as part of the Bahamian Payments System Modernisation Initiative to improve financial inclusion and access (CBoB. 2019). The Sand Dollar represents a direct
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WP 0 5/202 1 September 2021 Car ibbean Currency Convertibility in an Era of Central Bank Digital Currency Kevin Finch, Chantal Garcia -Singh, Kateri Duke Resea rch Department The wave of inter est in Central Bank Digital Currencies (CBDCs) has reached the shores of the Caribbean. While the objectives in the regional context have focused on reducing cash usage and improving financial inclusion, this paper proposes the use of CBDCs to facilitate c urrency convertibility with the express purpose of promoting intra -regional trade. Currency convertibility would be achieved through a Caribbean Plurilateral CBDC Swap Arrangement (C -PSA) Œ a network of bilateral swap agreements in national currencies amon g selected Caribbean central banks Œ that will leverage the deployment of a two -tiere d CBDC architecture. Assuming retail, intermediated, token -based CBDC design existed in participating countries, small traders, service entrepreneurs and others whose prim ary mode of payment is cash -based, would be able to use mobile wallets . Commercial banks would facilitate exchange payments received in one currency to their respective national currencies without using the US dollar as the vehicular currency. This reduces the call on precious foreign exchange reserves and, more importantly, moves a step closer to advancing the objective of deeper economic integration under the CARICOM Single Market and Economy (CSME). JEL Classification: E42, E58, F1 3, F15, G21, O33 Keywords: Central Bank Digital Currency; Currency convertibility; Regional integration; Intra -regional trade . The Working Papers Series includes papers that are primarily written by Central Bank of Trinidad and Tobago research economi sts in order to solicit comments from interested readers and to stimulate discussion. The views expressed are those of the authors a nd not necessarily those of the Central Bank. Please send comments to commentsWP@central -bank.org.tt . © Central B ank of Trinidad and Tobago, 2021 Working Papers
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Central Bank of Trinidad and Tobago Working Papers ŠWP 0 5/202 1 September 2021 Page 1 Caribbean Currency Convertibility in an Era of Central Bank Digital Currency Kevin Finch Chantal Garcia -Singh Kateri Duke 1. Introduction Financial technology (ﬁfintechﬂ) can prospectively revolutionise the conduct of financial services and t he underlying technology can provide solutions to longstanding societal challenges. Digital money and its variants (cryptocurrencies, stablecoins, etc.) have spawned the entry of new technology -centric private entities into the payments arena. However, ear ly adopters have had to contend with huge speculative premiums attached, as the digital versions of money are seen as more of an asset clas s than a medium of exchange. Central Bank Digital Currencies (CBDCs) are part of the public response to private initi atives to modernise the financial payments sphere. At present, Caribbean cross -border payments are generally viewed as costly, inefficient and facilitated by a few multinational banks which dominate the correspondent b anking sphere. Regarding the Caribbean Community (CARICOM), CBDCs are being explored for a variety of reasons such as to improve financial inclusion (in the case of The Bahamas) or to reduce the cost associated with heavy cash usage (in the case of the Organisation of Eastern Caribbean States [OECS]). While the objective of improved financial inclusion is preeminent in the international context, other objectives include : increasing payment system efficiency, improving monetary policy formulation and implementation, strengthening financial integr ity, addressing potential issues related to private payment systems, and more recently following the COVID -19 global health crisis, expediting stimulus payments and making payment systems more resilient against shocks (Kiff, et al. 2020) . However, the development of CBDCs can present even more gallant opportunities in the Caribbean context Œ perhaps providing the spark which reignites discussions towards deeper CARICOM trade and financial (monetary) integration. The objective of digital money fostering regional integration has not been fully explored in the international literature as yet. This paper seeks to contribute to the nascent interest in the area from the unique perspective of the Caribbean. Deeper regional integration has been stymied by a lack of progress on key elements of the CARICOM Single Market and Economy (CSME) 1, particularly movement towards an economic union and ultimately a currency union. The idea of a single Caribbean currency has been divisive, but it is not novel. Barbados, Guyana, the OECS and Trinidad and Tobago shared the same currency in colonial times . In fact, the Trinidad and Tobago currency remained linked to the EC dollar under the Sterling Area Agreement 2. Notions of a single currency dimmed as national currencies were inextricably linked to sovereign identities. Instead, a system of bilateral central bank swap agreements was established 1 The Revised Treaty of Chaguaramas established the CSME in 2001 and it came into force in 2006. 2 The Agreement facilitated free currency convertibility among Commonwealth member states.
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Central Bank of Trinidad and Tobago Working Papers ŠWP 0 5/202 1 September 2021 Page 2 to ease the encumbrances of intra -regional transactions. For example, up to the 1970s the Intra -Regional Paym ents Scheme (IRPS) saw the offsetting of payments with periodic net settlements. This transitioned to the CARICOM Multilateral Clearing Facility (CMCF) in 1976. The CMCF lasted less than a decade before collapsing in 1983 due to sizeable unpaid balances by Guyana. Interest in a common currency emerged once more in the 1990s, with the CARICOM Heads of Government (HOG) commissioning the CARICOM Central Bank Governors to prepare a report on Caribbean monetary integration. In July 1992, the HOG approved the re commendations of the Committee of Governors which revolved around the creation of supranational monetary authority and a single currency with a value linked to the US dollar. However, implementation stalled due in part to the amount of political capital su ch moves could consume. Hilaire (1992) examined the use of a Caribbean currency that functions exclusively as a unit of account for intra -regional transactions. While sound conceptually, separating the unit of account fr om the medium of exchange function of the Caribbean currency and the prerequisite to establish multiple layers of exchange rates (Caribbean currencies < unit of account > international currencies) appeared a challenging system to operationalise. In the en suing years, a number of thorny issues developed ranging from intra -regional trade imbalances to currency convertibility for small traders. On the latter, the inability of itinerant traders from St. Vincent and the Grenadines and Grenada to convert proceed s of their sales in Trinidad and Tobago to the EC dollar prompted the involvement of the respective governments and the implementation of countervailing measures by St. Vincent and the Grenadines in particular, which on March 1, 2018 saw all US dollar paym ents to Trinidad and Tobago requiring the prior approval of the Director of Finance and Planning 3. Such incidents create both implicit and explicit barriers to trade and run counter to the spirit of the Revised Treaty of Chaguaramas from which the CSME dra ws its life. At this time, in light of political economy considerations we concur that the pathway to full economic union need not run through a single currency as espoused in Blackman (1999) . As such, the objective of this paper is to develop a framework that addresses the cash convertibility challenges experienced at the retail level through the use of a Caribbean Plurilateral CBDC Swap Arrangement (C -PSA). Convertibility is broadly viewed in the context of the abilit y to convert local currency for ﬁhardﬂ currency. However, for the purposes of this paper, convertibility refers to the exchange of national currencies in the Caribbean region. The use of conventional bilateral swap arrangements applied in the context of di gital currencies sheds a different perspective on the convertibility issue. Improving currency convertibility has a few distinct advantages. Farrell and Worrell (1994) advanced that establishing convertibility can accele rate investment in tradeables by eliminating the incentive for capital flight by removing the need for inflation 3 ﬁSt. Vincent implements new rule for US$ payment s to Trinidad .ﬂ iWitness News , February 8, 2018. Accessed August 3, 2020 . https://www.iwnsvg.com/2018/02/08/st -vincent -implements -new-rule -for -us-payments -to-trinidad/ .
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Central Bank of Trinidad and Tobago Working Papers ŠWP 0 5/202 1 September 2021 Page 3 hedges, reducing information costs of exporting and eliminating the risks derived from changes in government™s strategy for managing the exchan ge rate. There is similar work being undertaken at the regional level. In 2019, the Caribbean Development Bank established a working group on cross -border digital payments to explore the feasibility of a Caribbean Settlement Network (CSN). The CSN aims to undertake intra -regional cross -border payments for trade and the settlement of remittances using digital versions of Caribbean currencies. However, there has not been significant advancement in defining the scope or the financial burden -sharing of this ar rangement. The major difference between the CSN and what is proposed in this paper is that the former envisions creating a not -for -profit regional public entity where transactions would be conducted through bilateral digital currency swap agreements . Also, the use of Distributed Ledger Technology (DLT) is deemed the appropriate vehicle to reduce trade costs. We do not propose establishing an additional layer of bureaucracy but to leverage the existing payments infrastructure of central banks. Even tually, given the scalability of CBDCs and their potential benefits, a more omnipotent public digital currency may emerge , which reflects the aspirations of the CSME. The paper is structured as follows: section 2 would delve into the literature on currency convertibility in the Caribbean, central bank currency swaps and CBDCs. Section 3 set the background for the study, while section 4 outlines the conceptual framework for the C -PSA and discusses some of the implications. The paper concludes in section 5 . 2. Literature Review 2.1 Currency Convertibility in the Caribbean Boosting intra -regional trade has been elusive, as CARICOM import and export statistics have indicated that Caribbean jurisdictions have consistently had more open trade with the United States (US ). High trade barriers have adversely impacted intra -regional trade, inclusive of excessive exchange rate volatility and the thin liquidity of Caribbean national currencies. As a result, much of the Caribbean trade literature has discussed measures to a dvance integration between economies and improve settlement systems, which in turn is expected to advance trade and economic development. Clarke (1996) provides a comprehensive characterisation of currency convertibilit y. Convertibility is defined as the capacity to convert a domestic currency into an external ﬁharderﬂ currency 4. Clarke (1996) further distinguishes between current account and capital account convertibility. Current ac count convertibility refers to the settlement 4 A ﬁhardﬂ currency in this context refers to a currency which is likely to maintain its value and not suffer significant price volatility. These are often referred to as reserve currencies and based on the IMF™s Currency Compositio n of Official Foreign Exchange Reserves (COFER). Information from the COFER for the third quarter of 2019 highlights that the primary reserve currency is th e US dollar (62 per cent), followed by the euro (20 per cent).
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Central Bank of Trinidad and Tobago Working Papers ŠWP 0 5/202 1 September 2021 Page 4 restrictions on trading goods and services and is a critical part of compliance with IMF Article VIII obligations. Capital account convertibility, conversely, involves the capital and financial flows freedom of movement , which is more difficult to attain even for developed countries, according to Clarke (1996) . Thus, the majority of the literature tends to focus on the current account or , what is known as ﬁpartial currencyﬂ con vertibility. The research indicates that while current account convertibility can benefit macroeconomic development and a nation™s competitive advantage, the short -term effects on domestic employment and current account imbalances can be detriment al. Clarke (1996) advocated that countries should have appropriate macroeconomic management, or they are likely to struggle with currency convertibility measures. Over the past few decades, there have been several prop osals for resolving the Caribbean™s intra -regional trade and currency conversion challenges. Some Caribbean researchers have advocated for monetary integration to increase competitiveness and trade, given the region™s small size and geographic proximity (Henry 2002) . However, there has been little agreement on whether a common currency or coordinated exchange rates were the best option for monetary integration. Caribbean territories struggle with integration demands becau se it often limits countries™ fiscal and monetary independence (Farrell and Worrell 1994) . Additionally, the combination of fixed and floating exchange regimes further undermines the prospects for successful integration. The most comprehensive attempt at addressing currency convertibility was the advent of the CMCF in 1976. Primarily, the CMCF was designed to facilitate settlement of approved commercial trade between participating countries and circumvent the pressures on forei gn reserves. Some goals of the CMCF were to assuage foreign exchange pressures, trade bureaucracy and improve monetary coordination. However, the CMCF had relatively weak enforcement mechanisms, which quickly lead to the abuse and subsequent dissolution of the facility. CMCF™s failure was attributed to member countries™ profligacy and the use of the facility to purchase goods that they could not afford. For example, Jamaica™s balance of payments needs alone far exceeded the capital of the facility (Blackman 1999) . More recently, developed country central banks have adopted bilateral currency swaps to aid in currency convertibility and liquidity support (Goldberg, Kennedy and Miu 2010) in the f ace of financial market imbalances. When countries engage in a bilateral swap, they agree to supply currency to another central bank at a contracted exchange rate. In the aftermath of the 2008 Global Financial Crisis (GFC), US Federal Reserve (Fed) swap li nes were extended to both developing and emerging countries to meet currency demands (Bahaj and Reis 2018) . However, while analyses indicate that these swaps were successful in maintaining liquidity, these facilities were only temporary measures to stabilise the price and value of the reserve currency in the respective countries.
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Central Bank of Trinidad and Tobago Working Papers ŠWP 0 5/202 1 September 2021 Page 5 2.2 CBDCs: The New Payments Frontier 2.2.1 Virtual Currencies and Cross -Border Payments Correspondent banking relationships (CBRs) are vital to the Caribbea n to facilitate international trade, foreign direct investment and remittances, but cross -border payments are typically slow, costly and opaque. Shortcomings have only been exacerbated in the Caribbean region by the withdrawal of CBRs on account of busines s profitability, reputational risk and regulatory risk related to anti -money laundering and terrorist financing. 5 Where relationships have been maintained or new CBRs have been secured, banks have been subjected to increased administrative fees, longer pro cessing times and added due diligence on transactions due to the elevated perception of risk (CFATF 2019, CBTT 2019) . These concerns may push users toward unregulated payment options such as cryptocurrencies and stable coins, which have been proffered as enablers of more efficient cross -border payments compared to correspondent banking models (Bank of England 2020) . While they may facilitate faster and cheaper transfers, private virtual curr encies may lack operational robustness, appropriate risk management, legal certainty and consumer protection (Cœuré 2019) . Regulators have diverged in their response to the expansive growth of virtual currencies and their under lying disruptive technologies. While some have urged caution in their adoption, others have explored the technologies to provide a modern solution to traditio nal payment system challenges. 2.2.2 The Emergence of CBDCs CBDCs have emerged as a legal -tender, dig ital payment alternative to the proliferation of private, non -fiat virtual currencies , which have infiltrated the payments market. A CBDC can be described as an electronic version of money that is created and issued by a monetary authority, but CBDC is not generally regarded as currency. Ideally, all CBDCs offer a stable unit of account and function as both a medium of exchange and a store of value, but may be broadly distinguished by accessibility Œ ﬁwholesaleﬂ CBDCs are restricted to selected institutions for wholesale settlements (such as interbank payments), whereas ﬁgeneral purposeﬂ or ﬁretailﬂ CBDCs are widely available to the public (much like physical cash) (Barontini and Holden 2019) . Other design features proposed by Aue r, Cornelli and Frost (2020a) include operational architecture (direct, hybrid, intermediated or indirect claims on the central bank); infrastructure (conventional or DLT -based); technology (token -based or account -based); and the possibility of cross -border li nkages (Table 1 ). 5 As of November 2019, at least 16 ba nks in the Caribbean lost CBRs (CFATF 2019) .
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Central Bank of Trinidad and Tobago Working Papers ŠWP 0 5/202 1 September 2021 Page 7 Figure 1: CBDC Design Decision Tree Source: Adapted from Auer and Böhme (2020) . Note: Broader red line indicates the more popular central b ank design choices. 2.2.3 Motivation for Issuing CBDCs Against the backdrop of a dynamic technological landscape, regulatory interest in CBDCs has piqued across the globe and has engaged the attention of international bodies. In late 2019, the Bank for Interna tional Settlements (BIS) issued a survey to central banks representing three -quarters of the world™s population and found that 80 per cent of regulators were currently (or so on to be) engaged in CBDC work. Compared to 70 per cent one year earlier (Boar, Holden and Wadsworth 2020) . While the survey results suggested that issuance of CBDCs in the short term was unlikely, emerging market economies (EMEs) were generally progressing faster than advanced economies (AEs) concerning experimentation. This was likely due to stronger motivating factors for EMEs including financial inclusion (retail); financial stability (wholesale); domestic payments efficiency (retail and wholesale); and payments safety (retail and wholesale). AEs lik ewise found payments safety to be ﬁvery importantﬂ for retail CBDCs, but considered cross -border payments efficiency the primary motivator for wholesale CBDCs. Both EMEs and AEs found cross -border payments efficiency to be ﬁimportantﬂ. Central banks may al so be driven by declining use of cash; reducing costs associated with the distribution of cash; formalising the shadow economy and reducing tax evasion; and countering the growth of private forms of money (Engert an d Fung 2017, Mancini -Griffoli, et al. 2018, CEMLA 2019) . 2.2.4 Leveraging CBDCs for Cross -Currency, Cross -Border Transactions Though it has not been the primary focus of domestic projects (Auer, Cornelli and Frost 2020b), several jurisdictions have been c ollaborating to explore CBDCs as it pertains to cross -currency and cross -border interoperability. The BIS, Payment validation Centralised CBDC Accounts High degree of control retained over CBDC process. Payments are authenticated through user identification. DLT -Based Token CBDC Operations are decentralised, with the central bank™s role limite d to guaranteeing value. DLT -Based CBDC Accounts Validators maintain central bank accounts and require identification to complete a transaction. Centralised Token CBDC High degree of control retained over CBDC process and payments are verified by use of data encryption keys. CBDC Design Not a CBDC Yes Central Authority Identification Identification Central bank guarantees the value Liability for Claims Upd ate token supply and ledgers Infrastructure Payment validation Access Technology
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Central Bank of Trinidad and Tobago Working Papers ŠWP 0 5/202 1 September 2021 Page 8 together with six AE central banks 6, formed a working group in early 2020 to share experiences on their independent assessments of domestic CBDC feas ibility , including use cases, design choices and knowledge of emerging technologies (Bank of Canada 2020) . In conjunction with the Board of Governors of the Federal Reserve System, the group published a report outlining the fou ndational principles and core features of CBDCs. 7 The report indicated that further research on the implications of cross -border CBDC arrangements was necessary but suggested that central banks could design individual domestic CBDCs around a common set of standards, as well as harmonise legal and regulatory frameworks, to support the interoperability of CBDC systems. Kiff et al. (2020) supported this consideration in their research o n retail CBDCs. Several multi jurisdictional teams have aggregated resources to explore this possibility at the final stage of domestic projects. Experimentation and proofs of concept have largely considered wholesale CBDC solutions rooted in DLT. Box 1 highlights notable projects. 6 Bank of Canada, Bank of England, Bank of Japan, European Central Bank, Sveriges Riksbank, Swiss National Bank. 7 Bank of Canada et al. (2020) .
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Central Bank of Trinidad and Tobago Working Papers ŠWP 0 5/202 1 September 2021 Page 9 BOX 1: CBDC PROJECTS WITH CROSS -BORDER APPLICATIONS Bank of Canada, Bank of England, Monetary Authority of Singapore In 2018, the Bank of Canada, Bank of England and the Monetary Authority of Singapore produced a report to understand the challenges associated with cross -border payments and settlements and to explore how innovative models could improve efficiencies in processing cross -border transactions. The report outlin ed three potential solutions or hypothetical future states, one of which provided three variations based on the issuance of wholesale CBDCs (Bank of Canada, Bank of England, Monetary Authority of Singapore 2018) .1 The first var iation considered currency -specific, wholesale CBDCs which could only be transmitted and exchanged within the home jurisdiction through a wallet held at the home central bank. To hold foreign CBDCs, participants must therefore open wallets at different cen tral banks. The second facilitated CBDC transactions across borders by allowing participants to hold multiple , currency -specific, wholesale CBDC wallets at their home central bank. This contrasts to the first variation , where the home central bank only supp orts the home CBDC. The final variation considered a single, universal, wholesale CBDC , that is backed by a basket of currencies and accepted by all participant central banks. Jasper -Ubin Project (Bank of Canada and the Monetary Authority of Singapore) Projects Jasper (Canada) and Ubin (Singapore) are independent initiatives, launched in 2016, which explored the use of wholesale CBDCs across DLT platforms to improve efficiency in interbank payments and settlements. Interoperability between different DLT p latforms to facilitate a cross -border, cross -currency settlement system was considered in the latter stages of the respective initiatives . The feasibility was tested in 2019 via the Jasper -Ubin project (Bank of Canada and Monetary Authority of Singapore 2019) . The Bank of Canada and the Monetary Authority of Singapore, with support from J.P. Morgan and Accenture, proposed three conceptual des igns for cross -border payments. The intermediaries approach (where an intermediary has ac cess to both the foreign and local networks); widened access to a network (where transacting parties have direct access to central bank liabilities on both networks); and multiple currency support within a network (whe re parties have direct access to forei gn and local currencies on the domestic network). The proof of concept for the Jasper -Ubin experiment focused on the intermediary approach , and a Canadian Dollar -Singapore Dollar CBDC transaction was successfully completed across the respective DLT platform s based on atomic Hash Time -Locked Contracts (HTLC) 2. Project Inthanon -LionRock (Bank of Thailand and Hong Kong Monetary Authority) Project Inthanon -LionRock, introduced in 2019, offered the use of a cross -border, corridor network to bridge proposed DLT -based, wholesale CBDC networks Inthanon (Thailand) and LionRock (Hong Kong) to enable direct, real -time cross -border transactions amongst resident banks via CBDC tokens. The DLT -based model also facilitates foreign exchange price discovery on the corridor network to execute cross -border Thai Baht -Hong Kong Dollar transactions with atomic Payment -versus -Payment settlements 3 (Bank of Thailand and Hong Kong Monetary Authority 2020) . It is envisioned that the design of the novel co rridor network model would improve cross -border settlement efficiency, liquidity management efficiency and local regulations compliance. The proof of concept describes a model with a corridor operating node (joint responsibility of the central banks), part icipating bank nodes and foreign exchange liquidity providers, alongside respective central banks which support token conversion between a domestic bank node and the corridor operating node. The usefulness of the proposed solution was presented in a case s tudy of a trade -related exchange between a Thai corporation importing goods from a Hong Kong corporation. In 2021, the Bank of Thailand and the Hong Kong Monetary Authority entered the second
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Central Bank of Trinidad and Tobago Working Papers ŠWP 0 5/202 1 September 2021 Page 10 Box 1: CBDC Projects with Cross -Border Applications (cont™d) ph ase of Project Inthanon -LionRock in collaboration with the People™s Bank of China (Digital Currency Institute) and the Central Bank of the United Arab Emirates. The joint initiative has been renamed the Multiple CBDC (m -CBDC) Bridge Project and will explor e cross -border foreign exchange payment in a multi jurisdictional context (Hong Kong Monetary Authority 2021) . Project Aber (Saudi Central Bank and the Central Bank of the United Arab Emirates) In January 2019, the Saudi Cent ral Bank (SAMA) and the Central Bank of the United Arab Emirates (CBUAE) issued a joint statement declaring their intention to launch a joint digital currency, Aber (CBUAE 2019) . Among other things, Aber is expected to improve the settlement of remittances between the two countries by enabling banks to directly engage with one another. The proof of conce pt and subsequent pilot project examined a DLT solution that could be accessed by a limited number of banks within each country . Three use cases were considered: the first case explored cross -border settlement between the two central banks; the second explored domestic settlement between three commercial banks in each country; and the third explored cross -border transactions betwe en the commercial banks using the CBDC. The Project confirmed that the use of DLT to transact Aber was technically viable and offered notable improvement over centrali sed payment systems in the two countries (CBUAE and SAMA 2020 ). ____________________________________ 1 The group leveraged previous exploratory work undertaken in 2016 by the Bank of Canada and the Monetary Authority of Singapor e on the issuance of wholesale CBDCs across DLT platforms to improve efficiency in inte rbank payments and settlements in the domestic payment system (Projects Jasper and Ubin, respectively). 2 HTLC uses hash locks and time locks to ensure atomicity of a transaction over two DLT platforms, that is, either the transact ion succeeds in its entir ety or it fails and funds are returned to the sender. The receiver of the payment either acknowledges receiving the payment prior to a deadline (timeout) by generating cryptographic proof of payment (hash lock) or forfeits the ability to cla im the payment, which results in the payment being returned to the payer (Bank of Canada and Monetary Authority of Singapore 2019) . 3 Atomic Payment -versus -Payment settlements leverage smart contracts to ensure that the final transfer of a pa yment in one currency occurs if and only if the final transfer of a payment in another currency or currencies takes place.
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