1989 Report of the Auditor General of Canada

Main Points

13.1 Canadian authorities buy and sell foreign currencies to moderate short-term swings in the external value of our dollar. This intervention activity leads to a reduction of foreign exchange reserves when our dollar is depreciating and an increase when it is appreciating (paragraphs 13.19 and 13.20).

13.2 Foreign exchange assets are balanced by public debt, denominated in both foreign currencies and Canadian dollars. Income earned on these assets is generally less than the cost of servicing the associated debt. Thus, managers seek to improve earnings and reduce costs, while ensuring that funds are always available for intervention and that risks are considered (13.26 to 13.28).

13.3 Since 1980, significant amounts of gold held in Canada's foreign exchange reserves have been sold. Proceeds have been retained in reserves and invested in interest-earning foreign currency assets. As well, interest has been earned on gold loans (13.37 to 13.40).

13.4 As foreign reserves grew from early 1987, opportunities were taken to pay down high-cost unmatured debt denominated in foreign currencies. A process for systematic analysis of less obvious investment alternatives is being developed. The feasibility of extending this system to simultaneously evaluate borrowing, liability adjustment, and risk coverage options should be considered (13.33 to 13.35).

13.5 Opportunities to improve returns and reduce costs may entail increased risk. We are suggesting that the feasibility of developing more formal, but flexible, risk guidelines for program managers be examined, along with systems for monitoring risk exposure and evaluating any reaction required (13.44 to 13.53).

13.6 Intervention and foreign exchange operations do not lend themselves to incorporation as part of the government's annual budget and estimates. However, the absence of comprehensible reference material on this subject does nothing to encourage informed and regular parliamentary debate about these operations. We believe that more comprehensive coverage in this area should be developed and clearly presented to Parliament (13.54, 13.55 and 13.81).

Background and Audit Scope

Broad Objectives

13.7 International trade and capital flows have always been an important source of economic development, employment growth and improvement in economic well-being in Canada. Orderly exchange markets facilitate such international commerce.

13.8 The broad objective of Canada's exchange rate strategy is to contribute to orderly markets, with emphasis on the external value of the Canadian dollar (C$) relative to its United States counterpart (US$).

Historical Setting

13.9 Toward the end of World War II, major industrialized and trading countries sought to promote stable exchange rates as a means of fostering renewed international commerce. Under the Bretton Woods Agreement, Canada and its major trading partners agreed to abide by a system of fixed, but adjustable, exchange rates. In 1950, Canada alone decided to pursue a floating exchange rate regime. In other respects, we continued to share the goals of the Agreement and to be an active member of the International Monetary Fund (IMF) -- created, in part, to promote the exchange objectives of the accord. Through membership in the IMF, Canada has sought to contribute to these objectives.

13.10 Against a background of severe exchange market pressures, Canada returned to a fixed exchange regime in 1962. Since 1970, however, we have maintained a floating exchange rate.

13.11 In 1973, the Bretton Woods system of fixed exchange rates broke down. Since then an eclectic system has evolved. Under an amendment to the IMF Agreement, member countries are allowed to adopt an exchange rate arrangement of their choice, even though the goal of orderly international monetary conditions remains intact.

13.12 Although the IMF continues to be at the centre of the international exchange and monetary system, in recent years multilateral communication and co-operation between the monetary and exchange authorities of the leading industrial and trading nations has expanded greatly. Canada is an active partner in this.

13.13 Canada's floating exchange rate policy relies on international market forces to determine the basic price of the C$. Since 1970, the strategy of successive Canadian governments has been to intervene in these markets to slow the rise or fall of the C$ compared with the US$. This reflects the assumptions that exchange rate volatility has undesirable economic consequences and that intervention can help reduce such volatility.

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The Nature of Intervention

13.14 In the main, intervention consists of buying US$ with C$ to offset upward pressures on the Canadian dollar, or selling US$ for C$ to counter downward pressures on the external value of the C$. At the moment of intervention, the government has traded one currency asset for another.

13.15 Intervention takes place frequently. Over short periods of time it may involve both the buying and selling of US$ as pressures on the C$ shift. Consequently, the government must have access to substantial amounts of both dollar currencies at all times. U.S. funds are obtained through the issuance of federal government debt denominated in foreign currencies or through the purchase of US$ in the intervention process. The latter leads to increases in C$ debt to fund such purchases.

13.16 The Currency Act provides authority for intervention. It establishes the Exchange Fund Account (EFA) through which intervention takes place and in which most foreign exchange reserves are held. This legislation also specifies general restrictions on the range of assets that may be held by the EFA.

13.17 The Financial Administration Act (FAA) and the annual Borrowing Act(s) provide the legal authority for borrowing and public debt operations, in both C$ and in foreign currency terms.

13.18 Foreign exchange reserves include currencies and other assets in addition to US$, as a result of obligations to support intervention activities on a co-operative international level and other historical and policy factors.

Changing Levels of Foreign Exchange Reserves

13.19 Intervention by Canadian authorities to dampen short-term volatility in the price of the C$ -- called "leaning against the wind" -- also resists somewhat more fundamental pressures toward appreciation or depreciation of the C$. When the C$ is depreciating, sales of foreign exchange outstrip purchases and foreign exchange reserves decline. Eventually, the government may have to borrow foreign currency to replenish reserves.

13.20 Intervention during periods when there is upward pressure on the C$ has the opposite effect. Foreign exchange reserves build up, and debt denominated in foreign currencies tends to be repaid. C$ advances to the EFA and domestic borrowing rise. Exhibit 13.1 illustrates the association between trends in the exchange rate and the rise and fall of public debt payable in foreign currencies.

(Exhibit not available)

Recent History

13.21 Since early 1987, with the Canadian dollar strengthening against its U.S. counterpart, purchases of foreign currencies have outweighed sales, and foreign exchange reserves have increased sharply. Some of the increase in reserves has been used, when opportunities have arisen, to pay down public debt denominated in foreign currencies. Exhibit 13.2 provides a picture of the changing level of foreign currency assets in the EFA and of associated foreign-denominated public debt. It also illustrates the net foreign currency position for recent years when the C$ was at first falling and then recovering sharply.

(Exhibit not available)

Responsibilities

13.22 The Financial Sector Policy Branch of the Department of Finance is responsible for managing foreign exchange intervention, assets and associated liabilities.

13.23 The Bank of Canada is designated as the government's agent respecting intervention operations and day-to-day management of foreign exchange assets and related liabilities.

Scope

13.24 The audit examined how the Department of Finance manages the portfolio of assets and liabilities associated with Canada's intervention in foreign exchange markets. By and large, this entailed an examination of Exchange Fund Account operations excluding intervention activities per se.

13.25 However, these operations are interrelated with the overall financial operations of the government. Thus we examined the management of Canada's overall financial requirements and its public debt, to the extent that they are affected by advances to the EFA and receipts from intervention activities transacted through the EFA.

13.26 Briefly, increases in foreign reserve advances to the EFA are ultimately financed through government borrowing. On the other hand, C$ purchased in intervention operations are returned and netted against C$ advances. Public debt denominated in foreign currencies is redeemed using foreign currency holdings of the EFA.

Observations and Recommendations

Shifting Managerial Concern

13.27 As shown in Exhibit 13.1, the C$ followed a long, declining path against the US$ until early 1986. During that period, the principal concerns of responsible managers were:

(Exhibit not available)

• to replenish liquid foreign currency assets in the EFA, through foreign currency borrowing; and
• to ensure quick access to foreign currency, in addition to that held in the EFA, through establishing commercial lines of credit and new, short-term borrowing programs.

13.28 With the growth in international reserves held in the EFA -- from US $2.6 billion at the end of 1986 to US $13.6 billion two years later -- management has also had to consider how to deploy reserves that may not be needed for immediate intervention and how to manage cost-effective adjustments to the stock of existing foreign liabilities.

Management Style

13.29 The Financial Sector Policy Branch of the Department of Finance focusses primarily on strategic considerations with much of the day-to-day activity associated with intervention, asset and liability management, and borrowing delegated to the Bank of Canada. The rapid change in the exchange and financial environment in recent years demands more frequent strategic reassessment than in the past.

13.30 The Branch's approach to managing this process is to ensure that it has qualified staff in place to evaluate the changing environment, the advice that it receives from outside sources, and any new or anticipated operational opportunities or constraints. Formal systems and processes for monitoring and review of strategies and operations are not extensively developed nor are they considered necessary by senior Branch officials.

Delineation of Investment Opportunities

13.31 Managers continue to be preoccupied with maintaining ready access to foreign currency for intervention to moderate downward pressure on the C$.

13.32 However, the pressure on the C$ over the last couple of years has, on balance, been upward. This has led to an accumulation of sizeable foreign exchange reserves, both in total and net of liabilities payable in foreign currencies. No evidence was found that this turnabout was anticipated or that processes were in place beforehand to enable managers to evaluate quickly what portions of reserves were available for investment. Although the Currency Act generally specifies assets which may be held in the EFA -- by way of currency and the maximum term to maturity -- formal processes were not in place to consider the full range of alternative placement opportunities.

13.33 Nonetheless, program managers moved to apply expanded reserves to the reduction of high-cost outstanding debt denominated in foreign currencies as opportunities arose.

13.34 Moreover, Finance is developing a system to enhance investment income through ongoing evaluation of reserve levels and potential demands on them, particularly the amounts needed to meet intervention requirements under various assumptions about market conditions in the future. This initiative involves officers of the Bank of Canada as well as of Finance.

13.35 Program officers must deal with a growing range of asset placement alternatives, borrowing options and risk coverage techniques. It is unlikely that these can all be regularly considered without support of automated systems. Simultaneous consideration of numerous investment, borrowing and liability adjustment alternatives is now practiced by a number of large private sector portfolio management operations. The government cannot adopt this approach directly because of constraints inherent in the public sector context. However, this added complexity reinforces the argument that systems are needed to assist managers to organize and analyze alternatives in the context of overall program objectives.

13.36 The Department of Finance should consider extending the system currently under development for assessment of investment alternatives to include simultaneous consideration of borrowing, liability adjustment and risk options.

Department's response: With the recent growth in the level of Canada's international reserves, portfolio management has taken on added significance. As noted in this report a system is currently under development which should assist in the assessment of investment options.

In considering extending this system or developing a similar system to assist in the management of Canada's foreign-currency-denominated liabilities, it should be noted that apart from Canada Bills, Canada's foreign currency borrowing program is dormant. It has been more than two years since Canada has issued foreign-currency-denominated debt. Foreign-currency borrowings have been few in number, but relatively large in size. The approach taken by the Department has been to carefully analyze the borrowing options available at the time, with currency risk being thoroughly examined prior to issue. At the present time, from a combined portfolio perspective, risk associated with debt denominated in overseas currencies is minimal.

Insofar as liability adjustment is concerned, it may be remarked that recent practice has been to repay foreign currency debt as it has fallen due and to take advantage of early repayment options, including purchasing Canada's foreign-currency debt on the open market, when there has been an economic advantage to doing so. Existing unhedged overseas debt is monitored and possibilities for reducing exposure, through swaps, early retirements, or other means are evaluated.

Financial markets evolve, at times significantly and rapidly, and such a system would require frequent adjustment and updating if it were to remain relevant. Taking into account the present level of reserves and access to short-term credit, there would be ample lead time to put such a system in place, should it appear that foreign borrowing could be resumed. Should events unfold along these lines this recommendation would be considered.

The Special Case of Gold Holdings

13.37 Over many years, a variety of government programs -- including support for Canada's gold mining industry -- led to an accumulation of gold inventories which peaked at over 33 million fine ounces at the end of 1965. Canada's gold reserves are held in the EFA, although they serve no active role in foreign exchange market intervention.

13.38 Gold has earned only modest amounts of interest -- through the gold loans program; however, the amount has increased steadily. Although it would not be possible to quickly convert all of the approximately 17 million fine ounces of gold currently held in the EFA to interest-earning securities, the interest that could have been earned on the roughly C$ 7.8 billion -- at market prices -- held as gold reserves at 31 March 1989 would have been about C$ 800 million this year alone. Moreover, conversion to foreign currency -- approximately US$ 6.5 billion -- would increase by about 50 percent the Exchange Fund's holding of liquid foreign currency assets available for intervention purposes.

13.39 From the outset of the 1980s, the government has actively managed its gold reserves. This has involved periodic sales of bullion to the market; 5.0 million fine ounces yielding US$ 2.4 billion (C$ 2.9 billion) excluding accumulated interest earnings, were sold during the period 1980 through 1988. The timing and scale of bullion sales have been keyed to market conditions, while avoiding a discernible pattern which could fuel speculation.

13.40 As well, a gold loan program has been developed, with income of C$ 7.1 million in 1988. Since gold holdings could not be sold off quickly without a severe adverse effect on gold prices, low-risk use of the remaining balances can yield substantial incremental revenues, even at low interest rates. Gold loans to financial institutions have expanded rapidly in the last several years.

13.41 We found that the objectives of the gold sales and the gold loans programs are being pursued with diligence. Incremental earnings from the gold loan program and from interest earned on the invested proceeds of gold sales are large. Interest earned on the proceeds of gold sales since the inception of the program in 1980 is estimated by Finance at US$ 1.4 billion.

13.42 The gains on gold sales, which represent the difference between market and book value at the time of sale, are included as part of the net valuation gains (losses) of the EFA. However, Exhibit 13.3 below presents such gains separate from annual gains and losses recorded for other EFA assets. At the end of 1988, the book value was C$ 56 per fine ounce while the market value was C$ 489 per ounce. Clearly, realized gains on sales of large quantities of gold can overshadow valuation gains and losses associated with the management of assets and liabilities involved in intervention operations. They tend to obscure the need for effective management practices in this area.

(Exhibit not available)

Risk Management

13.43 Valuation gains and losses. The valuation data presented in Exhibit 13.3 reflect the changing C$ value of EFA assets and associated liabilities, including gains and losses from intervention activity.

(Exhibit not available)

13.44 The value of foreign exchange reserves and associated liabilities will rise and fall with changes in exchange rates. For instance, the US$ assets acquired before the fact will be worth less in terms of C$ following an increase in the price of the C$, and vice versa. The valuation impact on liabilities will be opposite to the effect on assets. Thus, if assets and liabilities are equal for any one currency, there will be no valuation gains and losses, even as the C$ moves in relation to it. The net liability position for any one currency (or set of highly correlated currencies) is thus the major factor in determining the government's exposure to currency losses or gains.

13.45 While valuation gains on net holdings of assets and liabilities denominated in overseas currencies were recorded in earlier years, valuation losses have been incurred in recent years, as shown in Exhibit 13.3. This reflects the general decline in the value of the C$ compared to the overseas currencies in which Canada has issued public debt for EFA purposes and the excess of liabilities over assets held in these currencies during this period.

(Exhibit not available)

13.46 Risk-reward trade-offs. There has been no need to issue long-term foreign currency liabilities for over two years. However, previously the government approved borrowing in overseas currencies to take advantage of lower interest rates. This exposed the government to the risk of loss if the US$ declined and to the opportunity for capital gains if it rose against the foreign currency in question. Finance estimates indicate that interest cost savings have exceeded net valuation losses on overseas currency debt issues that were not immediately converted to US$ liabilities; however, these savings do not show up in the accounts, while the valuation losses do.

13.47 Managers in the Financial Sector Policy Branch at Finance have sought to reduce exposure to exchange losses, while minimizing interest costs through borrowing in overseas currencies. For more recent issues, both the liability and currency are converted into US$ at the time of issue.

13.48 However, similar efforts to protect against currency risks on uncovered, outstanding foreign liabilities have not been made. This is partly because the values of assets and liabilities denominated in overseas currencies fortuitously have converged, leading to greater coverage of currency risk. Liabilities denominated in overseas currencies have been deliberately reduced. However, the increase in assets denominated in the same currencies is largely coincidental. EFA holdings of assets denominated in overseas currencies reflect policy decisions concerning Canada's involvement in co-operative international undertakings rather than investment considerations or moves to reduce currency risks.

13.49 The most complex and important challenge for managing assets and liabilities denominated in several currencies is the determination of an "acceptable" degree of risk-taking arising from exchange rate fluctuations. However, there are other risks and opportunities that may affect revenues and costs. For example, decisions based on correct anticipation of future interest rate trends can improve investment returns and reduce interest costs on debt. On the other hand, there is an obvious risk that interest rates will move in the opposite direction. Another consideration is that losses, or gains, may result if investments must be converted to cash before maturity in order to fund intervention transactions.

13.50 Two fundamental and interrelated strategic questions should be addressed:

• To what extent should the government take risks and seek gains when managing assets and liabilities denominated in foreign currencies?
• To what extent should managers be directed to seek to minimize interest costs of borrowing in foreign currencies and to maximize returns on the investment of EFA assets, given the primacy of meeting liquidity needs for intervention?

13.51 Senior management of the Department should examine the feasibility of developing formal guidelines for program managers to give them parameters of risks and rewards within which to operate. These guidelines should cover borrowing, managing debt, and investing EFA resources not immediately required for intervention purposes, in assets denominated in foreign currencies. They should be reviewed regularly and adjusted when warranted.

Department's response: As noted in the response to the previous recommendation (paragraph 13.36), Canada's foreign-currency borrowing program is essentially dormant and overseas currency risk is at a low level. The Department would be willing to consider the development of more formal guidelines in this area if it appears likely that the foreign-currency borrowing program would be reactivated.

While the Department is willing to examine the feasibility of developing more formal guidelines in the other areas mentioned in this recommendation, it should be noted that currency risk is inherent in the operation of an exchange fund. The currency composition of Canada's international reserves is largely a consequence of intervention activity - which is the raison d'être of the Exchange Fund. Opportunities to alter the currency composition of Canada's reserve assets on portfolio grounds are limited, if the underlying purpose of the Exchange Fund and Canada's international obligations are to be respected.

13.52 Officers at Finance evaluate periodically the extent to which liabilities in overseas currencies are covered by assets denominated in the same, or highly correlated, currencies. Options for reducing the liability portfolio to counter imbalances -- currency risk exposures -- are presented for consideration. Assets denominated in overseas currencies are determined largely by policies on multilateral co-operation. Moreover, the number of options for manipulating the portfolio of unmatured debt denominated in foreign currencies is increasing. Under these conditions, there is a need for ongoing monitoring of risk exposure and evaluation of options for risk control. Moreover, such a process might logically extend to other risk-reward considerations.

13.53 Formal systems should be in place at the Department of Finance for monitoring and evaluating risk or opportunity positions from the perspective of assets, liabilities and the combined portfolio. A process that updates operational constraints should be included; for example, the redefinition of holdings of overseas currencies required for co-operative international intervention should be a priority.

Department's response: The EFA's net foreign currency position is monitored and evaluated periodically, with full account taken of the operational constraints in place. The Department will examine the feasibility and cost-effectiveness of putting a system in place to make this process more formal and regular.

As noted in the response to the second recommendation (paragraph 13.51), portfolio considerations can only play a limited role in influencing the currency composition of the Exchange Fund's assets. The nature of the Exchange Fund's operations is such that operational constraints do not change frequently; nevertheless, the Department will consider establishing a more formal process of updating or reaffirming existing constraints. For foreign currency liabilities, see the responses to the first and second recommendations (paragraphs 13.36 and 13.51 respectively).

Information to Parliament

13.54 Although parts of the story about foreign exchange market intervention and management of Canada's foreign exchange assets and liabilities may be found in public documents, there is no comprehensible, consolidated discussion of the operations underlying this important macroeconomic policy area. Indeed, published financial data, even including explanatory notes, cannot reveal the quality of managerial performance, particularly cost-saving achievements.

13.55 Accountability depends on both Parliament and senior government managers having a clear idea of the objectives to be achieved and the performance of those responsible for meeting them. This is particularly important since EFA operations cannot be projected with confidence and, therefore, they are not examined by Parliament as part of the annual budget and estimates process. This section provides a general outline of some of the information that might be included, in more complete form, in improved reporting to Parliament.

13.56 Canadian dollar defence fund. The foreign exchange reserves of Canada are now very high compared with recent years. Exhibit 13.4 illustrates the level and growth of these reserves in terms of US$ which form the bulk of all foreign currency assets in the EFA.

(Exhibit not available)

13.57 The foreign currency assets held in the EFA are the principal resources used in the intervention process. They are also the EFA's primary base on which investment income is earned. Special Drawing Rights of the IMF are used to settle accounts with the IMF but seldom for intervention-related purposes.

13.58 As discussed previously, gold is not used in intervention. However, since a high level of reserves has a strong psychological value in discouraging speculation against the C$, inclusion of gold in reserves supports the program's objective and is consistent with international practice. Exhibit 13.4 adds to the book value of EFA gold stocks the additional value that would be expressed if they were valued at full market prices.

(Exhibit not available)

13.59 If the C$ came under prolonged downward pressure and our foreign currency assets became depleted, Canada could obtain additional foreign currency, under set conditions, through several standby arrangements now in place.

13.60 Canada has commercial line-of-credit arrangements with two consortia of financial institutions -- one Canadian, the other international. The total arrangement is now for US$ 7 billion, down from US$ 7.5 billion several years ago. These facilities have not been activated for over two years, and the Department does not anticipate that they will be called on in the near term. The standby charges on these lines of credit -- US$ 6.7 million in 1988 -- have been negotiated downward in recent years.

13.61 Program managers perceive the remaining arrangements for access to foreign currencies, as shown in Exhibit 13.4, as sources of "last resort". The Bank of Canada - New York Federal Reserve arrangement was twice called on when Canada was on a fixed exchange rate during the 1960s. A review of undertakings during periods of severe exchange difficulties in the past leads us to assume that it may be possible to expand this arrangement and to establish similar accords with other central banks and national treasuries should conditions attached to them be politically acceptable.

(Exhibit not available)

13.62 The IMF borrowing rights derive from Canada's membership in that organization. Initial borrowing rights are unconditional and available on demand. Subsequent provisional rights, on the other hand, would be extended only if Canada were to agree to terms and conditions concerning the management of the domestic economy.

13.63 Canada's capacity to defend the external value of its currency is at an historically high level. Reserves and back-up access to foreign funds may well exceed intervention needs for some time into the future. This situation requires that managers actively seek to ensure that assets are earning appropriate returns and that debt servicing costs are reduced where possible. Thus comprehensible and complete reporting on reserve positions and prearranged access to foreign currencies is important.

13.64 Borrowing capacity. Like line-of-credit arrangements, well developed borrowing programs can be thought of as substitutes for holding foreign currency reserves.

13.65 Long-term borrowing alternatives are not being considered by officials at Finance in any systematic way. They do not consider that there is a need to do so, given current high foreign exchange reserve levels.

13.66 On the other hand, Canada has developed an ongoing short-term borrowing program over the last several years. The Canada Bills program has an outstanding debt balance of approximately US$ 1 billion, which is continuously rolled over to keep the program active. The objective is to have an economic, efficient and expandable short-term borrowing program as insurance that foreign currency can be raised if and when required. On balance, there is little if any net cost to the public purse; interest rates on Canada Bills borrowing are virtually identical to those earned on short-term investments denominated in US$. This program has been launched, maintained and evaluated in a very thorough fashion. However, its effectiveness in times of real need cannot be fully predicted from its performance during the past several years when there was relatively little downward pressure on the C$.

13.67 Performance measurement. We found that goals and objectives are specified for certain individual programs and activities within foreign exchange operations, and the achievements of their intended results are assessed.

13.68 For the foreign currency asset and liability portfolio as a whole, the overriding mission to be fulfilled is to maintain a capacity to intervene quickly to counter any downward pressure on the Canadian dollar. Understandably, given a decade of low reserve levels from the mid-1970s through 1986, there is much less clarity about operational constraints and secondary objectives such as cost minimization, revenue maximization and risk-reward tradeoffs.

13.69 As well, over the past five years there has been a rapid expansion of investment, credit and risk coverage alternatives available to portfolio managers. In this setting, Finance and the Bank of Canada have both recognized the need to develop more formal and automated accounting, portfolio information and analysis, and performance measurement systems. A substantial effort has recently been launched to meet this need, in part by modifying software systems developed for private sector operations. Such systems should be of assistance in the ongoing management of the Exchange Fund and related operations and in reporting to Parliament.

13.70 Program costs. Parliamentarians have recently inquired into the cost to taxpayers of maintaining foreign exchange reserves.

13.71 Recent analysis in this area indicates that Canadian intervention and foreign exchange reserve operations may generate net revenues over the long term, although this conclusion depends on the time period considered. However, there is no accounting presentation that provides that information. It would seem reasonable that the Department should report all income and costs associated with these operations to Parliament, as fully as possible.

Full income and cost information on foreign exchange operations should be reported to Parliament.

13.72 Exhibit 13.5 provides detail on the annual income of the EFA for the past five years. Investment income has grown sharply with the dramatic run-up in reserves over the past two years. Net valuation adjustments moved from a loss position in 1985 and 1986 to a gain position in 1987 and 1988, partly because of the appreciation of the C$ but largely as a result of exceptionally large gains on gold sales in the latter two years (see Exhibit 13.3).

(Exhibits not available)

13.73 Exhibit 13.6 is intended only as an approximation of the scale of costs involved in intervention and in the maintenance of foreign exchange reserves, not as a definitive measure of this operation.

(Exhibit not available)

13.74 In Exhibit 13.6 gains from gold sales (Exhibit 13.3) are deducted from the gross income (Exhibit 13.5) to show the net operating loss or income position of the EFA.

(Exhibits not available)

13.75 Interest payable in foreign currencies has come down since 1986 as debt denominated in foreign currencies has matured and otherwise been redeemed, as shown in Exhibit 13.6.

(Exhibit not available)

13.76 To this point, only the costs of servicing debt denominated in foreign currencies are included in Exhibit 13.6. However, intervention transactions also involve C$ receipts and disbursements and, respectively, the associated interest earnings and expenses are part of the total costs of intervention and maintenance of foreign exchange reserves.

(Exhibit not available)

13.77 When the C$ is depreciating and intervention leads to net purchases of C$ with foreign currencies, foreign exchange intervention will be making a net contribution of C$ to meet the government's financial requirements. When the C$ is appreciating and intervention leads to net sales of C$ against foreign currencies, there will be a net draw on the Consolidated Revenue Fund (CRF). In Exhibit 13.6, we show the interest on the EFA's Canadian dollar deposit position with the Receiver General for Canada -- which provides a running total of C$ drawings on and refunds to the CRF. It is shown as a reduction in interest costs when the balance is positive and an additional interest cost when the balance is negative.

(Exhibit not available)

13.78 The data and estimates presented in Exhibits 13.5 and 13.6 could be interpreted further. For example, higher levels of foreign exchange reserves do not alter the fact that total interest costs (Exhibit 13.6) continue to exceed the total investment income (Exhibit 13.5). We believe that further analysis of such fundamental information would be of interest to Parliamentarians and could be developed by the Department of Finance.

(Exhibits not available)

13.79 The cost of maintaining all foreign exchange assets, those in the EFA as well as in other accounts, would also include:

• the net costs of Canada's financial position with the IMF,
• the standby charges for commercial lines of credit, and
• the relevant operating costs of the Department of Finance and the Bank of Canada.

13.80 It is the nature of financial statements to duly record costs entailed in operations. However, no estimates are presented to the public that indicate the extent of savings that have been realized over the years from efforts to reduce interest and other carrying costs. In providing comprehensive reports to Parliament this feature of performance might well be included.

13.81 The annual report on the Exchange Fund Account and other official publications should be enhanced to provide Parliament with a complete and comprehensible picture of:

• the full extent of foreign exchange reserves and offsetting liabilities or debts, and back-up access to foreign currency;
• the net costs of maintaining these reserves and back-up arrangements, including trading profits (losses) arising from intervention; and
• the performance of the program.

Department's response: The Department will give further consideration to this suggestion. It notes, however, that considerable information relating to Canada's international reserves, foreign currency liabilities, and the operations of the Exchange Fund is available to Parliament and the general public. It is also the Department's understanding that, by international standards, Canada is relatively open about these matters. Requests for additional information, of the type suggested in the recommendation, have been infrequent.