Balance of Payments Reporting for Transactions of the European Monetary Cooperation Fund

International Monetary Fund
Published Date:
June 1992
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Quazi M. Hafiz and John F. Wilson 

In its investigation into global capital account discrepancies, the Working Party on the Measurement of International Capital Flows examined the European Monetary System (EMS), the European Monetary Cooperation Fund (EMCF), the creation and use of European currency units (ECUs), and the effect of reserve swaps on the credits and reserves of the member central banks. The present paper briefly addresses some salient features of these mechanisms and the implications that swap transactions have for the member countries’ balance of payments.1

The EMS was established in March 1979 to create a “zone of monetary stability in Europe” through close cooperation and coordination of monetary and exchange rate policies. The system operates under a set of rules governing exchange rate policy and market intervention as well as the extension of short-term credits to finance such an intervention. Basically, the EMS allows for exchange rate adjustment within a fixed range and through approved channels. Each currency has a central rate relative to the ECU and a grid of bilateral exchange rates, which cannot fluctuate more than 2.25 percent from the bilateral parities. A member central bank is obliged to intervene in the market when its currency reaches the margin. However, before a currency crosses the margin, a “divergence indicator”—measuring the deviation of a currency upward or downward from the community average—alerts the authorities to the need for some corrective measure. To facilitate compulsory interventions, a “very short- term” financing facility was created to enable participating central banks to use each other’s currencies as needed. The ECU, which is a composite currency consisting of specified amounts of members’ currencies, serves as the numeraire for the exchange rate mechanism, as the denominator for both credit operations and intervention, as a reference point for the divergence indicator, as a means of settlement, and as a reserve asset of member central banks.

The EMCF, which was established in 1973, serves as the central reserve institution relating to EMS transactions and has operational responsibility for some parts of the system.2 Of particular interest is its role in the creation of ECUs, their role as a reserve component, and the significance of the changing valuation of the unit for balance of payments entries.

Official ECUs were created at the outset of the EMS when the participant central banks deposited 20 percent of their gold and U.S. dollar reserves with the EMCF in return for a corresponding amount of ECUs. These transactions represented a swap of financial assets.3 Through the ongoing process of revolving three-month swaps, the ECU value of these reserves changes quarterly in line with changes in the gold and dollar holdings of the central banks and with the conversion of the contributed reserves at current prices and exchange rates. For balance of payments purposes, the swaps are treated as the sale of reserve assets to the EMCF in exchange for ECUs. When the swaps are reversed at the end of each period, the dollars and gold are repurchased.

Quazi M. Hafiz is a Senior Economist in the IMF’s Statistics Department. John F. Wilson was Director of the technical staff and is now a Senior Economist in the IMF’s Middle Eastern Department.

To determine the amount of ECUs acquired by a member country in a swap, each member’s gold component is valued either at the average market price of gold over the previous six months or at the average market price of the two fixings on the day before the swap date, whichever is less. Dollars are valued at the average dollar-ECU exchange rate on the two working days before the swap. At the start of each swap period (every three months), the old swap is reversed, and new amounts of reserves are deposited to ensure that they continue to represent 20 percent of the gold and dollar holdings of participant central banks. Accordingly, the quantity of official ECUs is determined by three factors: the price of gold, the exchange rate of the dollar Vis-à-vis the currencies of the EMS countries and the ECU, and the amount of gold and dollar holdings in members’ reserves.

Any change in members’ ECU holdings resulting from these factors give rise to transactions that should be recorded in the balance of payments of the EMCF and relevant member countries. This must happen for two reasons if symmetry is to be maintained in the global Capital account. First, the EMCF is construed as an international organization, and its transactions with member countries represent balance of payments items.4 Second, both swaps and their reversals constitute separate transactions for balance of payments purposes.

For present purposes, it is useful to think of the balance of payments accounts of EMS members stated in dollars, as they are in the Fund’s Balance of Payments Statistics Yearbook. EMS members swap only gold and dollar assets with the EMCF; therefore, changes in the dollar-ECU exchange rate during a swap period should have no effect on the balance of payments. However, changes in the dollar price of gold will cause revaluations of the gold component of successive EMS swaps, even in the absence of other transactions in the national gold stock. If 20 percent of a member’s gold stock is “sold” to the EMCF at a certain price in period 1, it will be “repurchased” at the same price at the start of period 2, but immediately resold at a different price, and so forth. Thus, price changes generate balance of payments transactions with the EMCF in the case of the gold component of swaps.

Quantity changes in national gold and dollar assets can likewise give rise to net balance of payments entries with the EMCF. For instance, if an EMS member buys (sells) gold or dollars for the purposes of intervention or portfolio management during a swap period, the dollar value of its assets with the EMCF will rise (fall) at the start of the next swap period by 20 percent of the transactions amount, assuming the price of the assets has remained steady.

Apart from short-term credit and other uses of ECUs, therefore, net balance of payments transactions of EMS members with the EMCF consist of the reversal of old swaps and the initiation of new swaps. Since a number of EMS members do not transact in gold except with the EMCF, when prices change their successive gold swaps are akin to realized capital gains or losses and constitute balance of payments transactions. The gold transactions are like the purchase or sale of securities or any other assets that have been purchased at one price, held until the price changes, and then sold at a profit or loss. In principle, EMS member transactions with the EMCF are “globally neutral” because EMCF balance of payments entries should offset entries in members’ national accounts.

The foregoing discussion suggests that in order for swap transactions of EMS members to be properly handled in a balance of payments framework two things are necessary: I) gold and dollar swaps should enter the accounts as sales and purchases of these assets against ECUs, and 2) the EMCF should report counterpart entries to the IMF.5 As noted in Chapter 8 of the Report on Capital Flows, part of the global capital account discrepancy arises because these procedures are not followed.

The following simplified illustrations show the kinds of entries that may be required in EMS members’ balance of payments statements. (In the EMCF statements, the same swap would be recorded with a reverse sign: an EMS member’s debit would be counted as an EMCF credit.) An EMS member country holds 10 million ounces of gold and $1,000 million in U.S. dollar reserves. For the first-period EMCF swap, the gold is valued at $165 an ounce—thus, total reserves (gold and dollars) amount to an equivalent of $2,650 million. The member’s contribution to the EMCF therefore amounts to the equivalent of $530 million (20 percent of gold and dollar reserves) and it receives ECUs equivalent to that contribution. The entries in the balance of payments of the EMS country—expressed in dollars—will be as follows.

Accounts of an EMS Country
Swap accounting for period 1
Reserve assetCreditDebit

During the first swap quarter, the member’s gold holdings (including swapped gold) increase to 12 million ounces and the price rises to $180 an ounce. U.S. dollar holdings (including swapped amounts) decrease to $975 million. Total reserves then equal $3,135 million. The member’s contribution during the second period amounts to $627 million. The entries in the next table show the reversal of the first swap and the initiation of the second swap, including the ECU allocation, that results.

Accounts of an EMS Country
Swap accounting for period 2
Reversal of

first swap
New swapNet

During the second swap quarter, the member’s gold holdings do not change, but the value of gold drops to $170 an ounce, and U.S. dollar holdings go up to $1,050 million. With total reserves then equivalent to $3,090 million, the member’s EMCF contribution and ECU allocation for the third period is $618 million and is recorded in its balance of payments as follows.

Accounts of an EMS Country
Swap accounting for period 3
Reversal of

second swap
New swapNet

These examples illustrate that changes in ECU holdings result not only from changes in the stocks of reserves but also from the changes in the price of gold. Although pure valuation changes of existing assets are excluded from the balance of payments, changes in ECU holdings resulting from gold revaluation are treated as balance of payments transactions because of the sale or purchase character of the swap operations.

As noted in the Report on Capital Flows, swap- related transactions are not reported uniformly by the EMS member countries in their balance of payments, and the EMCF does not submit reports on its side of the transactions. In the absence of figures from the EMCF, no discrepancies would arise in the absence of sale-purchase accounting by members. However, Germany, Italy, the Netherlands, Spain, and Portugal account for EMCF swaps in the recommended sale- purchase manner, so certain imbalances do arise. The Working Party neutralized these effects by making adjustments to global totals.

No information was available to the Working Party on ECU transactions that take place outside the swap operations described in this paper. Most such transactions relate to the use of short-term credit in connection with exchange market intervention, for which the EMCF makes provision. In concept, members’ debtor positions with the EMCF are shown in their balance of payments accounts as liabilities constituting foreign authorities’ reserves, while creditor positions are shown as part of reserves.

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