## _052606

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---

### I. INTRODUCTION
- The Fund’s legal framework promotes liberalization of member countries’ current accounts through legal obligations that facilitate free convertibility for payments and transfers for current international transactions.
- The last detailed discussion of acceptance of Article VIII obligations occurred within the 1992 biennial review of the Fund’s surveillance policy; Board view in 1992: many members had availed themselves of Article XIV for too long and should remove remaining restrictions; staff to intensify efforts to encourage acceptance of Article VIII obligations, especially long-standing cases where there are no restrictions subject to Articles VIII or XIV.
- Progress since 1992:
  - 165 out of 184 members have notified acceptance of Article VIII obligations and no longer avail themselves of Article XIV.
  - 95 acceptances were notified between 1992 and 2005.
- Reported associations following acceptance of Article VIII obligations (see Section IV trends):
  - Parallel market spreads, exchange rate volatility, inflation, and interest rates have tapered off.
  - Capital inflows and international reserves have increased.
  - Fiscal balances have improved.
- Remaining issues and opportunities:
  - Some members have availed themselves of Article XIV for over 40 years; not all members have notified acceptance.
  - Some members impose exchange restrictions or multiple currency practices (MCPs) without Fund approval.
  - Need for concerted staff effort to remove unapproved exchange restrictions and MCPs and ensure new changes are consistent with Article VIII obligations and macroeconomic considerations.
  - Growing demand for technical assistance in the foreign exchange area offers opportunities to expand the Fund’s involvement.
  - Scope to improve compilation of information on members’ exchange systems and understanding of economic implications of exchange restrictions and MCPs.
- Paper structure:
  - Section II: overview of legal framework.
  - Section III: recent trends in acceptance of Article VIII obligations and factors underlying trends.
  - Section IV: possible economic (and financial) benefits of current account liberalization.
  - Section V: implications for surveillance, enforcement of compliance with Article VIII obligations and technical assistance.

### II. LEGAL FRAMEWORK
- Objective: assist in establishing a multilateral system of payments for current transactions and elimination of foreign exchange restrictions that hamper world trade (Article I(iv)).
- Article VIII obligations cover exchange restrictions, MCPs, and discriminatory currency arrangements.
- Key legal provisions and interpretations:
  - Article VIII, Section 2(a): prohibits imposing exchange restrictions on payments and transfers for current international transactions, subject to exceptions.
  - Guiding principle: an exchange restriction exists where there is a direct governmental limitation on availability or use of exchange as such.
  - Payments for current transactions defined in Article XXX(d) as “payments which are not for the purpose of transferring capital,” including trade, services, interest, income, and certain amortization/depreciation payments.
  - Article VIII, Section 3: prohibits MCPs or discriminatory currency arrangements subject to exceptions; Fund expects official action not to cause exchange spreads/cross rate quotations to differ unreasonably from normal commercial costs and risks.
  - An MCP arises, in particular, when official action gives rise to a spread of more than 2 percent between buying and selling rates for spot exchange on its territory.
  - Article VIII, Section 4 concerns convertibility of officially-held balances; of limited operational relevance today.
- Sanctions for breach (Article XXVI): declaration of ineligibility to use Fund general resources, suspension of voting and related rights, compulsory withdrawal — not applied for breaches of Article VIII, Section 2(a) or 3.
- Lawful circumstances for exchange measures consistent with Article VIII:
  1. Measures approved by the Fund (Executive Board).
     - Approval generally granted when Board satisfied measure is: (i) imposed for balance of payments reasons; (ii) non-discriminatory between Fund members; and (iii) temporary with a clear timetable for removal.
     - Approval granted for a specified period.
     - Different procedure applies for restrictions imposed for security reasons (Decision No. 144-(52/51)).
  2. Measures maintained under Article XIV, Section 2 (transitional arrangements).
     - On joining the Fund, a member may avail itself of Article XIV, Section 2 to maintain/adapt exchange measures that were in place on its date of membership without prior Fund approval.
     - New exchange measures remain subject to Article VIII and may only be imposed with Fund approval.
- Notification of acceptance of Article VIII obligations:
  - A member is legally subject to Article VIII obligations from the moment it becomes a member; formal notification is not legally necessary.
  - Legal consequence of notification: member can no longer rely on Article XIV, Section 2 to maintain or adapt exchange measures (the right to rely on Article XIV, Section 2 is lost forever upon notification).
  - Fund’s recommendation: notify only after eliminating measures requiring Fund approval and after satisfying itself it is unlikely to need such measures in the foreseeable future.
- Distinction emphasized:
  - Acceptance of Article VIII obligations vs. an exchange system free of exchange measures — members have notified acceptance while maintaining or later imposing exchange measures inconsistent with Article VIII; conversely, some eliminate measures without notifying acceptance.

### III. ACCEPTANCE OF ARTICLE VIII OBLIGATIONS — TRENDS AND DRIVERS
- Historical status and growth:
  - Status in 1992 Board discussion:
    - 74 members had notified acceptance of Article VIII obligations.
    - Of those that had not, 68 had been members for more than 20 years.
    - 39 members did not maintain any restrictions under Article XIV, of which the Fund was aware.
  - Growth in acceptances 1945–2005:
    - Proportion of members notifying acceptance rose from less than 50 percent in 1993 to almost 90 percent in 2005.
    - 64 countries notified acceptance between 1993 and 1996.
    - Notifications increased again with seven countries notifying acceptance during 2004–2005.
  - As of end-December 2005:
    - 19 members (holding less than five percent of Fund quotas) have not notified acceptance of Article VIII obligations.
      - At least half of these have been members for more than 40 years.
      - Four countries do not maintain any exchange measures under Article XIV but are reluctant to notify acceptance.
- Post-notification maintenance/introduction of exchange measures:
  - 18 members that have notified acceptance presently maintain unapproved exchange measures not imposed solely for national or international security reasons.
  - 5 members that have accepted Article VIII obligations maintain approved exchange measures.
  - These countries hold about 10 percent of Fund quotas and represent a similar share of world GDP and world trade.
  - Combined with countries availing themselves of Article XIV, this amounts to almost 20 percent of world trade.
- Types of exchange measures maintained:
  - (i) limits on payments for invisible transactions (travel, medical, educational allowances);
  - (ii) limits on transfers from nonresident accounts;
  - (iii) foreign exchange budget allocation systems.
  - Some measures evidenced by nonsovereign external payments arrears.
  - Existing MCPs arise mainly from use of special exchange rates for official transactions and imposition of foreign exchange taxes and subsidies.
- Restrictions introduced in the context of anti–terrorist-financing and anti–money-laundering initiatives:
  - Number of countries maintaining such restrictions increased from 69 (37 percent of total reporting countries) in 2000 to 104 (54.5 percent of total reporting countries) in 2005.
  - There appears to be scope for improving reporting of such measures to the Fund; evidence suggests not all such restrictions have been notified.
- Underlying drivers:
  - Fund efforts (Article IV consultations, technical assistance, program conditionality, analytical work, AREAER) have been an important driver since 1992.
  - Trade liberalization and regional influences:
    - WTO negotiations, EU accession requirements, and bilateral/regional agreements (e.g., NAFTA) encouraged elimination of exchange measures.
    - A broader global environment in the 1990s fostered free markets, broader liberalization trends, institution building, and divestment of state holdings.
    - Emerging private sector interests and recognition of inefficiencies of exchange measures and need for greater exchange rate flexibility also encouraged convertibility.

### IV. ELIMINATION OF RESTRICTIONS AND MCPs — MACROECONOMIC IMPLICATIONS
- Historical and trade effects:
  - Trade-stifling effects were acute when many countries in the 1930s introduced multiple exchange rates to stimulate exports and discourage imports and to engage in bilateral trade and payments agreements.
- Economic distortions and costs from exchange measures:
  - Exchange restrictions cause undue delays in obtaining foreign exchange and shift transactions to parallel markets where premiums can change rapidly, reaching hundreds of percentage points in extreme cases.
  - Disparities between parallel market rates distort consumption, production, and investment decisions and impose heavy welfare costs by distorting import and export prices and introducing implicit taxes and subsidies that vary by type of transaction.
  - Studies have shown that countries with high parallel exchange rate volatility also exhibit greater price volatility.
  - Exchange restrictions can encourage rent-seeking, impose government losses from enforcement costs and inability to collect implicit taxes, lead to disintermediation and prevent development of financial institutions and markets, encourage illegal activity, and erode political capital domestically and abroad.
- Benefits associated with elimination and Article VIII acceptance:
  - Removal of restrictions on payments and transfers for current international transactions could reduce parallel market spreads and facilitate trade.
  - Elimination of MCPs could lead to unification of official exchange markets and more market-based pricing of foreign exchange.
  - Exchange rates may exhibit more stability as official markets deepen and develop.
  - Increased volume of transactions through the banking system could increase intermediated funds and provide more accurate information to authorities.
  - Acceptance of Article VIII obligations is often seen as a positive signal committing authorities to refrain from distortionary restrictions and could help build investor confidence and encourage capital flows.
- Causality, data limitations, and observed trends:
  - Difficult to establish causality between acceptance and improved macroeconomic outturns because:
    - a decision to accept may be taken long after elimination of exchange measures;
    - a member may accept without eliminating all measures or may impose new ones after acceptance;
    - lack of data on timing prevents econometric estimation of the impact of removal;
    - exchange measures may be replaced with current account controls that have equivalent economic impact but may not be subject to Fund approval;
    - removal and acceptance may be accompanied by sound macroeconomic policies contributing to favorable outcomes.
  - Observed trends (subject to qualifications):
    - Article VIII acceptance has been associated with declines in parallel market spreads across regions, time, and regardless of exchange rate regime.
    - Countries that accepted Article VIII obligations after removing all outstanding exchange measures seem to have experienced significantly lower parallel market spreads than countries that retained the measures.
    - On average, volatility of exchange rates with respect to the U.S. dollar has declined with acceptance of Article VIII obligations.
    - Inflation and interest rates have been lower and more stable, although there seems to be no clear correlation with acceptance of Article VIII obligations.
- Trade and invisibles:
  - No verifiable effect of the trend in Article VIII acceptance on international trade since 1992, although individual countries experienced significant trade growth after acceptance.
  - Removing trade-stifling exchange restrictions was often completed long before acceptance of Article VIII obligations.
  - Members accepting Article VIII obligations have experienced deterioration in the balance for invisible transactions, offset by capital inflows and improving reserve levels.
  - Restrictions on invisible transactions have been the most common type of exchange restrictions; their removal has worsened balances on invisible transactions but has often coincided with surges in foreign direct investment, capital inflows, and reserve build-up.
  - Countries that removed exchange measures prior to or with acceptance of Article VIII obligations have been more successful in building up reserves than those that retained measures.
- Fiscal implications:
  - Acceptance of Article VIII obligations has been associated with elimination of price-distorting MCPs that implicitly taxed export sectors and subsidized imports; where implicit import subsidies were not replaced with direct ones, acceptance has been associated with improved government balances.

### IV.B IMPLICATIONS FOR COUNTRIES MAINTAINING EXCHANGE MEASURES
- Survey findings (responses from 26 out of 33 surveyed desk economists):
  - Preventing capital flight, maintaining adequate reserves, and fiscal stability were main reasons for maintaining exchange restrictions and MCPs.
  - 14 countries (out of the 26 for which responses were received) maintain restrictions with the objective of maintaining adequate levels of reserves.
    - Of these 14, 11 have pegged exchange rate regimes, which require significant international reserves to be credible.
  - Restrictions were sometimes effective to secure funds for foreign debt repayment, but generally ineffective under strong reserve pressure and in crisis situations.
  - Some countries use exchange measures as fiscal instruments for revenue enforcement and income redistribution (e.g., tax certification requirements, multiple exchange rates resulting in MCPs).
  - Authorities sometimes fear removal will exacerbate fiscal imbalances, but cross-country experience shows these fears are often unwarranted since elimination of implicit subsidies can reduce government (quasi-)fiscal costs.
  - Economic significance assessment (imprecise):
    - Twelve desk economists consider the exchange measures of their assigned countries have a negligible or small economic effect and the impact of their removal should be manageable.
    - Six desk economists consider the measures are significant as they affect a substantial share of foreign exchange transactions.

### V. ISSUES GOING FORWARD — POLICY PRIORITIES AND FUND ACTIONS
- Continued Fund efforts needed to encourage liberalization and ensure Article VIII observance because:
  - reliance by some members on Article XIV transitional arrangements for extended periods;
  - imposition of exchange measures without Fund approval; and
  - need to ensure all security-related restrictions are reported to the Fund timely.
- Monitoring and pressing for removal of unapproved exchange measures:
  - In Article IV consultations, staff will continue to monitor the introduction of exchange measures subject to Fund jurisdiction.
  - On the basis of the most recently issued Article IV staff reports, there are 29 members that presently impose exchange measures without Fund approval in a manner inconsistent with their Article VIII obligations.
  - The number 29 comprises 18 members that have previously notified the Fund of their acceptance of the Article VIII obligations and 11 members that continue to avail themselves of the transitional arrangements of Article XIV, section 2, while maintaining exchange measures subject to approval under Article VIII.
  - Members should consult with Fund staff before introducing changes and notify the Fund as soon as possible when imposing restrictions for security reasons.
- Information completeness and AREAER role:
  - Under Article VIII, Section 5, members are required to provide the Fund with information on their exchange controls and official clearing arrangements.
  - Recent changes are reviewed in Article IV consultations; the AREAER compiles comprehensive systematic information and requires members to provide necessary data to continue this role.
- Encouraging Article VIII acceptance among Article XIV users:
  - Staff will encourage members availing themselves of Article XIV transitional arrangements to eliminate all exchange measures subject to Fund jurisdiction and notify acceptance of Article VIII as their balance of payments positions allow.
  - Seven countries accepted Article VIII obligations during 2004 and 2005; three of these opted to notify their acceptance before their exchange systems had been subject to a comprehensive review.
- Technical assistance demand and legal/administrative simplification:
  - Growing demand for Fund technical assistance in streamlining exchange regimes.
  - Fund staff have advised on reforms beyond elimination of exchange measures, often simplifying legal frameworks to promote trade and capital inflows by reducing administrative costs and red tape.
- Planned additional research by Fund staff in three key areas:
  - (i) Analysis of parallel markets, including their size, reemergence, and economic implications.
  - (ii) Effects of foreign exchange liberalization on macroeconomic developments and trade, controlling for other policies, and focusing on implications of re-imposing measures.
  - (iii) Economic implications of existing security-related restrictions.

### ASSESSMENT, ANALYTICAL METHODS, AND MEASUREMENT CHALLENGES
- Assessment and priorities:
  - The Fund’s present framework to address current account liberalization remains broadly adequate, but firmer implementation and better data are needed.
  - In light of the Fund’s resource constraints, the key focus will continue to be on:
    - monitoring members’ compliance with their Article VIII obligations,
    - pressing for the removal of unapproved exchange measures, and
    - helping member countries to establish and operate well-functioning and efficient foreign exchange systems.
- Analytical methods for estimating economic implications of exchange restrictions and MCPs:
  - Exchange restrictions and MCPs tend to increase the cost at which current international transactions are conducted by creating a wedge between the actual exchange rate and an exchange rate that would prevail without their existence.
  - Models on parallel markets can help assess costs arising from diversion of transactions from the official to the parallel market; the impact of restrictions or a change in the monetary stance on the parallel market spread is typically used to demonstrate distortions introduced through the functioning of a parallel market.
  - Montiel et al. (1993) summarize models analyzing properties of parallel markets, including volatility of parallel exchange rates and potential illegal arbitrage:
    - The real trade approach: analyzes the impact of restrictions on the parallel market rate and focuses on diversion of transactions demand for foreign exchange from the official to the parallel market.
    - The monetary approach: focuses on the role of expansionary monetary policy in increasing parallel market spreads, and the impact of the latter on incentives to under-invoice permitted trade and transact illegally through the parallel market.
    - The portfolio and currency substitution model: treats foreign exchange as a financial asset and emphasizes the role of asset composition in the determination of the parallel market exchange rate.
  - Analytical approaches must be tailored to country-specific conditions, taking into account:
    - types of restrictions in place,
    - main factors driving existing exchange rate markets,
    - macroeconomic policies,
    - prevailing exchange and capital account regimes (including existing legislation, institutions, and authorities’ current practices).
- Observability and measurement challenges:
  - The actual impact of restrictions and MCPs depends on factors that are not always readily observable:
    - Whether quantitative limits on invisible transactions are set high enough to accommodate actual demand for foreign exchange;
    - Authorities’ enforcement capacity;
    - Presence of other exchange controls that could prevent loopholes for evasion.
  - Volume of transactions in the parallel market would indicate unmet foreign exchange demand, but parallel market data are seldom readily available given the illegal nature of these markets.
  - The parallel market can provide an avenue for other illegal activities unrelated to exchange restrictions and MCPs, making it difficult to isolate transactions caused only by specific individual measures.
- Quantification efforts and empirical approaches:
  - Standard trade theory: used to analyze the welfare cost of maintaining a parallel market, taking into account net effects on domestic producers’ losses, consumer gains, and government losses due to import subsidies or export surrender requirements.
  - Monetary approach: applied to quantify the cost to a central bank of multiple currency practices; central bank purchases of foreign exchange from exporters at a more appreciated rate compared to the equilibrium rate and foreign exchange sales to importers at a less appreciated rate effectively introduce implicit export taxes and import subsidies, with the net tax (subsidy) reflected in the increase (decrease) of the central bank’s net foreign assets.
  - Parallel market approach with econometric analysis: used to estimate the reduction of official exports as a result of depreciation in the official and parallel exchange rates.

*Source — Excerpt from IMF PDF chapter/section titled "_052606 - 23.       Other factors were related to trade liberalization or regional efforts. These"*

### References..............................................................................................................

### _052606 - References..............................................................................................................

### I. INTRODUCTION
- The Fund’s legal framework promotes liberalization of member countries’ current accounts through legal obligations that facilitate free convertibility for payments and transfers for current international transactions.
- The last detailed discussion of acceptance of Article VIII obligations occurred within the 1992 biennial review of the Fund’s surveillance policy.
- Board view in 1992: many members had availed themselves of Article XIV for too long and should remove remaining restrictions; staff to intensify efforts to encourage acceptance of Article VIII obligations, especially long-standing cases where there are no restrictions subject to Articles VIII or XIV.
- Progress since 1992:
  - 165 out of 184 members have notified acceptance of Article VIII obligations and no longer avail themselves of Article XIV.
  - 95 acceptances were notified between 1992 and 2005.
- Reported associations following acceptance of Article VIII obligations (Section IV trends):
  - Parallel market spreads, exchange rate volatility, inflation, and interest rates have tapered off.
  - Capital inflows and international reserves have increased.
  - Fiscal balances have improved.
- Remaining issues and opportunities:
  - Some members have availed themselves of Article XIV for over 40 years; not all members have notified acceptance.
  - Some members impose exchange restrictions or multiple currency practices (MCPs) without Fund approval.
  - Need for concerted staff effort to remove unapproved exchange restrictions and MCPs and ensure new changes are consistent with Article VIII obligations and macroeconomic considerations.
  - Growing demand for technical assistance in the foreign exchange area offers opportunities to expand the Fund’s involvement.
  - Scope to improve compilation of information on members’ exchange systems and understanding of economic implications of exchange restrictions and MCPs.
- Paper structure:
  - Section II: overview of legal framework.
  - Section III: recent trends in acceptance of Article VIII obligations and factors underlying trends.
  - Section IV: possible economic (and financial) benefits of current account liberalization.
  - Section V: implications for surveillance, enforcement of compliance with Article VIII obligations and technical assistance.

*Prepared by a MFD-LEG staff team under the supervision of Ross Leckow and Udaibir S. Das.*

---

### II. LEGAL FRAMEWORK
- Objective: assist in establishing a multilateral system of payments for current transactions and elimination of foreign exchange restrictions that hamper world trade (Article I(iv)).
- Article VIII obligations cover exchange restrictions, MCPs, and discriminatory currency arrangements.
- Key legal provisions and interpretations:
  - Article VIII, Section 2(a): prohibits imposing exchange restrictions on payments and transfers for current international transactions, subject to exceptions.
  - Guiding principle: an exchange restriction exists where there is a direct governmental limitation on availability or use of exchange as such.
  - Payments for current transactions defined in Article XXX(d) as “payments which are not for the purpose of transferring capital,” including trade, services, interest, income, and certain amortization/depreciation payments.
  - Article VIII, Section 3: prohibits MCPs or discriminatory currency arrangements subject to exceptions; Fund expects official action not to cause exchange spreads/cross rate quotations to differ unreasonably from normal commercial costs and risks.
  - An MCP arises, in particular, when official action gives rise to a spread of more than 2 percent between buying and selling rates for spot exchange on its territory.
  - Article VIII, Section 4 concerns convertibility of officially-held balances; of limited operational relevance today.
- Sanctions for breach (Article XXVI): declaration of ineligibility to use Fund general resources, suspension of voting and related rights, compulsory withdrawal — not applied for breaches of Article VIII, Section 2(a) or 3.
- Lawful circumstances for exchange measures consistent with Article VIII:
  1. Measures approved by the Fund (Executive Board).
     - Approval generally granted when Board satisfied measure is: (i) imposed for balance of payments reasons; (ii) non-discriminatory between Fund members; and (iii) temporary with a clear timetable for removal.
     - Approval granted for a specified period.
     - Different procedure applies for restrictions imposed for security reasons (Decision No. 144-(52/51)).
  2. Measures maintained under Article XIV, Section 2 (transitional arrangements).
     - On joining the Fund, a member may avail itself of Article XIV, Section 2 to maintain/adapt exchange measures that were in place on its date of membership without prior Fund approval.
     - New exchange measures remain subject to Article VIII and may only be imposed with Fund approval.
- Notification of acceptance of Article VIII obligations:
  - A member is legally subject to Article VIII obligations from the moment it becomes a member; formal notification is not legally necessary.
  - Legal consequence of notification: member can no longer rely on Article XIV, Section 2 to maintain or adapt exchange measures (the right to rely on Article XIV, Section 2 is lost forever upon notification).
  - Fund’s recommendation: notify only after eliminating measures requiring Fund approval and after satisfying itself it is unlikely to need such measures in the foreseeable future.
- Distinction emphasized:
  - Acceptance of Article VIII obligations vs. an exchange system free of exchange measures — members have notified acceptance while maintaining or later imposing exchange measures inconsistent with Article VIII; conversely, some eliminate measures without notifying acceptance.

---

### III. ACCEPTANCE OF ARTICLE VIII OBLIGATIONS
#### A. Trends
- Status in 1992 Board discussion:
  - 74 members had notified acceptance of Article VIII obligations.
  - Of those that had not, 68 had been members for more than 20 years.
  - 39 members did not maintain any restrictions under Article XIV, of which the Fund was aware.
- Growth in acceptances 1945–2005 (Figure 1 summary):
  - Proportion of members notifying acceptance rose from less than 50 percent in 1993 to almost 90 percent in 2005.
  - 64 countries notified acceptance between 1993 and 1996.
  - After gradual decline, notifications increased again with seven countries notifying acceptance during 2004–2005.
- As of end-December 2005:
  - 19 members (holding less than five percent of Fund quotas) have not notified acceptance of Article VIII obligations.
    - At least half of these have been members for more than 40 years.
    - Four countries do not maintain any exchange measures under Article XIV but are reluctant to notify acceptance.
- Post-notification maintenance/introduction of exchange measures:
  - 18 members that have notified acceptance presently maintain unapproved exchange measures not imposed solely for national or international security reasons.
  - 5 members that have accepted Article VIII obligations maintain approved exchange measures.
  - These countries hold about 10 percent of Fund quotas and represent a similar share of world GDP and world trade.
  - Combined with countries availing themselves of Article XIV, this amounts to almost 20 percent of world trade.
- Types of exchange measures maintained:
  - (i) limits on payments for invisible transactions (travel, medical, educational allowances);
  - (ii) limits on transfers from nonresident accounts;
  - (iii) foreign exchange budget allocation systems.
  - Some measures evidenced by nonsovereign external payments arrears.
  - Existing MCPs arise mainly from use of special exchange rates for official transactions and imposition of foreign exchange taxes and subsidies.
- Exchange controls introduced in context of anti–terrorist-financing and anti–money-laundering initiatives:
  - Number of countries maintaining such restrictions increased from 69 (37 percent of total reporting countries) in 2000 to 104 (54.5 percent of total reporting countries) in 2005.
  - There appears to be scope for improving reporting of such measures to the Fund; evidence suggests not all such restrictions have been notified.

#### B. Underlying Factors
- Fund efforts to encourage elimination of exchange restrictions/MCPs and acceptance of Article VIII obligations have been an important driver since 1992.
- Staff promotion tools:
  - Article IV consultations, technical assistance, program conditionality, analytical work.
  - Fund publications, notably the Annual Report on Exchange Arrangements and Exchange Restrictions (AREAER), have played a useful role.

*Note: Figures and Appendix titles referenced in the source (e.g., Figure 1, Appendix I) are described in the text above.* 

*Source: AREAER database and MFD-LEG staff team material as presented in the supplied content.*

### 23.       Other factors were related to trade liberalization or regional efforts. These

### Other factors were related to trade liberalization or regional efforts. These

### Trade liberalization and regional influences
- Other factors encouraging liberalization included:
  - WTO-member practices to negotiate the elimination of exchange measures subject to Fund jurisdiction with countries seeking to join the WTO.
  - EU requirements that countries planning accession liberalize their rules governing international payments and transfers.
  - Other bilateral and regional agreements (e.g., NAFTA) requiring current account convertibility on transactions covered by the agreements.
- A broader global environment in the 1990s fostered free markets, broader liberalization trends, institution building, and divestment of state holdings.
- An important domestic factor was the emerging private sector, which generally had an interest in dismantling unnecessary controls.
- Countries were further encouraged to pursue current account convertibility by recognition of:
  - inefficiencies of maintaining exchange measures; and
  - the need for greater exchange rate flexibility to restore balance of payments viability.

### IV. ELIMINATION OF RESTRICTIONS AND MULTIPLE CURRENCY PRACTICES — A. Macroeconomic Implications
- Historical and trade effects:
  - Trade-stifling effects were particularly acute when many countries in the 1930s introduced multiple exchange rates to stimulate exports and discourage imports and to engage in bilateral trade and payments agreements.
- Economic distortions from exchange measures:
  - Exchange restrictions cause undue delays in obtaining foreign exchange and shift transactions to parallel markets where premiums can change rapidly, reaching hundreds of percentage points in extreme cases.
  - Disparities between parallel market rates distort consumption, production, and investment decisions and impose heavy welfare costs by distorting import and export prices and introducing implicit taxes and subsidies that vary by type of transaction.
  - Studies have shown that countries with high parallel exchange rate volatility also exhibit greater price volatility.
- Other distortions and costs:
  - Exchange restrictions can encourage rent-seeking behavior, impose government losses from enforcement costs and inability to collect implicit taxes, lead to disintermediation and prevent development of financial institutions and markets, encourage illegal activity, and erode political capital domestically and abroad.
- Benefits of elimination and Article VIII acceptance:
  - Removal of restrictions on payments and transfers for current international transactions could reduce parallel market spreads and facilitate trade.
  - Elimination of MCPs could lead to unification of official exchange markets and more market-based pricing of foreign exchange.
  - Exchange rates may exhibit more stability as official markets deepen and develop.
  - Increased volume of transactions through the banking system could increase intermediated funds and provide more accurate information to authorities.
  - Acceptance of Article VIII obligations is often seen as a positive signal committing authorities to refrain from distortionary restrictions and could help build investor confidence and encourage capital flows.
- Causality and data limitations:
  - It is difficult to establish causality between acceptance of Article VIII obligations and improved macroeconomic outturns because:
    - a decision to accept may be taken long after elimination of exchange measures;
    - a member may accept without eliminating all measures or may impose new ones after acceptance;
    - lack of data on timing prevents econometric estimation of the impact of removal;
    - exchange measures may be replaced with current account controls that have equivalent economic impact but may not be subject to Fund approval;
    - removal and acceptance may be accompanied by sound macroeconomic policies contributing to favorable outcomes.
- Observed trends (subject to qualifications):
  - Article VIII acceptance has been associated with positive developments, particularly declines in parallel market spreads across regions, time, and regardless of exchange rate regime.
  - Countries that accepted Article VIII obligations after removing all outstanding exchange measures seem to have experienced significantly lower parallel market spreads than countries that retained the measures.
  - On average, volatility of exchange rates with respect to the U.S. dollar has declined with acceptance of Article VIII obligations.
  - Inflation and interest rates have been lower and more stable, although there seems to be no clear correlation with acceptance of Article VIII obligations.
- Trade and invisibles:
  - No verifiable effect of the trend in Article VIII acceptance on international trade since 1992, although individual countries experienced significant trade growth after acceptance.
  - Removing trade-stifling exchange restrictions was often completed long before acceptance of Article VIII obligations.
  - Members accepting Article VIII obligations have experienced deterioration in the balance for invisible transactions, offset by capital inflows and improving reserve levels.
  - Restrictions on invisible transactions have been the most common type of exchange restrictions; their removal has worsened balances on invisible transactions but has often coincided with surges in foreign direct investment, capital inflows, and reserve build-up.
  - Countries that removed exchange measures prior to or with acceptance of Article VIII obligations have been more successful in building up reserves than those that retained measures.
- Fiscal implications:
  - Acceptance of Article VIII obligations has been associated with elimination of price-distorting MCPs that implicitly taxed export sectors and subsidized imports; where implicit import subsidies were not replaced with direct ones, acceptance has been associated with improved government balances.

### IV. B. Implications for countries maintaining exchange measures
- Survey of desk economists (responses from 26 out of 33 surveyed):
  - Preventing capital flight, maintaining adequate reserves, and fiscal stability were main reasons for maintaining exchange restrictions and MCPs.
  - Some members impose restrictions to prevent loss of international reserves through capital flight:
    - Currently, 14 countries (out of the 26 for which responses were received) maintain restrictions with the objective of maintaining adequate levels of reserves.
    - Of these 14, 11 have pegged exchange rate regimes, which require significant international reserves to be credible.
    - Restrictions were effective where used as an instrument to secure funds for foreign debt repayment, but generally ineffective under strong reserve pressure and in crisis situations.
  - Some countries use exchange measures as fiscal instruments for revenue enforcement and income redistribution:
    - Common restrictions include tax certification requirements and multiple exchange rates resulting in MCPs, which can indirectly tax some sectors and subsidize others.
    - Example effects: privileged access to foreign exchange for military or state-owned enterprises can reduce private sector competitiveness versus state enterprises.
  - Authorities sometimes fear removal will exacerbate fiscal imbalances, but cross-country experience shows these fears are unwarranted since elimination of implicit subsidies can reduce government (quasi-)fiscal costs.
  - Economic significance assessment (imprecise) based on share of affected foreign exchange transactions:
    - Twelve desk economists consider the exchange measures of their assigned countries have a negligible or small economic effect and the impact of their removal should be manageable.
    - Six desk economists consider the measures are significant as they affect a substantial share of foreign exchange transactions.

### V. Issues going forward — policy priorities and Fund actions
- Continued Fund efforts needed to encourage liberalization and ensure Article VIII observance due to:
  - reliance by some members on Article XIV transitional arrangements for extended periods;
  - imposition of exchange measures without Fund approval; and
  - need to ensure all security-related restrictions are reported to the Fund timely.
- Monitoring and pressing for removal of unapproved exchange measures:
  - In Article IV consultations, staff will continue to monitor the introduction of exchange measures subject to Fund jurisdiction.
  - On the basis of the most recently issued Article IV staff reports, there are 29 members that presently impose exchange measures without Fund approval in a manner inconsistent with their Article VIII obligations.
  - Members should consult with Fund staff before introducing changes and notify the Fund as soon as possible when imposing restrictions for security reasons.
  - The number 29 comprises 18 members that have previously notified the Fund of their acceptance of the Article VIII obligations and 11 members that continue to avail themselves of the transitional arrangements of Article XIV, section 2, while maintaining exchange measures subject to approval under Article VIII.
- Information completeness and AREAER role:
  - Under Article VIII, Section 5, members are required to provide the Fund with information on their exchange controls and official clearing arrangements.
  - Recent changes are reviewed in Article IV consultations; the AREAER compiles comprehensive systematic information and requires members to provide necessary data to continue this role.
- Encouraging Article VIII acceptance among Article XIV users:
  - Staff will encourage members availing themselves of Article XIV transitional arrangements to eliminate all exchange measures subject to Fund jurisdiction and notify acceptance of Article VIII as their balance of payments positions allow.
  - Seven countries accepted Article VIII obligations during 2004 and 2005; three of these opted to notify their acceptance before their exchange systems had been subject to a comprehensive review.
- Technical assistance demand and legal/administrative simplification:
  - Growing demand for Fund technical assistance in streamlining exchange regimes.
  - Fund staff have advised on reforms beyond elimination of exchange measures, often simplifying legal frameworks to promote trade and capital inflows by reducing administrative costs and red tape.
- Planned additional research by Fund staff in three key areas:
  - (i) Analysis of parallel markets, including their size, reemergence, and economic implications.
  - (ii) Effects of foreign exchange liberalization on macroeconomic developments and trade, controlling for other policies, and focusing on implications of re-imposing measures.
  - (iii) Economic implications of existing security-related restrictions.

*Italic: Source — Excerpt from IMF PDF chapter/section titled "_052606 - 23.       Other factors were related to trade liberalization or regional efforts. These"*

### 41.      The Fund’s present framework to address current account liberalization

### 41.      The Fund’s present framework to address current account liberalization

### Assessment and priorities
- The Fund’s present framework to address current account liberalization remains broadly adequate, but firmer implementation and better data are needed.
- In light of the Fund’s resource constraints, the key focus will continue to be on:
  - monitoring members’ compliance with their Article VIII obligations,
  - pressing for the removal of unapproved exchange measures, and
  - helping member countries to establish and operate well-functioning and efficient foreign exchange systems.

### Analytical methods for estimating economic implications of exchange restrictions and MCPs
- Exchange restrictions and MCPs tend to increase the cost at which current international transactions are conducted by creating a wedge between the actual exchange rate and an exchange rate that would prevail without their existence.
- Models on parallel markets can help assess costs arising from diversion of transactions from the official to the parallel market; the impact of restrictions or a change in the monetary stance on the parallel market spread is typically used to demonstrate distortions introduced through the functioning of a parallel market.
- Montiel et al. (1993) summarize models analyzing properties of parallel markets, including volatility of parallel exchange rates and potential illegal arbitrage:
  - The real trade approach: analyzes the impact of restrictions on the parallel market rate and focuses on diversion of transactions demand for foreign exchange from the official to the parallel market.
  - The monetary approach: focuses on the role of expansionary monetary policy in increasing parallel market spreads, and the impact of the latter on incentives to under-invoice permitted trade and transact illegally through the parallel market.
  - The portfolio and currency substitution model: treats foreign exchange as a financial asset and emphasizes the role of asset composition in the determination of the parallel market exchange rate.
- Analytical approaches must be tailored to country-specific conditions, taking into account:
  - types of restrictions in place,
  - main factors driving existing exchange rate markets,
  - macroeconomic policies,
  - prevailing exchange and capital account regimes (including existing legislation, institutions, and authorities’ current practices).

### Observability and measurement challenges
- The actual impact of restrictions and MCPs depends on factors that are not always readily observable:
  - Whether quantitative limits on invisible transactions are set high enough to accommodate actual demand for foreign exchange;
  - Authorities’ enforcement capacity;
  - Presence of other exchange controls that could prevent loopholes for evasion.
- Volume of transactions in the parallel market would indicate unmet foreign exchange demand, but parallel market data are seldom readily available given the illegal nature of these markets.
- The parallel market can provide an avenue for other illegal activities unrelated to exchange restrictions and MCPs, making it difficult to isolate transactions caused only by specific individual measures.

### Quantification efforts and empirical approaches
- Some attempts have been made to quantify the impact of exchange restrictions and MCPs in selected countries:
  - Standard trade theory: used to analyze the welfare cost of maintaining a parallel market, taking into account net effects on domestic producers’ losses, consumer gains, and government losses due to import subsidies or export surrender requirements.
  - Monetary approach: applied to quantify the cost to a central bank of multiple currency practices; central bank purchases of foreign exchange from exporters at a more appreciated rate compared to the equilibrium rate and foreign exchange sales to importers at a less appreciated rate effectively introduce implicit export taxes and import subsidies, with the net tax (subsidy) reflected in the increase (decrease) of the central bank’s net foreign assets.
  - Parallel market approach with econometric analysis: used to estimate the reduction of official exports as a result of depreciation in the official and parallel exchange rates.

*Source: 41. The Fund’s present framework to address current account liberalization*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2006/_052606.pdf_