Fund's Concepts of Convertibility

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Back Matter

Author(s):
International Monetary Fund
Published Date:
January 1971
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    Summary

    In practice, the “convertibility” of a currency is a relative concept. It can be assessed in relation to an abstract norm of complete freedom to use or exchange any balances of the currency at some defined rate of exchange. A number of concepts have been employed by the Fund; some have been included in the Articles and others have emerged in practice.

    The central concept of convertibility in the Articles is the convertibility of Article VIII, Sections 2, 3, and 4. Under it, the basic rule is that members must avoid restrictions on the making of payments and transfers for current international transactions, multiple currency practices, and discriminatory currency arrangements. In addition, a member that has accepted the obligations of Article VIII must convert balances of its currency in certain circumstances when those balances are presented for conversion by the monetary authorities of another member. Once a member has accepted the obligations of Article VIII, it can never retreat to the transitional arrangements of Article XIV.

    If a member’s currency is convertible under Article VIII, the member, with the Fund’s approval, may impose measures of the kind that normally it must avoid. If these measures are approved, the currency will not cease to be “convertible” in the technical sense of that term under the Articles. The member may restrict inward or outward transfers of capital without the need for approval. The obligation to convert balances for the benefit of the monetary authorities of other members is circumscribed in a number of ways. The maintenance of an effective par value is not one of the obligations of Article VIII, Sections 2, 3, and 4.

    Even though a currency is not convertible under Article VIII because the issuer has not given notice that it is prepared to accept the obligations of Sections 2, 3, and 4, the currency may have a high degree of de facto convertibility through the market, and perhaps even complete convertibility of this kind, because of the virtual or total absence of restrictions. The issuer will not be obligated to provide official conversion of balances for the benefit of other monetary authorities under Article VIII, Section 4, but although some drafters of the Articles had expected that the greater proportion of conversions would be made at the official level, most conversions are now made through the market.

    Various concepts of de facto convertibility have been recognized by the Fund. Article XIX recognizes the convertibility of certain balances for particular purposes under the Articles. The Fund has adopted a decision which permits wider margins for exchange transactions when rates of exchange are linked to a convertible or “externally convertible” currency. A concept of “currency convertible in fact” was incorporated, without definition, in the repayment provisions of the General Arrangements to Borrow.

    There are three major concepts of convertibility in the Fund. The first is convertibility under Article VIII. The second is a form of convertibility into gold. A member that freely buys and sells gold for its own currency, within the prescribed margins of par, with the monetary authorities of other members for the settlement of international transactions is deemed to be fulfilling the exchange rate obligations of the Articles. A member is freely buying and selling gold within the meaning of the Articles if it in fact buys and sells gold in transactions with the monetary authorities of other members and if it has no exchange restrictions of any kind. Whether a member is freely buying and selling gold within the meaning of the Articles if it follows narrower practices is a question that, with one exception, has not yet been settled.

    The last major concept was introduced in the Articles by the amendment that created the Special Drawing Account. It is called “convertibility in fact” but is not related to the similar language of the General Arrangements to Borrow. There are two categories of currency convertible in fact. The first category comprehends currencies which are convertible under Article VIII or Article IV, Section 4(b), and for which satisfactory procedures have been established to ensure that any balances of any one of these currencies obtained in transactions involving special drawing rights will be interconvertible with all other currencies of the first category. The currency must be provided at or converted through an official agency of the issuer at rates of exchange that assure the transferor of special drawing rights of the receipt of equal value whatever participant may be the transferee or whatever currency the transferee may provide. Convertibility in fact applies only to balances obtained in transactions involving special drawing rights and not to balances obtained in other operations or transactions, so that even in the first category, convertibility in fact applies only to certain balances of the currency. However, the issuer cannot prescribe limits on the balances that may be provided in transactions involving special drawing rights, and they will all be convertible in fact.

    Convertibility under Article VIII or Article IV, Section 4(b), is one of the conditions that must be met in order that a participant may have its currency recognized as a currency convertible in fact of the first category, but this condition was prescribed primarily because it was expected that participants designated as transferees of special drawing rights would be likely to hold these currencies in their reserves. The other conditions, however, were designed to avoid what might be regarded as shortcomings in the other main concepts of convertibility.

    If a currency is convertible in fact of the first category, any participant designated to receive special drawing rights may provide in return any balances of the currency without limit. Convertibility in fact of the second category may apply only to those particular balances of a currency that are specified by the issuer. The issuer may specify, however, that all balances shall be convertible in fact. The Fund must be satisfied that the issuer has established satisfactory arrangements for converting the specified balances into at least one of the currencies convertible in fact of the first category. Conversions must be at rates that assure the transferor of the receipt of equal value, and the balances must be provided at or converted through an official agency of the issuer.

    The problem of defining the convertibility of currencies has faced the drafters of other treaties, and the result has been a diversity of formulation. In the drafting of the charters of certain international organizations, there has been a tendency to rely on consultation with the Fund in the determination of whether a currency is convertible, but to reserve the ultimate decision to the other organization, which bases its decision on its own purposes.

    Appendix: Members That Have Accepted the Obligations of Article VIII, Sections 2, 3, and 4

    (August 31, 1970)

    MemberEffective Date of Acceptance
    ArgentinaMay 14, 1968
    AustraliaJuly 1, 1965
    AustriaAugust 1, 1962
    BelgiumFebruary 15, 1961
    BoliviaJune 5, 1967
    CanadaMarch 25, 1952
    Costa RicaFebruary 1, 1965
    DenmarkMay 1, 1967
    Dominican RepublicAugust 1, 1953
    EcuadorAugust 31, 1970
    El SalvadorNovember 6, 1946
    FranceFebruary 15, 1961
    GermanyFebruary 15, 1961
    GuatemalaJanuary 27, 1947
    GuyanaDecember 27, 1966
    HaitiDecember 22, 1953
    HondurasJuly 1, 1950
    IrelandFebruary 15, 1961
    ItalyFebruary 15, 1961
    JamaicaFebruary 22, 1963
    JapanApril 1, 1964
    KuwaitApril 5, 1963
    LuxembourgFebruary 15, 1961
    MalaysiaNovember 11, 1968
    MexicoNovember 12, 1946
    NetherlandsFebruary 15, 1961
    NicaraguaJuly 20, 1964
    NorwayMay 11, 1967
    PanamaNovember 26, 1946
    PeruFebruary 15, 1961
    Saudi ArabiaMarch 22, 1961
    SingaporeNovember 9, 1968
    SwedenFebruary 15, 1961
    United KingdomFebruary 15, 1961
    United StatesDecember 10, 1946

    See Appendix.

    Article VII, Section 3(b) is included in the quotation in footnote 10.

    James G. Evans, Jr., “Current and Capital Transactions: How the Fund Defines Them,” Finance and Development, Vol. 5, September 1968, pp. 30-35.

    Article VI, Section 1, which originally read: “Use of the Fund’s resources for capital transfers.—(a) A member may not make net use of the Fund’s resources to meet a large or sustained outflow of capital, and the Fund may request a member to exercise controls to prevent such use of the resources of the Fund. If, after receiving such a request, a member fails to exercise appropriate controls, the Fund may declare the member ineligible to use the resources of the Fund.

    (b) Nothing in this Section shall be deemed

    • (i) to prevent the use of the resources of the Fund for capital transactions of reasonable amount required for the expansion of exports or in the ordinary course of trade, banking or other business, or

    • (ii) to affect capital movements which are met out of a member’s own resources of gold and foreign exchange, but members undertake that such capital movements will be in accordance with the purposes of the Fund.”

    Section 1(a) was amended on July 28, 1969 to read as follows: “A member may not use the Fund’s resources to meet a large or sustained outflow of capital except as provided in Section 2 of this Article, and the Fund may request a member to exercise controls to prevent such use of the resources of the Fund. If, after receiving such a request, a member fails to exercise appropriate controls, the Fund may declare the member ineligible to use the resources of the Fund.” For an explanation of the amendment, see Joseph Gold, The Reform of the Fund, International Monetary Fund, Pamphlet Series No. 12 (Washington, 1969), pp. 20-22.

    See, for example, the U.S. Treasury’s Questions and Answers on the International Monetary Fund, June 10, 1944 (reproduced in The International Monetary Fund, 1945-1965: Twenty Years of International Monetary Cooperation (Washington, 1969), Vol. Ill: Documents, pp. 136-82), Answers to Questions 26, 33, and 34.

    Selected Decisions of the Executive Directors and Selected Documents (Washington, Fourth Issue, April 1970; hereinafter cited as Selected Decisions), p. 67.

    They are, however, “exchange control regulations” for the purposes of Article VIII, Section 2(b). See Joseph Gold, The Fund Agreement in the Courts (Washington, 1962), pp. 135-39; “The Fund Agreement in the Courts—VIII,” Staff Papers, Vol. XI (1964), pp. 468-81; “The Fund Agreement in the Courts—IX,” Staff Papers, Vol. XIV (1967), pp. 398-400.

    Selected Decisions, p. 99.

    Selected Decisions, pp. 92-93.

    Article VII, Section 3: “Scarcity of the Fund’s holdings.—(a) If it becomes evident to the Fund that the demand for a member’s currency seriously threatens the Fund’s ability to supply that currency, the Fund, whether or not it has issued a report under Section 1 of this Article, shall formally declare such currency scarce and shall thenceforth apportion its existing and accruing supply of the scarce currency with due regard to the relative needs of members, the general international economic situation and any other pertinent considerations. The Fund shall also issue a report concerning its action.

    (b) A formal declaration under (a) above shall operate as an authorization to any member, after consultation with the Fund, temporarily to impose limitations on the freedom of exchange operations in the scarce currency. Subject to the provisions of Article IV, Sections 3 and 4, the member shall have complete jurisdiction in determining the nature of such limitations, but they shall be no more restrictive than is necessary to limit the demand for the scarce currency to the supply held by, or accruing to, the member in question; and they shall be relaxed and removed as rapidly as conditions permit.

    (c) The authorization under (b) above shall expire whenever the Fund formally declares the currency in question to be no longer scarce.”

    Selected Decisions, pp. 98-100.

    Selected Decisions, p. 99.

    Article XI, Section 2.

    Rules and Regulations, Rule M-6. See Joseph Gold, The Fund and Non-Member States: Some Legal Effects, International Monetary Fund, Pamphlet Series, No. 7 (Washington, 1966), pp. 28-30.

    Article IV, Section 4(b).

    Selected Decisions, p. 19.

    Article V, Section 5; Article VI, Section 1; Article XV, Section 2.

    Article IV, Section 6.

    Article V, Section 3(a)(iii).

    Article V, Section 3.

    Note, however, the possibility of waivers under Article V, Section 4.

    International Monetary Fund Press Release No. 576 (August 18, 1966).

    Article XX, Section 4; Article IV, Section 1(a).

    Article IV, Sections 3 and 4(b).

    International Monetary Fund, Sixth Annual Report on Exchange Restrictions, 1955, p. 327; Twelfth, 1961, p. 282; Twentieth, 1969, p. 23.

    Quoted on p. 11.

    Selected Decisions, pp. 105-108.

    Quoted on p. 11.

    Article V, Section 1(b).

    Article V, Section 8(f).

    Article III, Section 4(a).

    Selected Decisions, p. 120.

    This refers to the currencies of members, but the Fund may “specify” a nonmember’s currency for inclusion in the calculations of monetary reserves (Article XIX(a)). This does not make the nonmember’s currency a “convertible” one under Article VIII, but it means that members’ holdings of this currency are to be included in the calculations of their monetary reserves for the purposes for which these calculations are made under the Articles. No criterion is established for the specification of nonmember currencies. No currency has been specified.

    Selected Decisions, pp. 119-20.

    International Monetary Fund, Annual Report, 1959, pp. 125-28; Tenth Annual Report on Exchange Restrictions, 1959, pp. 4-5.

    Article IV, Sections 3 and 4(b).

    Selected Decisions, p. 16. See also the Fund’s decisions of October 23, 1959 on discrimination for balance of payments reasons and June 1, 1960 on Article VIII and Article XIV for further references to external convertibility (Selected Decisions, pp. 97-100).

    Selected Decisions, pp. 68-82.

    Article VII, Section 2: “Measures to replenish the Fund’s holdings of scarce currencies—The Fund may, if it deems such action appropriate to replenish its holdings of any member’s currency, take either or both of the following steps:

    • (i) Propose to the member that, on terms and conditions agreed between the Fund and the member, the latter lend its currency to the Fund or that, with the approval of the member, the Fund borrow such currency from some other source either within or outside the territories of the member, but no member shall be under any obligation to make such loans to the Fund or to approve the borrowing of its currency by the Fund from any other source.

    • (ii) Require the member to sell its currency to the Fund for gold.”

    Selected Decisions, p. 73.

    Selected Decisions, pp. 74-75.

    Selected Decisions, pp. 87-89.

    Paragraph 12(b), Selected Decisions, pp. 75-76.

    See Article XI on the relations of members with nonmembers.

    Selected Decisions, pp. 17-18.

    Rules and Regulations, Rule F-4.

    See Article XXXII(b)(1).

    Article XXV, Section 2. In this pamphlet the terms “transferor” and “transferee” relate to the transfer of special drawing rights (and not the currency for which they are transferred).

    Article XXV, Section 4.

    Selected Decisions, pp. 37-43.

    If Terra carried out the conversion with Patria’s currency which Terra had not purchased from the Fund, the transaction might be one which Patria found useful as a cancellation of liabilities to Terra.

    Article XII, Section 5(d).

    General Arrangements to Borrow, Paragraph 15 (Selected Decisions, p. 76). The concurrence of participants in the General Arrangements is not necessary for a modification on a renewal of them (Paragraphs 15 and 19, Selected Decisions, pp. 76, 77-78).

    Rules and Regulations, Rules O-1 and O-2.

    Rules and Regulations, Rule O-6.

    The question arises whether a member can be assured of the right to get currency from the Fund for gold. This is a complex question on which only a few brief comments are possible in this footnote. When the amendments to create the Special Drawing Account were being drafted, the doubts which were advanced later on the question whether the Fund is obligated to purchase gold under Article V, Section 6, had not yet arisen. A question which was discussed, however, in the course of drafting was whether a transferee of special drawing rights might provide gold instead of currency convertible in fact, and one justification for this proposal was that the transferor would have been able to get the currency it wanted from the Fund. The proposal was not accepted for various reasons, including the unwillingness of some negotiators to equate special drawing rights with gold in this way.

    The question whether the Fund is obligated to purchase gold under Article V, Section 6, arose after the amendments were proposed but before they were accepted. The Fund adopted a policy on the purchase of gold under that provision on December 30, 1969, but without prejudice to the legal question whether the Fund is obligated to purchase gold (Selected Decisions, p. 56). On the same date, the Fund adopted a second decision, which, in effect, affirmed that the Fund would purchase gold from a participant that wished to obtain currency convertible in fact to provide to a transferor because the participant had been designated by the Fund as a transferee. The actual decision was that the Fund would not levy charges or collect costs in connection with the purchase, but the decision was an affirmation of the Fund’s readiness to purchase gold whenever it was offered in these circumstances (Selected Decisions, p. 61).

    These events can be summarized as follows: The doubt whether a participant would be able to sell gold to the Fund played no part in the decision to add interconvertibility to convertibility under Article IV, Section 4(b), as a condition of convertibility in fact, although before the amendments took effect, the doubt had arisen. After the amendments took effect, the problem was resolved by policy decisions. It should be noted, however, that the second decision to purchase gold which is referred to in the last sentence of the preceding paragraph refers to gold tendered to the Fund by the transferee of special drawing rights and not by the transferor. The problem discussed in the text is whether a transferor that had obtained the conversion into gold by the issuer of a currency convertible under Article IV, Section 4(b), which had been provided by the transferee could sell that gold to the Fund for the currency the transferor wanted. The first decision taken on December 30, 1969 would be relevant to that problem.

    Establishment of a Facility Based on Special Drawing Rights in the International Monetary Fund and Modifications in the Rules and Practices of the Fund: A Report by the Executive Directors to the Board of Governors Proposing Amendment of the Articles of Agreement (Washington, 1968; hereinafter cited as the Report on Special Drawing Rights), Section 24, p. 18.

    Rules and Regulations, Rule O-6.

    Rules and Regulations, Rule O-7.

    Rules and Regulations, Rule O-8.

    Rules and Regulations, Rule O-2(b).

    Selected Decisions, pp. 41-43.

    Report on Special Drawing Rights, Section 24, p. 18.

    Rules and Regulations, Rules O-3 to O-5.

    Article XXXII(b)(1).

    UN Treaty Series, Vol. 407 (1961), p. 44.

    Ibid., Vol. 403 (1961), p. 22.

    Ibid., Vol. 421 (1962), p. 35.

    Ibid., Vol. 437 (1962), p. 264.

    Ibid., Vol. 444 (1962), p. 264.

    For example, Article II, Section 2(c), (d), (g); Article IV, Section 1(a).

    Article II, Section 2(f).

    For example, Articles 6, 13, 15, and 24.

    Article 24 contains detailed provisions on the freedom from restrictions on the holding or use by the Bank or any recipient from the Bank of “convertible currencies” or certain other currencies received by the Bank. The following comment on Article 24 by the Preparatory Committee is interesting: “There was some discussion of the various criteria for determining whether a member country might be permitted to limit the use of its local currency subscription to the pro-curement of goods and services produced in its own territory. The Consultative Committee had in mind that the option to exercise any such procurement limitation should be confined to those member countries whose currencies were not freely convertible. It was suggested during the meeting, however, that the convertibility of currencies for current international payments might not provide an adequate criterion in all cases for determining whether the local currency sub-scriptions of members should be freely available for purposes of the Bank’s operations” (The Philippine International Law Journal, Vol. IV, Nos. 1 and 2 (January/June 1965), p. 233).

    Loc. cit.

    For example, Article 7, paragraph 2; Article 16(a); Article 18, paragraph 2(c); Article 27.

    International Monetary Fund Pamphlet Series

    (* Out of print)

    *1. Introduction to the Fund, by J. Keith Horsefield. (First edition in English 1964; in French and Spanish, 1965. Second edition in English, 1965; in French and Spanish, 1966; in German, 1967)

    *2. The International Monetary Fund: Its Form and Functions, by J. Marcus Fleming (in English, 1964)

    3. The International Monetary Fund and Private Business Transactions: Some Legal Effects of the Articles of Agreement, by Joseph Gold (in English and Spanish, 1965; in French, 1966)

    4. The International Monetary Fund and International Law: An Introduction, by Joseph Gold (in English, 1965; in French, 1966; in Spanish, 1967)

    *5. The Financial Structure of the Fund, by Rudolf Kroc. (First edition in English, French, and Spanish, 1965. Second edition in English, French, and Spanish, 1967)

    6. Maintenance of the Gold Value of the Fund’s Assets, by Joseph Gold. (First edition in English, 1965; in French and Spanish, 1967. Second edition in English, 1971; in French and Spanish, 1972)

    7. The Fund and Non-Member States: Some Legal Effects, by Joseph Gold (in English, 1966; in French, 1967; in Spanish, 1968)

    8. The Cuban Insurance Cases and the Articles of the Fund, by Joseph Gold (in English, 1966; in Spanish, 1968; in French, 1970)

    9. Balance of Payments: Its Meaning and Uses, by Poul H0st-Madsen (in English, French, and Spanish, 1967; in German, 1968)

    10. Balance of Payments Concepts and Definitions. (First edition in English, French, and Spanish, 1968. Second edition in English, French, and Spanish, 1969)

    11. Interpretation by the Fund, by Joseph Gold (in English, 1968; in French and Spanish, 1969)

    12. The Reform of the Fund, by Joseph Gold (in English, 1969; in French and Spanish, 1970)

    13. Special Drawing Rights, by Joseph Gold. (First edition in English and Spanish, 1969; in French, 1970. Second edition, with subtitle Character and Use, in English, 1970; in French and Spanish, 1972)

    14. The Fund’s Concepts of Convertibility, by Joseph Gold (in English and Spanish, 1971; in French, 1972)

    15. Special Drawing Rights: The Role of Language, by Joseph Gold (in English, 1971; in Spanish, 1972; in French, 1973)

    16. Some Reflections on the Nature of Special Drawing Rights, by J. J. Polak (in English, 1971; in French and Spanish, 1972)

    17. Operations and Transactions in SDRs: The First Basic Period, by Walter O. Habermeier (in English, French, and Spanish, 1973)

    18. Valuation and Rate of Interest of the SDR, by J. J. Polak (in English, 1974; French and Spanish, 1975)

    International Monetary Fund, Washington, D.C. 20431, U.S.A.

    Telephone number: 202 393 6362

    Cable address: Interfund

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