Appendix. Historical Experience in Establishing Convertibility
- Joshua Greene, and Peter Isard
- Published Date:
- March 1991
Historically, most countries have introduced current account convertibility rather late in their development process, usually after initiating industrial reforms and trade liberalization. Thus, few developing countries have had convertible currencies. In Africa, for example, only the 13 African countries whose currencies are pegged to the French franc have had convertible currencies, and even for these countries, convertibility has been limited to the French franc. Among industrial countries, convertibility has generally been acknowledged as a main policy objective. Introducing convertibility, however, has depended largely on economic circumstances, with most countries establishing current account convertibility only after securing what appeared to be a competitive industrial structure and an adequate level of international reserves. In addition, most countries have postponed introducing capital account convertibility until fairly late in their economic development, in the belief that it would involve even greater risk of external instability.
Postwar Western Europe
During World War II, normal international financial arrangements broke down. To conserve foreign exchange—mainly U.S. dollars—direct controls over trade and payments were greatly extended and, for the same reason, the currencies of most countries ceased to be convertible into dollars, except at administrative discretion, for both residents and nonresidents. Immediately after the war, only the currencies of Switzerland and the United States were convertible for current account transactions.
Throughout Western Europe, which had suffered heavy damage, most countries adopted extensive sets of bilateral trade agreements to conduct trading operations. Although there was general agreement that re-establishing convertibility was desirable, the uncertainty of trade prospects and concerns about lack of competitiveness vis-à-vis the United States kept most countries from doing so. Moreover, the one attempt to establish current account convertibility soon after World War II—by the United Kingdom, in 1947—was considered by leading observers as “a colossal failure” (Haberler (1954), p. 16) or a “disaster of the first magnitude” (Hinshaw (1958), p. 11), largely because the first three preconditions for convertibility discussed in Section IV had not been established.24 During this attempt, the United Kingdom received a $3.75 billion loan from the United States to help it implement provisions to make sterling fully convertible for “current transactions.” The loan, authorized under the Anglo-American Loan Agreement signed in December 1945 and ratified by the U.S. Congress in July 1946, became fully effective on July 15, 1947.25 One month later, the loan was virtually exhausted, and on August 20 convertibility was again suspended.
In light of the British experience, but recognizing that bilateral trade agreements and the accompanying trade restrictions were strongly hampering trade and the growth of their economies, the leading Western European countries established a central payments and clearing union to promote trade among themselves and encourage the elimination of trade restrictions. Under the resulting European Payments Union (EPU), created in 1950, member countries succeeded in eliminating most quantitative trade restrictions and in achieving substantial increases in both the volume of intra-European trade and the level of international reserves during a period when fixed exchange rates were the norm.26 Not until the end of 1958, however, did the member countries decide it was possible to terminate the EPU and declare current account convertibility,27 and most of the former EPU members actually waited until 1961 to accept the obligations of the IMF’s Article VIII. Establishing capital account convertibility generally took even longer. France and Italy, for example, abolished the last of their major restrictions on capital transactions only during the late 1980s.
Newly Industrializing Asian Economies
The newly industrializing Asian economies— Hong Kong, Korea, Singapore, and Taiwan Province of China—have achieved remarkable economic transformations over the past three decades based on outward-oriented development strategies. The experiences of these countries have received considerable attention (for example, Corbo and others (1985)), as have the factors that generally contribute to the success of outward-oriented development strategies (Krueger (1985) and World Bank (1987)).
The four Asian economies have followed very different timetables for accepting the obligations of Article VIII. Hong Kong, as a nonmetropolitan U.K. territory, moved to Article VIII status with the United Kingdom in 1961, and Singapore followed in 1968. By contrast, Taiwan Province of China had not accepted Article VIII status as of April 1980, when it ceased to represent China in the Fund, and Korea did not accept Article VIII status until 1988, after more than two decades of rapid growth and successful industrialization.28 Most of the Asian countries that had accepted Article VIII status continued to retain important restrictions on capital account transactions, however. Even Japan, which accepted Article VIII status in 1964, eliminated its remaining major capital account restrictions only during the 1980s.
Despite the different speeds with which they accepted Article VIII status, however, all of the newly industrializing economies took early measures to achieve the major concomitants of current account convertibility. In the late 1950s, Taiwan Province of China unified its exchange rate for most transactions and removed quota restrictions on imports, except for imports of certain luxury goods (Tsiang (1985), p. 37, and IMF (1960 and 1961)). It replaced an administrative foreign exchange allocation system with a system of continuous acceptance of import licenses, supported by a foreign exchange surrender requirement for exporters. Thereafter, most exchange transactions took place at a fluctuating exchange certificate rate that the authorities stabilized, and import licenses for most goods were approved automatically when accompanied by exchange certificates. Korea moved to a substantially unified exchange rate in 1965 and, apart from promoting certain infant industries selected for development, adopted a system for encouraging exports through measures aimed at achieving the allocation of resources to export industries that would emerge under free trade (Kim (1985), pp. 59–60; Westphal (1990), p. 44; and IMF (1966)). An exchange certificate market was created, similar to the system adopted in Taiwan Province of China, and procedures for obtaining import licenses were simplified.29
While the measures taken to liberalize exchange and trade restrictions may have contributed importantly to the remarkable growth experiences of the newly industrializing economies, the Korean case also illustrates the risks of such measures under nonsupporting policies. In particular, following the domestic financial reform and the related high interest rate policy adopted in 1965, Korea experienced an “explosive inflow of short and intermediate-term private capital [that] began in late 1966” (McKinnon (1973), p. 163). The authorities chose to maintain exchange rate stability and to avoid taking direct measures to restrict capital inflows, and instead accepted a rapid accumulation of international reserves and external obligations, along with substantial monetary expansion. This led to higher inflation and, eventually, to a shift in speculative pressures that led to a major devaluation of the won in June 1971.
As noted by Haberler (1954, p. 17), the attempt to restore convertibility started from a position of repressed inflation (that is, “price controls, rationing, subsidies and similar devices”) with “large, insufficiently blocked sterling balances owned by foreigners ready to seize their opportunity when exchange control was relaxed.” Although convertibility by nonresidents was to be limited to “new” sterling balances acquired through current account transactions, the formal and informal arrangements to ensure the inconvertibility of “old” sterling balances held outside the United Kingdom (which were estimated to be $14.9 billion at the end of 1946) proved ineffective in an environment in which it was estimated that “new” sterling was flowing from the Sterling Area to the outside world—through the current account—at an annual rate of about $5 billion (Hinshaw (1958), pp. 10–11).
It may be noted that John Maynard Keynes, who led the loan negotiations on the British side, felt that the target date stipulated by the United States was much too ambitious and negotiated an escape clause under which the British were entitled to request a postponement if conditions warranted. Keynes died in April 1946, and the United Kingdom decided not to exercise the escape option.
See Kaplan and Schleiminger (1989) for an extensive history of the EPU and the political and economic circumstances surrounding the move to currency convertibility in Western Europe.
During 1952–53, the authorities of the United Kingdom unsuccessfully sought international support for a “collective approach” to restore sterling convertibility based on a floating exchange rate (see Kaplan and Schleiminger (1989), pp. 164–84).
Among other Asian economies that have developed rapidly, Malaysia moved to Article VIII status in 1968, while Indonesia did so in May 1988 and Thailand, only in May 1990.
Thus, the percentage of imports for which licenses were automatically approved rose from 30 percent in 1964 to about 87 percent by the first half of 1967, although the automatic approval list in early 1967 still covered mainly capital and intermediate goods (Kanesa-Thasan (1969), p. 18).