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Unit 9: Indian Currency System

forced Britain to draw $US561 million from the IMF in 1956 with an additional stand-by Notes
negotiated worth up to $US739 million. This represented 100 per cent of Britain’s IMF
quota and was four times larger than any previous IMF drawing by any nation. These
stand-by arrangements have an historic importance because they represented a change in
direction for the IMF, whose main role up until that point had been to provide financial
assistance from temporary balance of payments imbalances arising from international
trade in goods and services.
Boughton (2000: 4) argued that prior to the Suez conflict, drawings under stand-by
arrangements was small and largely limited to either “gold-tranche drawing” or drawings
on the “first credit tranche (i.e., countries were borrowing no more than 25 per cent of
their quota)”. He also noted that at the time, the IMF was not constituted to lend to fund
shortages arising from speculative outflows of capital. [Reference: Boughton, J.M. (2000)
‘Northwest of Suez: The 1956 Crisis and the IMF’, IMF Working Paper No. 00/192, Washington,
International Monetary Fund. But the 1956 financial assistance to Britain was the first time
that the IMF had extended standby arrangements to help a nation quell a speculative
attack on its currency.
The British government was adamant that it didn’t want to devalue because it wanted to
avoid adding to the domestic inflationary pressures and it wanted to preserve the position
of the sterling as the second reserve currency and the dominant currency in the sterling
area. While it was running a surplus on the current account, this was offset by its external
investments and debt repayments on the capital account. As a result, the speculative
withdrawals of sterling meant Britain quickly lost reserves. Boughton noted (2000: 13)
that with only a “small cushion of liquid dollar-denominated claims” held by the Bank of
England, the markets started to dump sterling holdings, which put the $US2.80 sterling
parity at risk. It was in this context, which the Bank of England and the British Treasury
determined to fund the defence of the parity via an IMF stand-by arrangement. Of importance,
and this has bearing on what happened in 1976, Boughton (2000: 18) concluded that the
request for assistance was “political rather than economic” given that the current account
was in surplus, domestic economic policies were appropriate, and the currency was basically
stable. Britain could have devalued to head of the financial crisis but did not want the
political stigma they perceived would come with that option.
However, Britain did increasingly tighten domestic policy as a way of increasing the
external surplus and reducing domestic inflation Under US pressure to resolve the Suez
crisis, the only condition the IMF imposed with respect to the stand-by arrangement was
a British withdrawal from the Suez conflict. The IMF overcome its apparent problem of
not being able to lend to help defend a currency against speculative attacks by arguing
that the assistance was to support Britain’s move to full convertibility (see later) as part of
the policy of making international trade and payments freer. The desire by the IMF for full
convertibility was strong in the context of the development of the international trade and
payments system after World War 2. Article VIII, Section 2(a) of the IMF Articles of
Agreement states that “no member shall, without the approval of the Fund, impose
restrictions on the making of payments and transfers for current international transactions”.
In other words, any resident should be able to purchase other currencies at the official
parity in order to purchase foreign goods and services, which are recorded in the Current
Account of the Balance of Payments. This freedom is referred to as current account
convertibility. After World War II, the participating Bretton Woods nations, progressively
relaxed restrictions on imports and currency transactions. However, the War had destroyed
a large proportion of Europe’s productivity activity and most nations had few foreign
currency reserves. In that context, trade and the related payments arrangements were
predominantly bi-lateral.
Contd...

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