premia MCPs: - Emerged in commodity-exporting countries after terms-of-trade shocks. - Removal often occurred via unifying exchange rates supported by IMF programs. - Other MCP types that decreased: - Margin requirements and unremunerated advanced import deposit requirements common in 1980s, rare thereafter. - Bilateral payment agreement (BPA) MCPs virtually disappeared; currently one (Democratic Republic of Congo). - Broken cross rates rare; 10 instances since 1980 (6 historical, 3 since mid-1990s: Jamaica, Myanmar, Belarus). - MCPs solely on capital transactions are rare; examples include Belgium (until 1982), South Africa (1980s), and episodic cases in Philippines, India, Argentina, Mauritius. ### APPROVAL OF MCPS - Typical durations: - Average MCP duration: about 4.4 years. - Median: 3 years. - Mode: 1 year. - Over 20 percent eliminated within a year of identification; 8 percent eliminated in less than a year. - Some current MCPs: 2 have been in place for more than 25 years. - Reasons for long duration: - Taxes often persist >10 years; authorities need time to reform tax frameworks. - Potentiality-based MCPs persist if FX markets not developed to produce real-time reliable quotes. - Legacy guarantee schemes and interrupted surveillance (Eritrea, Somalia, Syria) delay MCP finding updates. - IMF approval statistics (since 1980; total MCPs reported = 506): - 108 measures (21 percent) were approved. - 79 measures (16 percent) were approved only for a part of their duration. - 298 measures (56 percent) were never approved. - Rest not subject to approval (MCPs solely related to capital transactions or Article XIV MCPs). - Reasons for lack of approval: - In >70 percent of non-approved cases, no clear timetable for removal. - Second reason: authorities did not request approval. - About 7 percent not approved because discriminatory (e.g., BPA). - Approval likelihood by type: - Parallel market MCPs and MCPs from official/specific transaction rate differences less likely to be approved. - Multiple price auction MCPs (potentiality-based) more likely to be approved. - Taxes and guarantees often approved later when authorities commit to removal plans. ### MCPS AND ARTICLE VIII ACCEPTANCE - Article status and MCPs: - Of 171 IMF members that accepted Article VIII status by 2017, 19 (11 percent) maintained MCPs. - Of 18 Article XIV members, 9 (50 percent) maintain MCPs. - Only a small fraction of MCPs maintained by Article XIV members are covered by Article XIV transitional arrangements; as of the report, South Sudan is the only country maintaining an MCP under Article XIV. - Historical pattern: - Article XIV MCPs prevalent in 1980s and 1990s with the rise of new IMF members after collapse of communist bloc; disappeared by 2000 until South Sudan joined in 2012. - Note on Article XIV: transitional arrangements allow members to maintain/adapt exchange restrictions and MCPs in place at membership; once a member notifies acceptance of Article VIII obligations, it can no longer rely on Article XIV. ### MACROECONOMIC PERFORMANCE OF COUNTRIES WITH MCPS: 1980–2016 — INTRODUCTION - Empirical analysis challenges: - MCPs often associated with poor economic performance, but evidence is scarce and causality is difficult to establish due to endogeneity. - Data and scope: - Unique database on MCPs constructed from IMF staff reports covering 154 IMF member countries (excluding advanced economies) from 1980 to 2016, annually. - For countries joining IMF later, data starts from year of membership. - Analytical approach: - One set of regressions analyzes macroeconomic factors associated with the presence of MCPs. *International Monetary Fund — MCPS: Economic Context and Experiences (selected excerpts).* ### introduction and maintenance of MCPs. Another set of regressions analyzes growth and inflation ### introduction and maintenance of MCPs. Another set of regressions analyzes growth and inflation ### B. Performance Before MCPs - Finding: Countries introduce and maintain MCPs when faced with macroeconomic concerns. - Logit-model evidence (Table 2) identifies factors associated with a greater probability of maintaining MCPs: - High inflation (coefficient 0.019, z-statistic 2.480; column (1)) - A depreciating real exchange rate (∆ Real effective exchange rate coefficient -0.012, z-statistic -1.770; column (1)) - Lower international reserves (∆ Reserves coefficient -0.038, z-statistic -1.740; column (1)) - Worsening terms of trade (∆ Terms of Trade coefficient -0.698, z-statistic -1.640; column (1)) - Additional associations: - Low trade shares (Trade openness coefficient -0.021, z-statistic -2.520; column (1)) - Low income levels (GDP per capita coefficient -0.447, z-statistic -2.020; column (1)) - Non-significant relations: - No statistically significant relation found between the probability of MCPs and GDP growth (Growth coefficients reported across columns: 0.869, -2.018, 0.577, -1.541 with respective z-statistics (0.380), (-0.840), (0.290), (-0.720)) - No statistically significant relation found between the probability of MCPs and the fiscal balance (note: regressions with the fiscal balance are reported separately because inclusion significantly reduces observations) - Table 2 sample and estimation details: - Observations: 3040 (columns (1) and (3)) and 2199 (columns (2) and (4)) - Number of countries: 126 (columns (1) and (3)) and 117 (columns (2) and (4)) - Advanced economies are excluded from the regressions. - All regressors are lagged. Z-statistics reported in parentheses. The qualitative results remain the same when country fixed effects and year fixed effects are controlled for. - Significance notation: ** p < 0.05; * p < 0.1. ### C. Performance with MCPs - Caution: Fundamental endogeneity issue—countries with macroeconomic concerns and BOP difficulties tend to resort to MCPs—requires using lagged variables and including regressors related to causes of MCPs to minimize bias. - Finding from linear regressions (Table 3 summary in text): - Countries with MCPs tend to experience lower growth. - Countries with MCPs tend to experience higher inflation. - Potentiality-based MCPs do not have a significant impact on growth and inflation. - Interpretation: - Lower growth after introduction of MCPs aligns with observed slower and smaller post-crisis recovery in GDP for countries with MCPs; pre-crisis performance shows no marked difference. - Inflation is both related to factors leading to MCPs and is affected by MCPs after crises. ### Selected Recent MCPs: Insights from Survey of Country Teams (Survey conducted January 2018) - Survey scope: - Countries with current or recently eliminated MCPs as of January 2018: Iran, Iraq, Maldives, Nigeria, Papua New Guinea, South Sudan, Sudan. - Countries with MCPs eliminated: Myanmar, Sao Tome and Principe, Suriname. - Responses were qualitative and based on staff assessments. - Primary motivations for introducing MCPs: - Mitigate balance of payments (BOP) pressures, including terms of trade shocks (Nigeria, Sudan, Suriname) and weak macroeconomic policies (Myanmar, Suriname). - Typical official actions leading to MCPs: - Limiting availability of FX (examples: limiting supply of FX at official exchange rate to commercial banks in Maldives; allocating FX to priority imports in Papua New Guinea; setting preferential rates for certain imports in Iran). - Staff assessment on addressing root causes: - Generally, MCPs did not address fundamental reasons for BOP pressures. - Alternatives often identified by staff: - Fiscal consolidation and phasing out of monetary financing (Iraq, Myanmar, South Sudan). - Fiscal and economic reform, including mobilization of non-oil revenues (South Sudan). - Increased exchange rate flexibility (South Sudan). - Targeted subsidies to imports instead of FX allocation or preferential rates (Papua New Guinea, Suriname). - Reported domestic distortions and external spillovers associated with MCPs: - Decrease in production and related outcomes: - Increased unemployment (Papua New Guinea). - Heightened volatility in exchange rates (Sao Tome and Principe). - Increased uncertainty of doing business (South Sudan, Sudan, Suriname). - Shortages in imports of intermediate goods (Papua New Guinea). - Loss of export competitiveness (Iran). - Lower government revenues (Suriname). - Reduced incentives for domestic production when imports subsidized (Iran). - Increase in inflation: - Associated with depreciations in parallel market exchange rates (Nigeria, Sao Tome and Principe, South Sudan). - Expansion of informal economy, rent seeking, weakened governance: - Expansion of informal economy (Sudan). - Rent seeking and weakened governance; reduced monitoring capacity for FX transactions (South Sudan, Suriname). - Financial sector effects: - Crowding out of bank lending as banks exploit spread between official and parallel rates (Iraq). - Impaired monetary transmission (Maldives). - External spillovers: - Lower trade and FDI (Myanmar). - Higher cost of repatriating investment income from abroad (Iraq) and remittances (South Sudan). - Reduced capital inflows (South Sudan). - Distorted trade (Sudan). - Table 4: Selected country experiences (high-level entries preserved as presented) - Iran - Official actions leading to MCPs: Providing FX for certain imports at preferential rates - Domestic distortions: Increases pressure on FX reserves; disincentivizes local production of intermediate goods - Externalities: Lowers export competitiveness; subsidizes industries importing intermediate goods - Iraq - Official actions: Limit on FX availability - Alternative potential policies: Fiscal consolidation - Domestic distortions: Crowds out bank lending; restricts financial sector development - Externalities: Raises cost to repatriating investment income - Maldives - Official actions: Rationing of FX at official rate to commercial banks - Alternative potential policies: Support demand for local currency - Domestic distortions: Weakens monetary policy transmission; limits central bank control of FX market - Externalities: Limited - Myanmar (eliminated in 2013) - Official actions: Limit on FX availability for both residents and nonresidents - Domestic distortions: Increases transaction costs - Externalities: Discourages FDI and trade - Nigeria - Official actions: Limit on FX availability - Alternative potential policies: Exchange rate flexibility - Domestic distortions: Increase in parallel market spread and distortions in economic decision making, likely contributing to higher inflation and lower economic growth - Externalities: Extended waiting period for repatriation of FX investments - Papua New Guinea - Official actions: Rationing of FX at official rate - Alternative potential policies: Free auctions and subsidies for crucial imports - Domestic distortions: Deepens and extends FX shortage; adverse effects on production and employment - Externalities: Importers face significant delays; difficulty obtaining FX to make dividend payments abroad - Sao Tome and Principe (eliminated in 2011) - Official actions: Rationing of FX - Domestic distortions: Higher exchange rate volatility; higher inflation - South Sudan - Official actions: Limit on FX availability - Alternative potential policies: Exchange rate flexibility; reduce inflation by stopping central bank financing of budget - Domestic distortions: Disintermediation of FX from formal market; high inflation; dollarization; rent-seeking and weakened governance - Externalities: Subsidizes imports; raises cost of remittances; increases uncertainty in doing business - Sudan - Official actions: Limit on FX availability; cash margin requirement for most imports - Alternative potential policies: Macroeconomic adjustment - Domestic distortions: Increases cost of doing business; weakens governance; damages macro credibility; enlarges informal economy - Externalities: Distorts trade - Suriname (eliminated in 2016) - Official actions: Providing FX at special rates for certain products and economic agents - Alternative potential policies: Adequate response to terms of trade shocks; targeted subsidies - Domestic distortions: Creates anti-export bias; undermines government revenues; reduces capacity for monitoring of FX transactions - Externalities: Increases uncertainty in doing business - Source for Table 4: IMF country team surveys. ### Methodology and Context (selected points from surrounding methodology chapter) - Purpose of new methodology (Main paper summary): - Assess exchange rate deviations that may result in MCPs using a market-based, country specific market norm rather than a uniform two-percent rule for permissible spreads. - Retain principle of commercial reasonableness: differentials arising from official action give rise to an MCP only if they exceed what could be attributed to normal commercial costs. - Rationale: - Developments in FX markets and availability of granular market data enable introduction of a market-based norm. - A tolerance margin for deviations remains important to avoid minor deviations leading to MCP findings. *Source: IMF staff estimates and country team survey material as presented in the supplied content.* ### 4. Price formation in the FX markets differs depending on the settlement date of the ### 4. Price formation in the FX markets differs depending on the settlement date of the transactions. ### Spot markets: transaction settled at maximum t+2 days - Staff distinguish between spot (settle at or less than t+2 days) and non-spot (settle at more than t+2 days) transactions; settlement date affects price formation and rates in the two markets cannot be directly compared. - Interdealer (wholesale) market is the “real” market where spot rates are formed; FX intermediaries (banks) intermediate to end users under a no-loss constraint, manage positions among themselves, and engage in proprietary trading to exploit arbitrage and keep a unitary system of exchange rates. - End-user pricing depends on transaction size: - Large transactions (usually corporations) are dealt with at banks’ treasury level and are fully integrated in wholesale pricing because they create positions that must be managed without delay. - Smaller transactions (typically individuals) are managed by bank branches that receive a budget and daily schedule of rates from the treasury; retail rates = wholesale rate + intermediary overhead costs and profit margins (dependent on retail competition). - Under the new methodology, FX transactions involving banknotes are classified as a segment of the spot retail market and have additional costs related to handling banknotes compared to electronic payments. - Interdealer market rates define all other spot rates where an interdealer market exists; staff propose interdealer market rates as core exchange rates for spot transactions for three reasons: - (i) it is the “real” market on which spot rates are formed; - (ii) it can be monitored continuously based on reliable benchmarks; and - (iii) official actions are typically reflected in wholesale-type transactions. ### Non-spot markets: transaction settled at more than t+2 days - The non-spot market provides hedging against exchange rate risk and includes forwards, swaps, and options—markets for future exchange rate transactions where rates are locked in advance or guaranteed. - Exchange rates prevailing in the wholesale forward market on the day of the transaction are considered an adequate proxy for commercial reasonableness for forward transactions. ### Market development since 1979 - Major developments: deepening and increasing sophistication of international FX markets. - Historical and recent turnover figures: - In 1979, available data showed USD 5.3 billion daily turnover on the New York stock exchange; spot, outright forwards, and swaps represented respectively 55.2 percent, 5.3 percent, and 29.5 percent of the total transaction amount. - According to the latest BIS “triennial central bank survey” referenced, average daily turnover in the foreign exchange markets was above USD 5 trillion, more than four times its level in 1995. - Liberalization reduced the number of countries without an interdealer market, but cases remain where wholesale markets do not exist: - The country has no separate legal tender (14 members). - Exchange rates are fixed at par or with a very narrow spread between the central bank’s FX buying and selling rates (10 members). - FX regulations explicitly or implicitly prohibit interbank transactions. - Trends in surrender requirements: - Number of countries with a full surrender requirement to the central bank declined from 22 in 1999 to 9 in 2016. - Number of countries with partial surrender requirements declined from 44 to 27 over the same period. - Standardization and technology: - Standardization of practices and technological advancement increased comparability of FX benchmarks. - Electronic platforms are the preferred trading channel with a share above 50 percent for all customer segments. - Spot segment: 64 percent of trades conducted electronically; some market reports suggest as much as 95 percent of all spot transactions could be electronic. - Banknote segment of the spot market: - 1979 review estimated banknote segment at USD 100 million in June 1978 (compared to USD 5.3 billion daily turnover for the rest of the market). - Evidence on banknote market turnover is limited; shipments-based estimates exist for euro and USD circulating outside home areas but do not measure market turnover. - Example country: banknote volume declined from 2.7 percent of spot transactions in 2003 to 0.5 percent in 2017. - Derivatives growth: - All FX derivatives (forwards, swaps, options) experienced rapid increase in turnover. - Foreign exchange swaps account for 47 percent share of the global market; outright forwards account for 14 percent. - FX swaps are mostly traded among intermediaries for liquidity management; forwards are mostly used by end-users. ### Market data availability and proposed sources - Data availability has increased substantially since 1979; staff previously relied on phone interviews and could include only 36 currencies in the 1979 review. - Today standardized exchange rate benchmarks (bid/ask, high/low, open/close, intraday and closing) are prepared and published daily by professional international benchmark administrators for all but five IMF members. - Staff proposes Thomson Reuters DataStream as the primary source of wholesale exchange rates; for the 14 members where DataStream data are not available, data can be sourced from Bloomberg. - Both Thomson Reuters and Bloomberg methodologies are subject to independent assessment of compliance with IOSCO principles for computation of financial benchmarks. - Predefined order of data sources to limit excessive reliance on a single source: - Primary: Thomson Reuters DataStream. - Secondary: Bloomberg. - If neither source can be used, representative exchange rates from other sources, including authorities, may be used if computed in compliance with IOSCO principles. - Typical difference between wholesale and retail/banknote rates: - Median difference between wholesale rates and banknote rates was 70 basis points on March 26, 2018. - Banknote wholesalers reported charging 15 to 20 basis points per 100 USD (30 basis points for higher risk location), implying a typical profit margin at about 50 basis points. ### Box 1 — Methodology for computation of FX benchmarks (summary of benchmark practices) - Thomson Reuters (World Markets/Reuters — WMR) computes FX reference benchmarks for 155 currencies; forward coverage for 76 currencies on Thomson Reuters. - WMR benchmark computation features: - Validation via pre-defined robustness checks, outlier rules, and expert judgment; suspicious contributions discarded; rates are the median of validated contributions from multi-contributor sources. - Sources by order of priority: (i) actual traded rates; (ii) rates of orders placed in matching order systems; (iii) banks’ quotes. In less liquid markets, bid/offer rates or prior transactions form the basis. - Primary infrastructure: Thomson Reuters Order Matching, EBS, Currenex; quotes from Reuters dealing system; other sources (central bank spot rates, official fixings) used as necessary. - Markets are grouped by liquidity for computation and validation: Trade Currencies (top 22), Nontrade Currencies (all others), Locally-traded Currencies (9 currencies), and CB or Official-fixing Currencies (15 currencies). - The 22 “Trade Currencies” list includes: AUD, CAD, CHF, CNH, CZK, DKK, EUR, GBP, HKD, HUF, ILS, JPY, MXN, NOK, NZD, PLN, RON, RUB, SEK, SGD, TRY and ZAR. - Locally-traded Currencies (9): CNY, IDR, INR, KRW, MYR, PHP, THB, TWD and BRL. - CB or Official-fixing Currencies (15): AOA, BOB, BZD, CRC, ETB, HNL, HTG, JMD, KGS, MRO, MVR, NIO, SRD, TTD and VEF. - Bloomberg BFIX: - BFIX FX reference rates are half-hourly snapshots of Bloomberg Generic Composite (BGN) using a time-weighted average price (“TWAP”) around fixing time. - BGN derives indicative bid and ask quotes from hundreds of sources (money-center and regional banks, broker-dealers, inter-dealer brokers, trading platforms); data are indicative and not based on actual trades. *Source: IMF staff — "Price formation in the FX markets differs depending on the settlement date of the transactions."* ### 21. Staff proposes replacing the current two percent rule with an indicator that reflects ### 21. Staff proposes replacing the current two percent rule with an indicator that reflects ### Rationale for change - Staff proposes replacing the current two percent rule with an indicator that reflects the range of exchange rates traded on a given day. - The bid/ask spread was considered as an improved application of the current two percent rule but not retained because: - The bid/ask spread is an imperfect benchmark for a market-based norm under the MCP policy. - In most cases (86 percent), the bid/ask spread is lower than 2 percent with most of the distribution concentrated between 0 and 75 basis points. - Official rates are 3.5 times more likely to deviate from the bid/ask spread than from the High/Low (H/L) range. - The bid/ask spread can be affected by less liquid markets and by stressed market conditions. ### Proposed market indicator (High/Low, H/L) - Market indicator defined: the highest and lowest wholesale exchange rates in the market on a given day (H/L). - Justification: - H/L reflects market developments during the day and reduces likelihood of “false” findings caused by timing of official reference rates. - FX market participants considered the H/L norm as most representative of market rates. - Although H/L range differs by country, the approach preserves uniformity through consistent methodology across members. - Mathematical expression (market boundary requirement): - (1) LOW ≤ R ≤ HIGH - R is the exchange rate arising for official action; - HIGH is the highest wholesale exchange rate of the day, i.e., the most depreciated rate of the day; - LOW is the lowest wholesale exchange rate of the day, i.e., the most appreciated rate of the day. ### Manipulation risk and safeguards - Main limitation: H/L range can be susceptible to manipulation through wash or round-tripping trades that widen the H/L range for the trading day. - Benchmark providers have built-in robustness checks to provide safeguards against potential manipulation. ### Tolerance margin to avoid capturing insignificant deviations - Staff proposes an additional tolerance margin (m) set as a percentage of the mid of the high and low rates (M_H/L) to avoid capturing small deviations without economic consequence. - Rule for MCP with tolerance margin: - (2) |R − M_H/L| / M_H/L ≤ m% - Staff recommendation: - A tolerance margin of +/- 2 percent around the mid of the H/L is considered adequate. - Empirical support: - 95 percent of the deviations are less than 2 percent from the mid of the H/L. - The +/- 2 percent margin minimizes changes relative to members that have already included the current policy in their measures (e.g., for exchange taxes). - Operationalized constraint: - (3) Min{LOW ; M_H/L − 2%} ≤ R ≤ Max{HIGH ; M_H/L + 2%} - Additional notes: - The +/- 2 percent tolerance would accommodate the typical spread between the wholesale spot rate and the banknote rate (about 70 basis points) in most cases reviewed. - In markets without an independent wholesale market (e.g., full central bank intermediation with buying and selling official rates), the methodology requires rates arising from official action remain within the +/- 2 percent tolerance margin from the mid of the official buying and selling rates. - A single deviation from the norm because of official action would be considered an MCP; staff did not adopt a requirement for consecutive occurrences. ### Monitoring and data availability - Once an official action is identified, deviation from the norm will be monitored on a continuous basis. - Market data availability: - Fund subscription to Thomson Reuters DataStream and Bloomberg provides close of day and intraday data for exchange rates covering bid/ask, mid-rates, and intraday H/L. - Current subscription through IMF Library (CFS) covers sufficient licenses; budget proposal approved to add licenses to increase access for country teams. - The service agreement provides instruments and intraday data necessary to apply the methodology. ### Treatment of transaction types - A. Spot Transactions - Banknote transactions are rare official actions and are treated as spot transactions. - Central banks that buy and sell banknotes usually operate fixed exchange rate regimes and apply spreads that result in deviations between banknote and wholesale rates that are lower than the +/-2 percent permissible margins. - Banknote rates resulting from official action must remain within the H/L or the permissible margin of the wholesale spot market. - If authorities can provide representative banknote-rate data, staff will compare benchmark-provider H/L results with authority-provided banknote data and use the data that results in the most favorable treatment for the member. - B. Non-Spot Transactions - Official actions that affect non-spot transactions (forwards, FX swaps, options, exchange guarantee schemes) are covered if authorities use them in transactions or require market participants to use them and the official action creates market segmentation. - Forwards: - Market norm for forward rates arising from official action: daily H/L of the forward wholesale market. - Apply the same H/L and +/- 2 percent tolerance margin rule as for spot. - Data sources: Thomson Reuters DataStream provides outright H/L forward rates quoted by interbank market participants for 76 currencies; three additional currencies can be sourced from Bloomberg as secondary source. - Empirical note: 98 percent of the forward H/L were less than 2 percent in 2017. - If wholesale forward market exchange rates from benchmark providers are unavailable, representative market data from other sources or theoretical forward prices may be used. - Theoretical forward: computed by adding the difference between local and foreign interest rate for the maturity of the forward to the spot wholesale market rate. - To avoid an MCP, rates arising from official action should remain in the +/-2 tolerance margin of the theoretical price. - FX Swaps: - Spot leg assessed as other spot transactions. - Forward leg or implicit forward in FX swaps compared with market forward rate or theoretical price at same maturity; official forward must remain in the permissible margin to avoid an MCP. - Options: - The methodology applies only if the option is exercised. - “Effective exchange” rate = strike price + option premium. - If exercised at an effective exchange rate that deviates from equivalent market transactions with similar terms, an MCP arises. - Assessment: check whether, at inception, the effective exchange rate was within the H/L of effective exchange rates of comparable market options or within +/- 2 percent from the mid of the H/L. - Where market option data are unavailable, representative exchange rates from other sources (including authorities) or a theoretical price of the option with similar terms will be used. ### Implementation considerations - Market and calculated forward rates can be monitored continuously for 178 members; the rest do not have national legal tender. - Staff may need to assess whether the domestic interest rate used by benchmark administrators is the most representative; alternative local data may be used if more representative. - Assessment of non-spot transactions may become more frequent; further refinement and guidance may be needed as experience accrues. *Source: ppea2019015* ### 41. In practice, the assessment of options would have to rely mainly on theoretical ### 41. In practice, the assessment of options would have to rely mainly on theoretical ### Theoretical option pricing: calculators and default settings - Option markets are often not deep and standardized enough to provide relevant price benchmarks. - Both Reuters and Bloomberg provide the possibility to calculate theoretical option prices for a wide range of contracts, including “exotics.” - The default setting is based on: - the data available to the benchmark administrator, and - their assumption regarding expected volatility. - The default setting uses the “Black-Scholes formula” for simple contracts. - Staff proposal: - Use Reuters as the default calculator for theoretical option prices under the methodology. - If Reuters is not available, use Bloomberg’s calculator. ### Adjusting default parameters for local representativeness - Staff would assess whether the default parameters used by the theoretical price calculator of benchmark administrators are the most representative for the country. - Staff may use alternative data sourced from local markets to change parameters of the calculation, in particular: - implied volatility, and - the local currency interest rate, to obtain option prices. - Guidance on alternatives: - Alternative implied volatility should be based on prices formed in the domestic market that reflect expected exchange rate volatility. - Alternative local interest rates should be based on actual cost of funding for the relevant maturities. - In the absence of such information, assessment would be based on the theoretical option price derived from the default setting of the calculator, depending on the type of option. ### Preliminary illustrative results of testing the new methodology — scope and purpose - These tests apply the new methodology to spot transactions and incorporate the refined application of the concept of official action as laid out in the Main paper. - Tests are based on information currently available to staff and market conditions prevailing at the time when the tests were conducted. - The preliminary results are illustrative and meant to show potential impact of proposed changes on existing and possible new MCPs. - A full jurisdictional analysis, including discussions with the authorities, would be made if and when the new policy enters into effect, before an MCP finding can be made. - Footnote: Thomson Reuters provides FX Option Calculator as FXOC and Bloomberg provides similar calculator as OVML; both include multiple pricing models depending on the type of option being evaluated. ### A. Types of official actions analyzed - Staff tested combined effect of the proposed methodology and refined concept of official action on different types of official actions that can result in MCPs. The tests present results on: - (i) official exchange rates; - (ii) dual and multiple FX markets; - (iii) auctions; - (iv) official actions increasing the cost of foreign exchange transactions. ### Use of official exchange rate in FX transactions — findings - Analysis considered only official exchange rates which are used in FX transactions. - Staff established that 108 members used an official exchange rate for transactions with FX end-users or foreign exchange intermediaries. - Staff identified 38 members using the exchange rate of the previous days in official transactions, including 5 members calculating official exchange rates with a more than one-day lag. - Of these 38: - 27 members compute official rates based exclusively on market exchange rates (combination of interbank and dealer-client rates or any one of these rates). - 5 members determine rates inter alia on results of FX auctions. - 5 members retain some discretion in determination of the official rate. - Information is unavailable on the lag used by 1 member. - Impact of new methodology on MCPs from official exchange rates: - Currently, 12 countries have MCPs arising from the use of official exchange rates that deviate or may deviate from other exchange rates. - Staff identified thirteen instances in which official rates deviate from the H/L. - Among those, four also deviate from the mid of the H/L by more than +/-2 percent and would result in MCPs under the new methodology. - This would represent a decrease by two thirds of the number of existing MCPs arising from use of official exchange rates. - None of the current MCPs assessed based on potentiality are captured by the new methodology. - The four cases where official exchange rate is outside permissible margins emerge from systematic review of all members’ practices. - Lagged official rates: - Of members using lagged official rates for transactions, twelve members have their official rates outside the H/L range. - Out of these twelve, six also deviated from the mid of the H/L by more than +/-2 percent. - These cases were excluded from results in line with the proposal not to consider them under the MCP policy if they meet certain criteria. ### Dual and multiple FX markets — findings and methodology application - Official action can lead to market segmentation and give rise to MCPs (e.g., regulation imposing specific markets or hindering arbitrage). - Staff identified 32 members having dual or multiple FX markets (based on country team survey and 2016 AREAER reporting, excluding auction-derived dual rates and official rates). - Methodology was applied to 10 of the 32 dual markets that were either reported as legal or have an undetermined legal status. - Reference for H/L and mid of H/L: primary (largest by volume) wholesale spot market. - Mid of the H/L in the secondary market was considered as the rate arising from official action (R in Equation 3). - In absence of H/L for the secondary market, an alternative representative rate (usually a single rate) was used. - Data limitations noted: for secondary markets, data often come from central bank or private sector monitors, with non-standardized methodologies (opening/closing rates, simple averages, midpoints). - Results: - Currently, eight MCPs arise from dual or multiple markets. - Five out of the 8 MCPs arise from illegal markets and are excluded under proposed revision (illegal parallel markets addressed through exchange restrictions policy). - Systematic review revealed exchange rates of the secondary markets in five countries are outside the H/L and permissible margins. ### Auctions — criteria, review, and test outcomes - Under Main paper proposal, FX auctions (including multi-price auctions) would not be considered under the policy as long as they do not segment the FX market. - Auction criteria to avoid segmentation: - (i) grant access to all intermediaries in the country’s wholesale FX market so they can make purchases for themselves and on behalf of clients; - (ii) ensure the bid exchange rate submitted by participants is the only criterion used to determine allotment; - (iii) not set constraints on the range or level of exchange rates that can be submitted. - Staff reviewed auction regulation of 33 members to identify those inconsistent with criteria. - Review based on publicly available information and a survey sent to country teams. - The survey indicates 19 auctions appear to result in market segmentation by providing FX for specific purposes and only partially based on price proposed. - Data limitations: for 20 of the 33 members operating an auction, data were obtained; for some auctions, data unavailable as authorities do not publish results or no auction was organized during review period. - Methodology application for segmenting auctions: - Reference for H/L and mid of H/L: spot wholesale market. - Auction bid rates treated as reflective of secondary market (auction). - Weighted average rate (WAR) of successful bids represents rate arising from official action (R). - Auctioneers publish marginal rate and WAR of successful bids. - Impact on MCP findings: - Of 33 members operating an auction, 19 either do not provide access to all FX intermediaries or include allotment criteria different from the bid rate. - Applying the test to those 19 auctions reduces findings from current 8 (all based on potentiality) to 2. - One of the 2 findings overlaps with a current MCP. ### Official actions increasing the cost of foreign exchange transactions — scope and outcomes - Such official actions continue to be captured under MCP policy, including: - exchange taxes (4 MCPs in 2017), - margin requirements, and - other unremunerated compulsory local currency deposit requirements prior to FX purchases (3 MCPs in 2017). - Calculation: exchange rate arising from official action is local currency deposited augmented by interest forgone due to deposit requirement. - Methodology applied by checking whether effective exchange rate resulting from official action remains in H/L and within +/-2 tolerance percent margin around mid of H/L. - Results: - Number of cases where official action increases cost of FX transactions exceeding permissible margins declines to 3 from 7 with application of the methodology. - Two members currently maintaining taxes on FX transactions exceeding 2 percent are captured by the new methodology. - Authorities of three other members maintain a compulsory deposit requirement. - Official action increased cost of buying FX beyond the H/L range for two of these members. - Official action increased cost outside the +/- 2 percent permissible margin for one of them. ### B. Aggregate results of applying the methodology - Figure 7 depicts MCPs as of end-2017 and preliminary results discussed above. - First column of chart shows 35 of the 45 MCP findings in 2017, classified into four MCP categories: different exchange rates for distinct transactions, dual and multiple FX markets, auctions, and official action increasing the cost of foreign exchange transactions. - The 10 MCPs not included arose mostly from practices that could not be tested during this review due to lack of data. - Among the 35 current MCPs, 18 are based on potential rather than actual deviations from the current two-percent rule. - Second column of the chart illustrates findings based on application of the H/L norm only. - Third column presents findings resulting from official actions that are out of the H/L and deviate by more than +/-2 percent from the mid of the H/L. - Note: The results are based on data for the period April to October 2017. *Source: ppea2019015 - IMF staff report excerpt (pages provided).* ### 60. The proposed changes to the policy lead to fewer but better targeted findings. The ### 60. The proposed changes to the policy lead to fewer but better targeted findings. The ### Aggregate results and key quantitative outcomes - The H/L norm, in combination with the proposed changes in the definition of official action under the new policy, would reduce the number of findings to 33. - The number of MCPs would decrease to 14 with the addition of the +/-2 percent tolerance margin. - Exchange rates of members with MCPs based on potentiality remained within the permissible margin, while the systematic review of all members flagged a few cases that were not previously identified as MCPs. - 38 members are reported to operate auctions in 2016, according to the AREAER. - For auctions regulation screening, preliminary assessment covered 33 countries where auction regulations were available: - 14 had auctions that seem to satisfy the criteria. - 19 auctions did not meet the criteria. - 17 of those 19 failed the allotment criterion. - 2 of those 19 failed the access criterion. - None failed both criteria at the same time. ### Methodological changes that drive the results - Use of H/L and midpoint comparisons: - Rate set by the authorities (R) would be measured against wholesale market H/L on a given day or 2 percent from the midpoint of the H/L, whichever is higher. - If (R) is within H/L, or 2 percent of the midpoint on either side, no MCP arises. If outside, an MCP arises. - Under the new policy, rates resulting from official action would be compared against the H/L and the midpoint, not against each other. - Spreads between different rates set by the authorities, including buy/sell spread, would not be subject to the 2 percent margin; this allows in practice a deviation of 4 percent or more (if the H/L itself is wider than 4 percent) between them. - Lagged official exchange rates: - Under current policy, an MCP arises if the lagged official rate and the market rate deviate—or has the potential to deviate—by more than 2 percent. - Under the proposed policy, lagged exchange rates would not lead to MCP when (i) the official rate is computed as a weighted average of transactions between intermediaries and/or between intermediaries and their clients; and (ii) the transactions included occurred no more than one day ago. - Bilateral payments agreements (BPA): - Current MCP arises if the “special” exchange rate in the BPA deviates—or has the potential to deviate—by more than 2 percent from spot market rate. - Proposed approach: the special rate (R) would be measured against the H/L and the 2 percent tolerance margin at the BPA settlement date. - Exchange guarantee schemes: - Current policy: self-financed schemes (premia sufficient to cover exchange risks) do not give rise to an MCP; self-financing is evaluated when the system is set up and liabilities are incurred. - Proposed policy: depending on features, exchange guarantee schemes could be assessed under methodology for non-spot transactions as forward or option. Like the current policy, self-financed schemes would not give rise to MCPs. - Foreign exchange auctions: - Current policy: MCP arises if auction exchange rates differ or have the potential to differ by more than 2 percent from the prevailing market exchange rate; in multi-price auctions, MCP arises if winning bid rates deviate—or have the potential to deviate—by more than 2 percent between themselves. - Proposed policy: auctions would not be captured if they (i) grant access to all intermediaries in the country’s wholesale FX market; (ii) ensure bid exchange rate is the only criterion to determine acceptance; and (iii) do not set constraints on the range or level of exchange rates that can be submitted. Such auctions would not result in MCPs even if differences exceed permissible margins. - For auctions that do not comply, R is the weighted average of successful bids (or marginal exchange rate in single price auctions), and assessment checks if R remains in the H/L and the permissible margins. - Dual or multiple FX markets: - Current policy: MCP arises if spreads between rates in different markets deviate—or have the potential to deviate—by more than 2 percent. - Proposed policy: staff determine primary (largest) wholesale spot market and secondary market resulting from official action. Reference H/L and midpoint is the primary wholesale spot market; the secondary market mid of H/L is considered R. If no H/L for secondary market, the available rate (usually a single rate) is used and checked against the H/L and tolerance margin. - Illegal parallel exchange markets would be excluded from MCP analysis; jurisdictional analysis would focus on the exchange restriction imposed in the official market. - Measures that increase the cost of FX transactions: - Import deposit requirements: under current policy, import deposit requirements give rise to MCPs when interest paid on the deposit is lower than the market rate; under proposed policy, R is based on effective exchange rate reflecting the cost of interest forgone and checked against the H/L and the permissible +/-2 percent margin around the mid of H/L at maturity. - Exchange taxes: exchange taxes above 2 percent give rise to an MCP under both current and proposed policy. Under proposed policy, R would be considered as the mid of the H/L plus the tax and checked against the permissible +/-2 percent margin around the mid of H/L. ### Auction assessment framework and screening criteria - Conceptual framework: - In absence of official actions other than organizing the auction, auction rates are expected to be integrated with interbank (wholesale) market rates. - Participants choose to participate or refrain based on alternatives in the interbank market; bids should align with rates at which participants can re-sell FX to other intermediaries or clients. - The marginal rate of a well-calibrated auction should remain in the H/L range; deviations arise if intended allotment is notably less than or if allotment is excessively large relative to market positions. - Auction regulation screening criteria (two criteria): - Access: All intermediaries in the wholesale FX market can participate; auction is not open to end-users of FX. - Allotment: Rate is the only criterion to allot bid; bids ranked by exchange rate offered and FX awarded according to ranking within intended allotment; authorities do not set constraints on the range or level of exchange rates that can be offered. - Operational implication: - The 2 percent limit introduced by some members to avoid that the auction gives rise to an MCP would need to be removed to satisfy the allotment criterion. - Auctions that fail the screening are presumed to segment the FX market and act as allocation systems rather than true auctions. ### Preliminary application results and implications - Among 33 countries with available auction regulations, 14 auctions met the proposed criteria and would not be captured under the MCP policy. - Among the 19 auctions that did not meet the criteria, 17 failed the allotment criterion and 2 failed the access criterion. - The proposed revisions reduce the number of findings to 33 and reduce MCPs to 14 with the +/-2 percent tolerance margin, indicating fewer but better targeted findings under the revised methodology. *Source: IMF staff estimates.* ### 11. Once auctions that are organized according to best practices have been ### ppea2019015 - 11. Once auctions that are organized according to best practices have been ### Tests for auctions that segment the FX market - The methodology is applied to auctions that segment the FX market after identifying auctions organized according to best practices based on the analysis of the FX auction regulations. - Figure II.3 presents the preliminary results of the tests applied to the auctions that do not meet either the access or allotment criterion. ### Weighted-average vs. wholesale H/L test (deviation from market-based norm) - A deviation from the market-based norm (H/L) is considered to occur whenever the weighted average of the successful bid at the auction is not within the high-low range of the interbank market. - The weighted average of the successful bid rates at the auction is considered as reflecting the secondary market that is the auction. - A weighted average of the successful bid rates within the high-low range indicates there is some room for arbitrage between the auctions and the wholesale market. ### Threshold to identify significant breaches (permissible margin) - To retain only the most significant breaches, when the weighted average rate is not within the H/L range, the methodology assesses whether the weighted average rate deviates by more than +/- 2 percent from the mid of the FX wholesale market H/L. - A country is considered to have an MCP when this second threshold is exceeded. - While six countries have current MCPs arising from FX auctions, the new methodology identifies only two countries where the weighted average exchange rate exceeds both the H/L and the permissible margins. ### Quantitative test outcomes (summary) - Initial tests classify auctions against: - H/L criterion (pass / fail) - H/L + Permissible margin (pass / fail) - Sources: IMF staff calculations and IMF staff assessment. ### Appendix III — Computation of the Official Exchange Rate for Margin Requirements - Margin deposit requirements remunerated below market rates due to official action are assessed under the MCP policy following the methodology at maturity. - The effective exchange rate of the transaction (R), that includes the forgone interest, is compared with the wholesale spot market H/L and the permissible margin. - When authorities require margin requirements remunerated below market rates they raise the all-in cost of buying FX and change the effective exchange rate that market participants face. - Formula: - R= 퐷퐶∗ (푖_k − 푖_g) ∗ 퐺 ∗ 푇 - Definitions: - DC is the amount of domestic currency required by official action to be deposited to obtain one unit of foreign currency. - 푖_k is the annualized domestic currency market interest rate. - 푖_g is the annualized rate at which the cash margin is remunerated. - (푖_k − 푖_g) represents the difference between market rates and the remuneration of the deposit margin. - G is the margin requirement. G=0.5 means that a market participant wishing to exchange 100 unit of the domestic currency must deposit 50 unit of the domestic currency as cash margin. - T is the period during which the deposit must be kept. Since interest rates are annualized, it is necessary to adjust the formula for cases where participants will be required to keep the deposit for less than a year. For instance, if participants are required to keep the cash margin for 3 months, T=0.25. - Note: If the maturity of the margin is not stipulated by the authorities, staff could use the average duration of margin deposit based on information by market participants or those subject to the margin requirement. ### Numerical examples and MCP determination - Example 1: - Authorities require banks to provide deposit margins equal to 100 percent of the amount of domestic currency to be exchanged (G=1), up to a year (T=1), for no remuneration (푖_g=0), while the market interest rates is 14 percent (푖_k = .14). - The amount of domestic currency (DC) demanded is the market exchange rate. - R= M 퐻/퐿 ∗ (1.14) ∗ 1∗1 - This would result in the effective exchange rate to be outside of the High-Low range and to deviate by more than 2 percent from the mid of the H/L. Under the proposed policy, an MCP would be found. - Example 2: - Banks are required to provide cash margins equal to 50 percent of the amount to exchange (G=0.5), for three months (T=0.25), for no remuneration (푖_g=0), while market interest rate is around 13 percent (푖_k=0.13). - The effective exchange rate at which market participants can transact is outside of the High-Low range but remains within the 2 percent margin. Under the proposed policy no MCP would be found. *Source: IMF staff calculations and assessment as presented in the provided content.* --- _Source: https://www.imf.org/-/media/files/publications/pp/2019/ppea2019015.pdf_