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MONTHLY REVIEW, SEPTEMBER 1961 150 T he Business Situation The economy is now moving up to new high ground. The recovery in output to pre-recession peaks is completed, and a period lies ahead in which the economy’s ability to advance rapidly to a reasonably full utilization of resources will be tested. In the second quarter, the nation’s output of goods and services rebounded sharply and reached a level some 1 per cent, in real terms, above the pre-recession peak of a year before. Since midyear, the pace of the ad vance has been somewhat more moderate than during the recovery phase. So far the economy appears to be taking in its stride the heightening of world tensions and the plans for further increases in defense spending. There is no evidence as yet that consumers or businessmen have drastically revised their attitudes. This generally restrained reaction undoubt edly stems from the fact that the economy is still not using available manpower and physical resources to the full. The steel, automobile, and residential construction industries, for instance, are all operating well below capacity. The number of unemployed has been at about five million (seasonally adjusted) for fully nine months, and approxi mately one million of these have been out of work for at least six months. THE ADVANCE BRO AD ENS In July the Federal Reserve’s seasonally adjusted index of industrial production rose two points to 112 per cent of the 1957 average, breaking past the pre-recession record of 111 per cent (see Chart I). Increases in the output of materials and of equipment were larger than in June, and consumer goods production continued to rise although less than in the previous month. Furthermore, new orders received by manufacturers of durable goods advanced another 1 per cent, seasonally adjusted, and covered a wide range of both defense and civilian goods, in contrast to a rather limited range the previous month. The ad vance in industrial activity has thus clearly broadened, suggesting the establishment of a firm base for a strong economic rise. Inventory accumulation—which in the spring was heav ily concentrated in the auto industry—is one factor stimu lating production. Total inventories rose Vi of 1 per cent in July, the largest gain since mid-1960, with a major part of the increase occurring in durables manufacturers’ stocks. This had been foreshadowed in a quarterly survey taken by the Commerce Department in May, when manufacturers of durables reported that they intended to accumulate inventories at a rather substantial pace during the JulySeptember quarter. Evidence of further inventory accu mulation is contained in the latest survey by the National Association of Purchasing Agents. The survey showed that by August the vast majority of the association’s mem bers had shifted from a policy of inventory liquidation to a policy of inventory stability or accumulation, and that about one fourth of the members were planning to add to inventories in September and October. In construction as in manuf acturing, activity appears to be not only advancing but also broadening. Although total construction outlays toned up in March, several sectors continued weak. One of these, the Government sector, has moved up during the last three months, how ever, and should continue strong. With regard to the private sector, private housing starts (which often indi cate the strength of residential outlays some two months later) were down slightly in July. Nonetheless, the JuneJuly total for this erratic series was almost 10 per cent higher, seasonally adjusted, than that for April-May. In addition, requests for Government-backed mortgages, which usually also are a guide to residential construction trends, remained firm. E M P L O Y M E N T A N D C O N S U M E R S P E N D IN G The employment picture is mixed. The improvement in construction and manufacturing activity and a continuing expansion in the service industries nudged up July’s non* agricultural employment, as measured by the Bureau of Labor Statistics payroll survey, by V2 of 1 per cent, sea sonally adjusted, to a new record (Chart I). At the same time, the household survey conducted by the Census Bureau showed nonagricultuiral employment dropping almost 1 per cent and remaining at that level in August. (This latter series, which has a wider coverage than the payroll survey and includes domestic workers, the self-employed, and nonpaid family workers, is generally considered a less useful guide for month-to-month fluc tuations.) Total employment., seasonally adjusted, also FEDERAL RESERVE BANK OF NEW YORK Chart I RECENT ECONOMIC INDICATORS S e a so n a lly adjusted Per cent Per cent 120 120 Billions of d ollars Billions of dollars 16 -------- i 16 N e w o rd e rs fo r d u ra b le goods 14 i i I i i I i i I i i i Billions of dollars Billions of d ollars 5.0 5.0 4.5 4.5 Construction a ctiv ity 1 I 1 I 4.0 M illio n s of persons 54 ---------------------- I 1 I J — 1_ 1_ 1. 1 .1 1 1 I 1 I 4.0 M illio n s of p ersons , 54 52 N o n a g ric u ltu ra ! e m p lo y m e n t* 1 I 1 I I I I I 1 I I 111I 50 U nem ploym ent ra te I I I I 1I I I 1I I 1I I 1960 151 in percentage terms, than did disposable income—despite the slight decline, relative to income, in the second quarter of 1961. In July, retail demand for goods continued to be sluggish. Sales of durables declined by almost 2 per cent, seasonally adjusted, and nondurables by almost 1 per cent. The weakness in durables was actually limited, however, to the automotive sector, where sales fell sharply. Appliances and furniture and a number of other durables lines that had been weak earlier showed strength for the second month in a row. More recent data suggest that in the first weeks of August automobile sales held up reasonably well con sidering the shortages of many models, and the Federal Reserve Board’s latest Quarterly Survey of Consumer Buying Intentions, taken during the third week of July, points to a rather promising sales outlook for automo biles over the next half year. The survey reveals a de clining interest, on the other hand, in household appli ances. It is very possible, however, that the continuing improvement in the outlook for business and for job op portunities may prompt consumers to spend more than they foresaw7 a month and a half ago. J_L 1961 Payroll survey. Chart II Sources: Board of G overnors of the Federal Reserve System; United States CONSUMPTION EXPENDITURES Departm ents of Commerce and Labor. C O N S U M P T IO N AS A PERCENTAGE C H A N G E IN C O N S U M P T IO N O F DISPOSABLE IN C O M E OVER THE YEAR P ercent_____________ ____________ ______________________________________ Per cent fell slightly in July, according to the household survey, but recouped about half of that loss in August. The lower levels of employment in these two months were only partly offset by a contraction of the labor force—even though many young people dropped out because they were unable to find summertime jobs—and the unem ployment rate was 6.9 per cent in both July and August. The rate has now been hovering around that level for nine straight months. Personal income was another series that pushed up to a new record in July. However, if the special life insur ance dividends received by veterans are left aside, the month’s rise amounted to only Vi of 1 per cent. As personal income has moved upward, disposable income (personal income after taxes) has also increased. In the April-June quarter, disposable income was about 3 per cent higher than a year earlier. The percentage of disposable income spent for goods and services, however, was lower (Chart II), mainly reflecting a 7 per cent decline in sales of dura ble goods. Expenditures on nondurables also failed to keep pace with disposable income and, in dollar terms, rose only slightly. Services, however, actually rose more, T otal cons;umption expenditui 1 1 1 Services 1 1 ....... 1 Noi ndurable goods **'■>* 1 1 1 D u ra b le goods -5 1 1 III 1960 ......... .. 1 I II i p £1 Note: Based on se a so n a lly adjusted data. Source: United States Department of Commerce. Second quarter 1960— second quarter 1961 MONTHLY REVIEW, SEPTEMBER 1961 152 The International Economic and Financial S cen e The economies of Western Europe and Japan continue to enjoy boom conditions, but the very rapid expansion of the past year and a half has begun to slow down in a few countries. In addition to vigorous domestic growth, most of these countries have benefited from a steady in crease in their exports, and have been able to achieve and maintain a high level of international reserves. The United Kingdom, however, has recently been faced with severe balance-of-payments difficulties that required not only ex tensive domestic measures but also large-scale assistance from the International Monetary Fund. Great Britain’s drawing from the Fund—the largest in that institution’s history—underscored the importance of the approaching IMF annual meeting in Vienna and the continuing discus sions regarding the further adaptation of the Fund to the changing pressures on the international payments mechanism. T H E B R IT IS H PAY M EN TS PROBLEM Britain’s balance of payments on current and long-term capital account has been in substantial deficit since 1958. In 1960, this deficit was hidden by a record inflow of short term funds. Early in 1961—partly as a result of the uncer tainties following the revaluations of the German mark and the Dutch guilder—this inflow was reversed, and Britain’s over-all payments position began to weaken, despite some improvements in the trade accounts. In spite of several nonrecurring receipts, and the substantial temporary as sistance rendered by various foreign central banks to help support sterling, Great Britain’s international reserves fell $792 million from the end of January to the end of July, when they totaled $2,453 million (see chart). Great Britain’s payments difficulties reflected the con junction of a number of basic problems. Perhaps most critical were renewed pressures on costs and prices arising from spreading labor shortages and a faster rise in demand than in output. The resulting increase in the trade deficit in 1960 was aggravated by the stimulus to imports from the dismantling of import controls and by the cyclical weakening of North American demand for British exports. At the same time, there was some question as to whether a number of industries were making the technological improvements necessary to meet foreign competition. Finally, Britain’s traditional surplus on service transactions dwindled as earnings from shipping and oil fell and overseas military outlays rose, and foreign-aid commit ments increased. To buttress the country’s international financial position, the British Government at the end of July and the begin ning of August announced a new “austerity” program employing both monetary and fiscal policy weapons, rather than relying as in recent years primarily on monetary re straint. The series of measures to be implemented this year and next was designed to curb domestic demand, hold the line on costs, reduce overseas expenditures, and bolster the pound against further short-run pressures, thus establishing a base from which the economy can make the necessary longer term adjustments in productivity, prices, and the composition of industrial output. With respect to monetary policy, Chancellor of the Exchequer Selwyn Lloyd said that the government’s aim was “to make credit more expensive and more difficult to get . . . particularly . . . credit for personal consumption and property development”. To accomplish this, and at the same time to curb short-term capital outflows, the bank rate was raised to the so-called “crisis” level of 7 per cent from 5, and the requirement for special deposits by the English and Scottish banks was increased (to 3 per cent from 2 for the former and to lYz per cent from 1 for the latter). The government and the Bank of England made it clear they expected the banks to respond to the restraint meas ures by curtailing their lending (especially for personal consumption and speculative purposes) rather than by reducing their government securities holdings. In addi tion, for the first time in history the Bank of England issued a direct request to sales finance companies (which in Britain obtain a good deal of their resources by accept ing deposits) not to seek nonbank funds as a means of escaping the effects of the credit tightening. In the area of fiscal policy, Chancellor Lloyd’s major step was to invoke to the full his new power to raise the existing rates of purchase taxes and certain customs and excise duties by 10 per cent. If the rates are kept at the new level for the remainder of the current fiscal year, they are expected to raise revenue by some 2 per cent, enough to more than offset the deficit in the current budget. More over, Mr. Lloyd announced his intention to present legis lation to tax gains from short-term trading in securities and real estate. FEDERAL RESERVE BANK OF NEW YORK The government also declared that it would curb the expansion of its own expenditures and, where possible, would reduce projected outlays. Most of this restraint, however, is not to take effect until the fiscal year beginning April 1962, as the government believes that it is too late to cut current fiscal-year expenditures significantly with out undue waste of resources. Strong efforts will be made to reduce overseas military spending, to hold foreign aid down to current levels, and to curb diplomatic spending abroad. On the domestic front, government programs to encourage house buying will be eliminated and investment in nationalized industries is to be sharply curtailed. In addition, the Chancellor announced that private overseas investment outside the sterling area is to be reduced through closer governmental review and that private busi ness is to be encouraged to repatriate more of its overseas earnings. The government’s major effort to hold down costs in industry is an attempt to restrain wage boosts and to dis 153 courage increases in dividends. In his July statement, the Chancellor particularly urged labor and management to hold wage rises in abeyance “until productivity has caught up [with previous increases] and there is room for further advances”. Shortly thereafter, the government imposed a temporary wage and salary freeze in many areas of public employment and requested that this lead be followed throughout the economy. For the longer term, the government announced its in tention to enter into negotiations toward British member ship in the European Economic Community (Common Market), a decision that of course is potentially of the greatest economic and political significance. Should the difficult consultations that will soon commence prove suc cessful, the challenge of European economic integration may be expected to stimulate Britain to make substantial investment in new production facilities as well as to adapt production and sales techniques to the expanded market and more intense competition of the EEC. Finally, in order to bolster the country’s reserve posi tion and to demonstrate decisively its ability to defend the value of the pound, on August 8 Britain drew $1.5 billion from the International Monetary Fund, with an additional $0.5 billion made available to it for one year on a stand-by basis. This drawing was made in nine currencies—only about one third of the total being dollars—and was in tended both to bolster British reserves (which, in fact, rose sharply in August) and for the repayment of the credits granted Britain under the foreign central bank coopera tive arrangements. The significant strengthening of ster ling that followed the announcement of the drawing, together with some signs later in August that domestic inflationary pressures might be easing, gave ground for hope that Britain was moving toward its immediate economic policy objectives. T H E L E N D IN G A C T IV I T IE S O F T H E IN T E R N A T I O N A L M O NETARY FUND The $2.0 billion equivalent ($1.5 billion in cash and $0.5 billion stand-by) of financial assistance extended by the International Monetary Fund to the United Kingdom last month is a dramatic example of the contri bution that the Fund can make to the strengthening of the reserve position of a major trading nation and inter national financial center in a time of stress. Such assist ance not only enables countries with temporary balanceof-payments disequilibria to execute well-conceived cor rective programs, but may also prevent international financial difficulties from spreading from one currency to another. These objectives are in line with the purposes of the Fund as set forth in its charter: (1) to promote ex 154 MONTHLY REVIEW, SEPTEMBER 1961 change stability, to maintain orderly exchange arrange ments among its members, and to avoid competitive ex change depreciation; (2) to assist in the establishment of convertibility on current account and in the elimination of exchange restrictions; (3) to facilitate the expansion and balanced growth of international trade; and (4) to promote international monetary cooperation by way of consultation and collaboration. To these ends, the Fund makes its resources available to any member that is ex periencing temporary payments difficulties and that is seek ing to redress its position “without resorting to measures destructive of national or international prosperity”. The Fund has enjoyed a considerable measure of suc cess in fulfilling its stated purposes. Among the reasons for its success have been its willingness to make financial assistance available promptly and on an adequate scale, its insistence that borrowers adopt programs designed speedily to correct their payments difficulties, and its readi ness to adjust its operations, within the limitations of its charter, to changing international payments conditions and problems. Such changes have been especially pronounced during the past year or two, and it is expected that the need to make further modifications in Fund policy will be discussed at the Fund’s forthcoming annual meeting this month in Vienna. The Fund’s resources, contributed by its seventy-one member countries, totaled $15.0 billion equivalent at the end of July 1961, of which some $3.3 billion was in gold and $6.4 billion in dollars and other convertible cur rencies. Each member has a quota which is related to its importance in world trade and its international reserve position. The quota fulfills two major functions: (1) it defines the amount of a member’s subscription to the Fund (25 per cent of which is normally in gold and the balance in the member’s currency) and (2) it determines the amount of other member country currencies that a member may draw (borrow). (Under the articles of agree ment, member countries may not draw gold from the Fund.) Each member’s drawing rights consist of a “gold tranche” (which is equivalent to the member’s gold con tribution to the Fund) and four “credit tranches”, each one equal to 25 per cent of the member’s quota.1 Draw ings are made by the borrowing country depositing with the Fund the equivalent amount of its own currency. Draw ings must generally be repaid in no more than three to five years, the payment being made through the repurchase of the member’s currency with gold or convertible foreign exchange. These requirements ensure the revolving nature of the Fund’s resources. All told, forty-six members have drawn a total of about $6 billion from the Fund since its inception in 1947. Most of the drawings have been made since 1956, and the $1.5 billion British drawing last month plus aggregate cash drawings by about twenty other countries will mean that the Fund’s assistance in 1961 will be the highest for any year since the Fund began operations. The Fund’s relative inactivity in the earlier postwar years was due in part to the Fund’s decision to abstain from providing assistance to recipients of Marshall Plan aid, to the activity of the European Payments Union in helping to finance payments imbalances among the West ern European countries, and to generally good reserve positions of underdeveloped countries during the period when commodity prices were still relatively high. Also in this early period Fund policy on use of its resources had not yet been reformulated along the lines indicated below. During this period, the Fund made a series of important decisions that provided most useful guidelines for later Fund assistance and also reflected the Fund’s willingness to adapt itself to changing circumstances. In the first of these decisions, announced in 1952, the Fund recorded its readiness to extend stand-by arrangements under which a member, once its request for assistance has been approved, is authorized to draw a specified amount of foreign exchange from the Fund within a limited period without further application to the Fund. Even if no drawings are made—and this is frequently the case— these arrangements serve the useful function of giving reassurance that, in times of potential or actual stress, additional assistance is available if needed while the member incurs a much smaller charge for the authoriza tion than for an actual drawing. Some twenty of these arrangements are currently in effect with unused draw ing rights of about $1.2 billion. Concurrent with this 1952 decision, the Fund expressed its readiness to grant a member the overwhelming benefit of any doubt in requests for drawings through its “gold tranche”. These decisions were later followed by: (1) the adoption of a liberal attitude regarding requests for drawings within the first credit tranche, provided the members seeking such assistance are “making reasonable efforts to solve their problems” and (2) sympathetic con 1 A member may augment its drawings to the extent that the Fund’s sideration of additional drawing requests extending be holdings of its currency are less than 75 per cent of its quota. Such a situation would arise where the Fund had previously lent the member’s yond the first credit tranche, provided the member is currency and had not yet re-established its position in the currency, undertaking a comprehensive program designed to main either because the drawing was still outstanding or because it had tain or restore sound monetary conditions. In practice, been repaid in gold or a different currency. FEDERAL RESERVE BANK OF NEW YORK 155 creased. Indeed, since 1958 an increasing proportion of drawings on the Fund has been in nondollar currencies, notably in German marks, sterling, French francs, and Italian lire. Last year, for example, only about 50 per cent of total drawings was in dollars, and this year the proportion promises to be even smaller. The significant changes in international trade and pay ments growing out of the adoption of convertibility by the major Western European countries have given rise to new problems for the Fund. Perhaps the most striking of these stems from the sharp increase in investor sensitivity to the relative attractiveness of major international finan cial centers. Movements of funds between major countries have consequently expanded in volume and have at times become so large as to exert strong pressures on principal currencies. In dealing with such pressures, the monetary authorities of the countries concerned have acted simultaneously on a number of fronts. Through informal consultations with their opposite numbers abroad, sometimes within the forums provided by the Fund, the Bank for International Settlements, and the Organization for Economic Coopera tion and Development, they have analyzed these pressures and have exchanged views on how to cope with them. Beyond this, when the pressures grew to critical propor tions in the weeks following the revaluations of the mark and the guilder last March, a group of central banks, at their monthly meeting in Basle, Switzerland, issued a pub lic declaration of mutual cooperation and support. They implemented this declaration not only by extending short term credits, but also through coordinated operations in the foreign exchange markets. However successful these operations have been in re storing orderliness to the foreign exchanges, it is clear that central bank cooperation cannot be a substitute for the type of assistance that can and should be provided by the Fund. Inter-central bank credits are normally of a short-term character, whereas the speculative capital flows that require their use may not always be reversed promptly. In dealing with such problems the credit facili ties of the Fund can perform a vital service. The Fund has clarified its interpretation of the articles of agreement so as to eliminate any doubt that its resources can be used for capital transfers. Efforts are also being made to ensure that the Fund’s role in this area will not be impeded by possible inadequacies in its holdings of certain currencies. The Fund’s Managing Director, Mr. Per Jacobsson, has proposed that the major industrialized countries should 2 Often other financial institutions ( international, governmental, and agree to lend stated amounts of their currencies to the private), confident of the soundness of a stabilization program ap proved by the Fund, will enter into "parallel arrangements” that may Fund under conditions to be specified. As to the United provide the country in question with assistance of longer duration States position, Secretary of the Treasury Dillon has stated than that available from the Fund. since 1953 the Fund has increasingly waived the limita tion on drawings in excess of 25 per cent of a member’s quota in any twelve-month period, and in the recent past most drawings and stand-by arrangements have involved a waiver. Within the framework of these decisions, the Fund has extended assistance for four main purposes, which cannot, of course, always be clearly distinguished in practice. One has been to assist members to meet seasonal balance-ofpayments deficits: many Latin American countries have benefited from such aid, which usually has been repaid within six to twelve months. A second purpose has been to strengthen the international reserves of members that are undertaking stabilization programs. Such programs are often formulated with Fund help and are designed to remove long-standing inflationary pressures or to elimi nate multiple exchange rate practices.2 Fund assistance has also been extended to relieve temporary payments strains stemming from a variety of other difficulties, ranging from inflationary booms in the borrowing countries to recessions in their major export markets. Finally, Fund assistance has been extended to major currencies to meet emergency situations which, if allowed to continue, could result in serious international payments disruptions. The most noteworthy example of this last type of assist ance was that extended to the United Kingdom in 1956 and again this year to support sterling, which had in each instance come under strong speculative pressures. The Fund’s resources have been considerably bolstered in recent years to meet the growing needs of the interna tional economy. In 1959-60, the board of governors of the Fund agreed to a general 50 per cent rise in quotas, with larger increases in a number of cases. As a result, the Fund’s gold and dollar holdings, which had been severely taxed by heavy drawings in 1956-57, were raised by $2.3 billion, and its holdings of other currencies were augmented by another $2.9 billion. At the same time, each member was henceforth assured, because of its in creased quota, of being able to obtain proportionately greater assistance than previously. The quality of the Fund’s resources was likewise given a substantial boost when, at the end of 1958, fourteen European countries made their currencies externally con vertible. Through this move, which increased the Fund’s holdings of convertible currencies from $1.2 billion equiva lent to $4.4 billion, the usefulness of the institution’s hold ings of the major European currencies was greatly in 156 MONTHLY REVIEW, SEPTEMBER 1961 that “the United States is participating in exploratory dis cussions which we hope will lead to an agreement among the industrial countries to provide stand-by credits to sup plement the Fund’s resources of needed currencies”. An agreement along these lines would constitute a further salu tary step in the progressive adaptation of the Fund to changing conditions. It is hoped that the negotiation of such an agreement will be given encouragement at the Vienna meeting and that all details can be worked out by the end of the year so that the United States and other industrial countries can obtain whatever legislative ap proval may be necessary in early 1962. International Developm ent Lending Institutions In recent years the efforts of major industrial nations to provide more economic assistance to the less developed countries have proceeded along two separate but related lines. Not only have they enlarged their bilateral aid pro grams, but they have also taken steps to increase both the number and the activities of international institutions designed to finance economic development. The first, and for some years after World War II the only, international long-term lending institution was the International Bank for Reconstruction and Development (IBRD), whose fifteenth anniversary will be observed this month in Vienna where the annual meetings of the bank and the International Monetary Fund are being held. The IBRD was organized to supply capital-hungry parts of the world with the long-term funds needed for economic re construction or development at a time when there was little hope that private capital, unaided, would risk inter national investment outside the Western Hemisphere. Although the IBRD’s original capital was doubled in 1959, thus adding substantially to its capacity to mobilize capital resources for the developing countries, it had become clear even earlier that its lending facilities needed to be supple mented by other forms of development finance. Accord ingly, two supplementary institutions were set up as IBRD affiliates—the International Finance Corporation in 1956 and the International Development Association in 1960. In addition, another major institution, the Inter-American Development Bank, was established in 1960 to promote development on a regional basis.1 1 There are, of course, a number of other important official organi zations, both world-wide and regional in scope, that provide funds for economic development. Some of these are international institutions, such as the European Common Market’s Overseas Development Fund; others are national agencies, such as the Development Loan Fund and the Export-Import Bank in the United States and broadly similar bodies in several European countries. All these agencies, however, are outside the focus of this article. T H E I N T E R N A T IO N A L B A N K F O R R E C O N S T R U C T I O N AND DEVELOPM ENT Among international institutions, the IBRD has not only the longest experience in the field of development financing, but also by far the largest resources. On June 30, 1961, its subscribed capital amounted to $20 billion, and the aggregate of the loans it had extended totaled more than $5V2 billion. The bank, which now has seventy member countries, is governed by a board of directors chosen by its members, with the voting power of each director determined by the size of the capital subscription of the country or countries he represents. The United States subscription of $6.4 billion is slightly less than a third of the total. The IBRD was designed to stimulate the flow of long term investment capital across national frontiers and there by to contribute to the development of economic resources and growth of production and income, particularly in the nonindustrial areas of the world. According to its charter, its purpose is to “promote private foreign investment by means of guarantees or participations in loans and other investments made by private investors; and when private capital is not available on reasonable terms, to supple ment private investment by providing, on suitable condi tions, finance for productive purposes out of its own capi tal, funds raised by it, and its other resources”. As matters turned out, the IBRD found it neither practical nor pru dent to give its guarantee to loans raised in private capital markets by borrowers with widely varying credit ratings. Consequently, from the beginning it concentrated on mak ing, from its own resources., direct long-term loans for productive projects. The IBRD’s funds have be:en derived from three major sources which have varied in relative importance over the past fifteen years (see Chart I). Initially, the IBRD FEDERAL RESERVE BANK OF NEW YORK relied heavily on its own subscribed capital, of which $2 billion has been paid in. Second, the IBRD has raised funds by issuing its own bonds and notes, which are of course backed by the capital subscriptions of its members. A third source, which has lately become quite important, has been the sale of participations in IBRD loans to pri vate investors. In addition, in more recent years the IBRD’s available funds have been swelled by its sizable earnings and, at the same time, loan repayments have freed resources for new loans. All in all, from the start of its operations through mid-1961 the IBRD had avail able for lending a gross total of almost $6 billion. i b r d b o n d is s u e s . The most important single source of IBRD’s funds today is the sale of its obligations on the world’s capital markets. Some $2.2 billion of its bonds and notes were outstanding at the end of June 1961. Once the bank had overcome the initial investor re sistance to a new type of security as well as legal barriers to the purchase of its bonds by various institutional in vestors, it became extremely successful in floating large and frequent issues in the United States. Moreover, a rising amount of dollar bonds and notes, originally sold 157 in the United States, soon found their way into the port folios of individual and institutional investors outside this country. It has taken longer, on the other hand, to gain direct access on a substantial scale to financial markets else where. In the immediate postwar period, the United States market was the only one that could provide funds. With the strengthening of the foreign industrial countries’ economies over the past decade, however, the IBRD was gradually able to broaden the geographical base for its securities issues. During the early 1950’s, as capital mar kets abroad were opened up, small issues began to be sold both publicly and privately in Western Europe and Canada. In more recent years, borrowing in Western Europe was stepped up sharply. While the IBRD’s debt is now denominated in seven currencies, its United States dollar securities account for three fourths of the total (see Chart II). However, a sub stantial proportion of the dollar debt—upward of 40 per cent—is estimated to be held outside the United States, so that the institution now owes more than half of its total funded debt to investors abroad. ib r d l o a n o p e r a t io n s . Although access to capital markets abroad has not always been easy, the IBRD has not been hampered in its lending activities by lack of funds. Any limitation on its loan operations has come rather from a dearth of loan projects that are suitable under the IBRD’s standards. These standards are, in cer tain respects, similar to those of the private investor, except that on loans to private entities the IBRD charter requires a government guarantee. The productive charac ter of the projects submitted by would-be borrowers is appraised, and repayment prospects are assessed accord ing to exacting criteria. The IBRD does not normally lend for projects involving social overhead cost, such as schools, housing, or hospitals, which do not produce revenue and cannot be expected to lead to direct and prompt increases in the borrowing country’s produc tive potential and foreign-exchange earning capacity. It may also find it impossible to finance worthy and pro ductive projects in cases where the borrowing country’s over-all ability to service the loan is in doubt because of an already-heavy foreign debt burden or poor balance-ofpayments prospects. It is indicative of the rigorousness of the IBRD’s standards that there has never been a de fault among the approximately 300 loans made since 1946. Except for some $500 million of war reconstruction loans to Western Europe in 1947 and 1948, IBRD lend ing has been devoted to stimulating economic develop ment. Until the early 1950’s its loan operations remained 158 MONTHLY REVIEW, SEPTEMBER 1961 Chart II IBRD: OUTSTANDING FUNDED DEBT JUNE 30,1961 In m illions of U.S. dollcjrs T o ta l: $ 2 ,2 2 8 Source: International B ank for Reconstruction and Development. fairly modest, but the pace has since then quickened considerably and new loan commitments have for sev eral years averaged about $700 million annually (see Chart III). A certain slackening has become noticeable of late, however, in part because some of the IBRD’s borrowers have by now established a sufficient credit standing with private investors so as to be less dependent on its loans. At the same time, other borrowers have accumulated heavy foreign debt burdens which are likely to make difficult the servicing of additional loans. IBRD loans have been heavily concentrated in public utilities, particularly in two major categories that are usually the prerequisites of industrial expansion—power and transportation facilities (see Chart IV). Next in im portance in the IBRD portfolio are loans for the construc tion or development of basic industrial facilities, followed in turn by loans for agricultural improvement, irrigation, and the like. The projects assisted by the IBRD have touched every corner of the globe and have included con struction of some of the world’s largest dams, whole net works of roads to open up isolated regions to industrializa tion and agricultural development, huge port installation projects, and the rehabilitation of entire national railway systems. IBRD funds have also helped finance the estab lishment and expansion of steel, cement, fertilizer, and numerous other heavy and light manufacturing industries, as well as the development of mineral and other natural resources. IBRD loans are medium or long term, mostly in the 15- to 25-year range, depending on the nature of the project financed. They are repayable in semiannual in stalments, normally beginning after a grace period of two to five years. The interest rate they carry (currently 53A per cent) is based upon the rate at which the IBRD raises funds in the market, to which is added a W a per cent serv ice charge. Because of the nature of the projects financed, most IBRD development loans are quite large, ranging in size from several million up to as much as $100 million. For the same reason, many sire extended to governmentowned or government-controlled sectors of the economy. When making industrial loans, however, the IBRD prefers to finance privately owned concerns, in the belief that manufacturing is usually best left to private enterprise. While the government-guarantee requirement and the rela tively modest scale of private industrial undertakings in underdeveloped countries make it difficult to administer such assistance directly, the IBRD has found ways to channel funds to private industry through local develop ment banks, many of which have been created at IBRD initiative. 159 FEDERAL RESERVE BANK OF NEW YORK The IBRD generally limits its financial assistance on an investment project to the foreign exchange portion of the cost of the project. This limitation cannot, of course, be applied rigidly in the case of countries, such as Japan, that are already producers of capital equipment and where the direct import costs of a development project may therefore be small in relation to the total cost. The main objective of the policy has been to ensure that the borrowing country, through taxation or by other means, mobilizes local resources to make a significant contribu tion of its own to the investment effort. Until now, how ever, progress toward this objective has been rather modest and some borrowers have consequently failed to secure maximum possible results from the use of IBRD resources. Also, in order to ensure maximum benefits from the aid granted, the use of the proceeds from an IBRD loan is not tied. Procurement can be effected in any IBRD mem ber country or in Switzerland which, without being a mem ber, has cooperated closely with the IBRD. In general, on any sizable project, the IBRD requires competitive bidding on contracts under its credits. Chart IV IBRD: LOANS BY PURPOSE JUNE 30, 1961 Gross totals in millions of U.S. dollars Total: $5,669 * These represent loans made to local development institutions and reloaned by the latter. THE IBRD, PRIVATE CAPITAL, AND ECONOMIC DEVELOPMENT. The IBRD remains faithful to its mission of not competing with, but on the contrary encouraging, private foreign in vestment. In the first place, it has made relatively few loans to the more industrialized countries of the world, where funds can usually be secured on private capital markets. Until recently, to be sure, it has been lending heavily to two industrial countries that are considered rather special cases—Italy, whose southern half remains underdeveloped, and Japan, where industrialization is still proceeding at an extremely rapid pace. However, the IBRD is now encouraging these two countries to raise elsewhere the funds needed to continue their development programs. At the same time, to help broaden the market for its borrowers’ obligations, the IBRD has frequently arranged to sell to private investors portions of the loans held in its portfolio or to have private lenders participate in some of its new loans. In most cases, the IBRD has kept the longer maturities, while private institutions have bought or participated in the shorter ones, without re quiring a formal guarantee from the IBRD. As the credit standing of IBRD borrowers has improved, some of them have supplemented IBRD loans with funds raised simul taneously by the public issue or private placement of their own securities in the United States. Finally, the IBRD has laid the groundwork for expansion of private foreign investment not only through its loan operations but also through its technical assistance to the develop- Source: International Bank for Reconstruction and Development. ing countries. The IBRD’s technical assistance to its member coun tries has been an invaluable part of its operations. This assistance has taken many different forms and has covered almost all aspects of development planning and execution, from engineering advice on problems of specific projects to help in the organization of domestic development banks and in broad-range development planning. Sometimes, as in the case of the Indus and Mekong river basins, these projects have crossed national borders. T H E I N T E R N A T IO N A L F IN A N C E C O R P O R A T I O N The International Finance Corporation (IFC) was created in 1956 to supplement the IBRD’s activities by providing finance for private undertakings under riskier circumstances than the IBRD and without the latter’s government-guarantee requirement. It acts as a catalytic agent in the process of development, securing as much pri vate participation in its investments as possible and eventu ally revolving its own funds by turning its successful in vestments over to private investors. The IFC’s financial resources are limited and its opera tions have been modest in scope. Although it is allowed MONTHLY REVIEW, SEPTEMBER 1961 160 by its charter to raise funds in the market, until now it has relied solely on its $97 million of capital funds. So far, the IFC has committed $45 million to forty industrial ventures in eighteen countries. The IFC confines its in vestment activities to privately owned and managed en terprises engaged in productive industrial activities — manufacturing, processing, or mining. The enterprises financed are usually of medium scale, the IFC’s invest ments ranging in size from $100,000 up to as much as $4 million. Generally, the IFC provides no more than half of the finance required for a project, expecting the re mainder of the required capital to come from private sources, domestic or foreign. Private interests have, in fact, supplied about three fourths of the total capital used in the various IFC development projects. Although the IFC, like the IBRD, is prohibited from investing in equities, it has developed ways of providing venture-type capital. The IFC is instructed by its charter to obtain a return on its investment commensurate with the risks undertaken and comparable with the returns obtained by private investors. This has led it to negotiate with its borrowers complex investment formulas that add some equity features—such as stock options and participa tions in profits—to what are formally fixed-interest loans. On the whole, the use of these devices has vastly com plicated the IFC’s operations and has constituted a serious obstacle to its expansion. Moreover, equity capital is often badly needed in new and expanding enterprises, which may already be overburdened with debt in their initial years of operation. To meet this need, a charter amendment has been proposed that would allow the IFC to make nonvoting equity investments. If the amend ment is ratified by the member governments, the IFC hopes to be better able to promote the expansion of private en terprise and to induce more local and foreign private investors to join in such activities. T H E IN T E R N A T IO N A L D E V E L O P M E N T A S S O C IA T IO N all of the external capital which they require to carry out their priority programs”. IDA credits, like those of the IBRD, are to be repaid in the? currency borrowed, in order to avoid the accumulation of large quantities of local cur rencies with little or no international usefulness. However, the debt servicing burden is to be minimized by very lenient repayment terms. The IDA is empowered to finance projects of high developmental priority, whether or not they are directly productive. Its activity may therefore be spread over a broader range of investments than the IBRD’s, including those of a primarily social character, such as housing or sanitation works. The IDA, whose membership consists of about three quarters of IBRD member countries, is to receive sub scriptions in instalments over the next four years of over $900 million. However, only the industrialized countries —including, besides Western Europe and the United States, Canada, Australia, Jaipan, and the Union of South Africa—are being required to make their subscriptions available in gold or freely convertible currencies. Hence IDA’s effective resources will amount to only about 80 per cent of its total subscriptions. The IDA’s charter provides that the adequacy of the institution’s resources will be reviewed periodically with a view to increasing the members’ subscriptions. Initially, the IDA’s convertible-currency resources are expected to support a lending rate of about $150 million a year. Sub sequently, the institution’s ability to help meet the de veloping countries’ financing needs will largely depend upon the willingness of the developed member countries to provide additional fund::;—upon their willingness, in effect, to internationalize a greater part of their development aid. Discussing the IDA’s prospects at the United Nations Economic and Social Council recently, Mr. Black said: It is to be hoped that in due course the obvious need, and IDA’s record of performance, will together justify a substantial increase in IDA’s financing capacities, and also that countries contemplating an expansion of their aid pro grams may see fit to channel a part of the addi tional funds through the IDA. Such a pooling of resources is by far the most effective and sat isfactory means of coor dinating development aid. The International Development Association (IDA) was established in the fall of 1960 to fill a gap of a different nature in IBRD’s operations: to make long-term develop ment loans on more flexible terms than are possible for T H E IN T E R -A M E R I C A N D E V E L O P M E N T B A N K the IBRD. In the words of Eugene Black, who is president The Inter-American Development Bank (IDB) differs both of the IBRD and of the new institution, the IDA, is to assist “countries whose foreign exchange situation is from the IBRD and its two affiliates in that it is a regional, such that they cannot borrow abroad at all on conven rather than world-wide, institution. It was organized early tional terms” and “those whose foreign debt service bur in 1960 by the members of the Organization of American den over the short and medium term is already so high States and aims to promote the general economic develop that they cannot prudently borrow, on conventional terms, ment and economic integration of Latin America. Its FEDERAL RESERVE BANK OF NEW YORK membership includes the United States and nineteen Latin American republics. The IDB is divided into two financially distinct entities: an Ordinary Banking Operations component that makes loans on approximately commercial terms to finance im mediately remunerative projects in countries capable of bearing the debt-servicing burden; and a Fund for Special Operations which provides credit to countries in special need and which also finances undertakings that will in crease the recipient’s productive capacity only indirectly and slowly (including, in particular, investments in health, housing, and the like). Loans from the latter fund are repayable in part or entirely in the borrower’s own currency and are made at relatively low rates of interest and for long periods, with amortization beginning only after a generous grace period. By using its ordinary capital only for commercial-type loans, the IDB should be able to supplement its members’ subscriptions by mobilizing private capital in much the same way as has the IBRD. The ordinary capital, like that of the IBRD, includes a paid-in portion of about $400 million and a callable portion of $450 million to serve as backing for bond issues. The groundwork for such issues is already being laid in both the United States and Western Europe. In addition, the IDB has already obtained participations by United States banks in a sub stantial number of the regular loans it has extended so far. The Fund for Special Operations, on the other hand, is to obtain its resources solely from the $150 million sub scribed by member countries. As the fund’s convertiblecurrency holdings may be quickly depleted, owing to the local-currency repayment feature to be used in most of its loans, provision has been made for eventual increases in the members’ contributions. Because the IDB aims to supplement rather than re place existing sources of development finance in Latin America, it is expected to make special efforts to co ordinate its activities with those of other lending institu tions. A beginning has already been made in this direc tion with a highway loan to Honduras in cooperation with the IDA, and a housing credit to Colombia in collabora tion with the United States Development Loan Fund. The regional character of the IDB offers good opportuni ties for working out a coordinated approach to develop ment lending on both the hemisphere and the country level. Of the more than $115 million of loans authorized to date, approximately $79 million have been extended to banks and local development institutions, which will relend the funds generally for small-scale projects in agri 161 culture, industry, and mining, in accordance with over-all plans worked out with the IDB’s assistance. The IDB is also administering, at the request of the United States, the larger part of the $500 million appro priated by the Congress last May for social development projects in Latin America. Loans under this program are to be on flexible terms, to finance important social projects, such as land improvement, water supply, and low-cost hous ing, and to foster the adoption by the recipient countries of the basic tax, land, and other reforms that will make rapid economic development possible. C O N C L U S IO N S While the supply of development capital available from international development lending institutions will un doubtedly remain only a small fraction of total require ments, the contribution of these institutions has already been significant. Through its loans, the IBRD has helped greatly in laying the foundations for economic growth in many countries. Moreover, the economic and technical advice offered by the IBRD, as an international institu tion, has sometimes been accepted more readily than if the advice had come from any national source. Beyond this, it has become clear that international lend ing institutions can effectively enlist the help of private capital to assist in the task of development financing. The experience of the IBRD, in particular, has shown that such institutions can very usefully play, in the international sphere, a role similar to that of financial intermediaries in national capital markets. Finally, it is now widely recognized that the current multiplication of lending agencies at both the government and the intergovernmental levels calls for ever-closer co ordination of aid-giving activities. The specific type of financing offered by some of the agencies, or the nature of their approach, may in themselves define broad areas of specialization. There may nevertheless be instances when the various lenders find themselves in competition with one another, or even working at cross purposes, if they do not reach agreement on common principles, con sistent with the over-all development objectives of those receiving assistance. The feasibility of effective interagency cooperation has been demonstrated many times in the past in the joint ventures of the IBRD with lending agencies of the United States and other governments, including the consortium of nations providing assistance to India and Pakistan, as well as in some of the first un dertakings by newcomers like the IDA and the IDB. 162 MONTHLY REVIEW, SEPTEMBER 1961 T he M oney M ark et in August The money market turned gradually firmer during the first half of August. A number of market factors com bined to produce a lower level of total free reserves, and available funds tended to be concentrated at the country banks. After midmonth, however, aggregate free reserves expanded and reserve balances moved to the money centers, bringing declines in most money market rates. Reflecting these developments, the effective rate for Federal funds was generally at 1% to 2% per cent during the first half of the month, but thereafter declined to a range of 1 to 2 per cent. Dealer loan rates posted by the New York City banks similarly moved from a 2 Vi to 3 per cent range to IVi to IV i per cent after midmonth. Activity in the market for Government securities was generally light. A cautious atmosphere prevailed early in the month, as the market pondered the possible impact of international tensions and of stepped-up defense expendi tures on an economy already advancing at a good pace. In this atmosphere, the decline of intermediate- and long term prices, which began in late July, continued through the first third of August, carrying some issues to new price lows for the year. As the month progressed, however, the feeling grew that this adjustment had run its course, while the light calendar of new corporate and tax-exempt bonds also helped to strengthen the Government market. Later in the month, price trends were dominated by anticipa tions of a “senior” advance refunding, which served to strengthen some of the 2V2 per cent intermediate bonds while dampening the long end of the market. In the Treasury bill market, bank selling in the firming money market over the first half of August, along with dealer attempts to reduce inventories in response to higher financing rates, contributed to a rise of Va percentage point or more in most bill rates. This rise was largely erased during the balance of the month, however, as the easier money market and dealer attempts to rebuild in ventories brought increasing demand and a pronounced decline in rates. M EM BER BANK RESERVES A substantial volume of reserves was absorbed during the first two weeks of the month by market factors, par ticularly a decline in float, an expansion in currency in circulation, and an increase in required reserves follow ing the Treasury’s July cash borrowing operation. Dur ing the following two weeks, market factors—primarily the midmonth rise in float—supplied reserves on balance and, in the final week, absorbed reserves once more as float again dropped sharply. Over the five weeks as a whole, market factors absorbed $571 million of reserves on a daily average basis. System open market operations largely offset swings in reserve availability arising from fluctuations in market factors throughout the month. On balance, open market operations supplied some $545 million in reserves over the five weeks, on a daily average basis. On a Wednesdayto-Wednesday basis, between July 26 and August 30, Sys tem holdings of Government securities maturing within one year decreased by $1,108 million, those maturing in one to five years rose by $1,389 million, and maturities in the over-five-year categories increased by $54 million. These changes reflected, in addition to operations, the exchange of maturing System holdings in the Treasury’s July refunding. Free reserves of all member banks averaged $502 mil lion during the five statement weeks ended August 30, compared with $586 million in the four weeks ended July 26. Average excess reserves declined by about $67 million to $569 million in August, while borrowings from the Federal Reserve Banks rose by $17 million to $67 million. TH E G O V E R N M E N T SE C U R IT IE S M ARK ET In the market for Treasury bills, rates climbed steadily over the first half of the month, with the three-month bill rate rising a full Va percentage point to 2.54 per cent bid, the highest level since last March. Contributing to the rise were a midsummer lull in nonbank demand, a grow ing supply of bills offered by banks reacting to the firm ing money market, and a lightening of inventories by dealers faced with higher carrying costs and an uncertain outlook. Bidding in the weekly auctions during this period was slack, with average rates on the three- and six-month bills rising to 2.519 and 2.765 per cent, re spectively, in the August 14 auction. These rates were 22 and 21 basis points higher than in the auction two weeks earlier and, together with the easing of money market conditions in the second half of the month, stimu lated an increased interest in bills. As the market supply diminished, rates moved steadily lower, and in the final FEDERAL RESERVE BANK OF NEW YORK Changes in Factors Tending to Increass or Decrease Member Bank Reserves, August 1961 In millions of dollars; ( + ) denotes increase, (—) decrease in excess reserves Daily averages—week ended Factor Net changes Aug. 30 Aug. 2 Aug. 9 Aug. 16 Aug. 23 + 83 - 395 + 27 + 15 - 57 + 27 - 75 - 115 + 25 - 53 - 28 + 103 - 100 + 30 + 14 + 13 + 301 + 70 + 15 - 86 + 1 309 + 120 — 10 7 96 + — 375 2 + 75 + — 189 TotsI...................... - 327 - 191 + + 311 - 203 - + Operating transactions Treasury operations*............... Federal Reserve float............... Currency in circulation............ Gold and foreign account......... Other deposits, etc................... 19 391 Direct Federal Reserve credit transactions Government securities: Direct market purchases or sale*.......................................... Held under repurchase agree ment!.............. ................... Loans, discounts, and advances: Member bank borrowings__ + 509 + 255 - 209 - + 79 + 40 + 66 - 190 + 25 — + 48 - + 1 —61 _ + 614 + 344 - 204 With Federal Reserve Banks.. . Cash allowed as reserves f........ + 287 8 + 153 - 231 Total reservesf.............. ................ Effect of change in required res e r v e s f ...'...................................... + 279 - - 452 Excess reservesf......................... - 173 + Daily average level of member bank: Borrowings from Reserve Banki. Excess reserves t ...................... Free reserves f ..... ................... 75 477 402 Other......................................... Bankers’ acceptances: Bought outright................... Under repurchase agreements. Total,.................... 84 85 6 + 556 __ 11 _ — 2 13 —■ _ 1 _ - 296 + 75 + 533 - 185 + 174 + - 15 10 + 128 85 + + 142 10 78 - 11 + 5 _ 43 + 152 + 158 + 58 - 12 + 58 - 190 + 47 - 7 + 15 - 38 Member bank reserves 80 123 557 434 + 62 604 542 25 2 37 597 560 37 612 575 67 J 569 % 5021 Note: Because of rounding, figures do not necessarily add to totals. • Includes changes in Treasury currency and cash, t These figures are estimated, t Average for five weeks ended August 30,1961. weekly auction of the month, on August 28, average issu ing rates were 2.321 and 2.617. At the month’s close* the three-month bill rate was 2*35 per cent bid, 7 basis points higher for the month, In the market for Treasury notes and bonds, under lying psychology remained cautious, reflecting the brighten 16S ing business picture, the budget implications of plans for greater defense spending, and expectations of sizable Treasury financing operations. However, after prices had declined by midmonth to their lowest levels of the year for some issues, there was a feeling that the adjustment might have been overdone, and some professional shortcovering developed. Losses were reduced particularly for the 2V2 per cent tap issues, which were strengthened by widespread reports that they might shortly be open to conversion in an advance refunding by the Treasury. For the month, most intermediate issues were y1Q to 3/a of a point lower while long-term issues, affected adversely by the same discussions of a possible “senior” refunding, were % to 1% points lower. O T H E R S E C U R IT IE S M A R K E T S In the corporate and tax-exempt bond markets, prices moved moderately lower over the first half of the month. The factors depressing Government bond prices made themselves felt in these markets also, but their influence was partly offset by the low summertime volume of new offerings following the high second-quarter pace. The $215 million volume of new publicly offered corporates was only half the $425 million July total and one fifth the $1.0 billion volume reached in June, while the $525 mil lion of new tax-exempt offerings rose only slightly from the $420 million July low and was still far below the $980 million June pace. Soon after midmonth, moreover, the virtual clearing of the corporate calendar and the rejection of the bid on $125 million of a scheduled $225 million State of California offering signaled a temporarily lightened current supply of new issues and prices firmed. Over the month as a whole, Moody’s index of yields on seasoned Aaa-rated corporates was unchanged at 4.45 per cent, while the average yield on similarly rated tax-exempts rose 1 basis point to 3.34 per cent.
@FedFRASER