In the articles of agreement and practice of the International Monetary Fund there have been a number of concepts of the convertibility of currencies. It is tempting to say that there have been seven types of convertibility to match Professor Empson’s Seven Types of Ambiguity, and indeed that number can be supported without any strenuous contraction or expansion of categories. Adoption of numerous concepts of convertibility has been largely in response to objectives of policy and not the result of a zeal for novelty.
The first part of this pamphlet examines the Fund’s concepts of convertibility and gives some impression of their purposes. The second part briefly discusses the efforts of the drafters of other international agreements to formulate convertibility provisions that rely on the Fund or its Articles. These drafters also have produced diverse results as they have sought assurances as to the usability, exchangeability, and exchange value of the currencies with which they were dealing.
It is possible to measure the convertibility of any currency by determining the extent to which its use, exchangeability, and exchange value are assured. The proposition can be put in another form. A currency can be said to be convertible without limitation if it meets the following three criteria: First, it can be used without restriction of a currency character for any purpose whatsoever. Second, it can be exchanged for any other currency without restriction of a currency character. The third criterion—more difficult to define because there are more possibilities—would be along the lines that the currency can be used or exchanged at its par value, or at a rate of exchange based on the par value, or at some legal rate of exchange, or at a rate defined in any other way considered desirable. If these three criteria are not satisfied, or not wholly satisfied, the currency may still be called convertible for some purpose or under some legal provision, but the convertibility falls short of the theoretical maximum. It follows that convertibility according to these concepts may be relative and that such terms as “convertible” or “inconvertible” may be misleading because of their lack of precision.
The first two criteria that have been mentioned refer to the absence of restrictions of a “currency character.” This description might be challenged as narrowing the scope of the concept of maximum convertibility, particularly if it is recalled that the classification of a restrictive measure as being within the trade or exchange field often depends on technical distinctions that do not reflect any economic differences. But the concept of convertibility is a currency concept, and it seems appropriate to assess it in relation to currency measures. To assess it, for example, in relation to such limitations on international transactions as trade restrictions, which admittedly restrict the use of currency indirectly, is not impossible, but it would not be traditional. It might be alleged that the absence of a right to convert a currency into gold is also a limitation on the maximum convertibility that can be conceived, but once again it is no longer traditional to think of convertibility into gold for private or even official holders of a currency as an essential element in the concept of convertibility.
I. Concepts in the Fund
1. Convertibility Under Article VIII
Payments and Transfers for Current International Transactions
The Articles contain the most intricate and original definition of convertibility in the whole of international law. It is the definition of that form of convertibility which each member of the Fund is supposed to adopt, sooner or later—and the sooner the better—for its currency. Many members have already put this convertibility into effect,1 and it is not presumptuous, therefore, to claim prime importance for it.
The currencies that meet this definition of convertibility are identified by Article XIX(d) as follows:
A member’s holdings of convertible currencies means its holdings of the currencies of other members which are not availing themselves of the transitional arrangements under Article XIV, Section 2, together with its holdings of the currencies of such non-members as the Fund may from time to time specify. The term currency for this purpose includes without limitation coins, paper money, bank balances, bank acceptances, and government obligations issued with a maturity not exceeding twelve months.
A member’s currency is convertible therefore if the member is not availing itself of the transitional arrangements of Article XIV, Section 2. That provision gives a member which is availing itself of the transitional arrangements certain privileges to maintain, adapt, or introduce restrictions on payments and transfers for current international transactions, as follows:
Section 2. Exchange restrictions
In the post-war transitional period members may, notwithstanding the provisions of any other articles of this Agreement, maintain and adapt to changing circumstances (and, in the case of members whose territories have been occupied by the enemy, introduce where necessary) restrictions on payments and transfers for current international transactions. Members shall, however, have continuous regard in their foreign exchange policies to the purposes of the Fund; and, as soon as conditions permit, they shall take all possible measures to develop such commercial and financial arrangements with other members as will facilitate international payments and the maintenance of exchange stability. In particular, members shall withdraw restrictions maintained or imposed under this Section as soon as they are satisfied that they will be able, in the absence of such restrictions, to settle their balance of payments in a manner which will not unduly encumber their access to the resources of the Fund.
A member formally refrains from exercising or ceases to exercise the transitional arrangements by giving notice to the Fund under Article XIV, Section 3, that it accepts the obligations of Article VIII, Sections 2, 3, and 4. Section 3 of Article XIV reads as follows:
Section 3. Notification to the Fund
Each member shall notify the Fund before it becomes eligible under Article XX, Section 4(c) or (d), to buy currency from the Fund, whether it intends to avail itself of the transitional arrangements in Section 2 of this Article, or whether it is prepared to accept the obligations of Article VIII, Sections 2, 3, and 4. A member availing itself of the transitional arrangements shall notify the Fund as soon thereafter as it is prepared to accept the above-mentioned obligations.
In this context “accept” means “perform.” It is this notice by a member which gives its currency the status of a “convertible” currency for all purposes under the Articles. By the end of August 1970 the 35 members listed in the Appendix had given the Fund this notice.
The analysis of the provisions of Article VIII must start with the distinction between Sections 2(a) and 4. Section 2(a) establishes the obligation of members to permit (1) payors to acquire and use currencies for particular transactions, and (2) payees to exchange the proceeds of these transactions. Section 2(a) contemplates freedom for parties, whether private or official, to transact their current business in the exchange markets of members. Section 4, on the other hand, prescribes rules for the conversion of balances of currency in conversion operations between the monetary authorities of members.
The first subsection of Section 2, “Avoidance of restrictions on current payments,” reads as follows:
(a) Subject to the provisions of Article VII, Section 3(b),2 and Article XIV, Section 2, no member shall, without the approval of the Fund, impose restrictions on the making of payments and transfers for current international transactions.
This provision must be considered together with the following section of Article VI:
Section 3. Controls of capital transfers
Members may exercise such controls as are necessary to regulate international capital movements, but no member may exercise these controls in a manner which will restrict payments for current transactions or which will unduly delay transfers of funds in settlement of commitments, except as provided in Article VII, Section 3(b), and in Article XIV, Section 2.
It is apparent that the distinction between current international transactions and capital transfers is of cardinal importance in understanding the scope of Article VIII, Section 2(a). In Article XIX, payments for current transactions are defined as follows:
(i) Payments for current transactions means payments which are not for the purpose of transferring capital, and includes, without limitation:
(1) All payments due in connection with foreign trade, other current business, including services, and normal short-term banking and credit facilities;
(2) Payments due as interest on loans and as net income from other investments;
(3) Payments of moderate amount for amortization of loans or for depreciation of direct investments;
(4) Moderate remittances for family living expenses.
The Fund may, after consultation with the members concerned, determine whether certain specific transactions are to be considered current transactions or capital transactions.
Economists would regard a number of the transactions listed in Article XIX(i) as capital transactions. Nevertheless, all the transactions in the provision are declared to be current for the purposes of the Articles. Under the “without limitation” clause, the Fund could decide to add other categories of transactions to those deemed current for the purposes of the Articles, but the Fund has not exercised this authority so far. The last sentence of Article XIX(i) establishes a procedure by which the Fund can decide whether specific transactions are to be considered capital or current. This was no doubt intended to be a kind of arbitration procedure in connection with actual transactions when there is a difference of opinion between the members interested in particular transactions.3
Obviously, one of the most important limitations on the scope of the concept of convertibility in Article VIII is the power that members retain to restrict capital transfers. Subject only to the exception of certain transactions which would be treated as capital transfers but for their inclusion in Article XIX(i) and which therefore must be treated as current transactions, members may restrict any movements of capital, whether outward or inward. It is true, of course, that any controls which members exercise for this purpose may not be operated in such a way as to restrict payments for current transactions. The further qualification that capital controls must be operated in such a way that they will not “unduly delay transfers of funds in settlement of commitments” means that the use or transfer of balances not subject to capital control must not be impeded by untoward delay in permitting payments or transfers for current transactions as the result of a system of controls designed to segregate capital transfers. In short, the purpose of the language relating to delay is to eliminate any doubt that the concept of the restriction of payments and transfers for current international transactions goes beyond outright prohibition or limitation and includes the hindrance of undue delay in permitting settlements. The quotation from Article VI, Section 3, about “undue delay” does not mean that if balances have been subjected to capital controls under the authority of that provision, they must nevertheless be freed from those controls in order to permit the use of them in settlements for current transactions.
The distinction between the obligation of members to avoid restrictions on payments and transfers for current international transactions and their freedom to control capital transfers results from one of the purposes of the Fund, which is formulated as follows in Article I:
(iv) To assist in the establishment of a multilateral system of payments in respect of current transactions between members and in the elimination of foreign exchange restrictions which hamper the growth of world trade.
One means of adjustment which the drafters thought should continue to be available to members without the need for approval by the Fund was the control of capital movements. Indeed, the Fund itself was given the authority to call for capital controls in certain circumstances.4 The drafters were convinced that freedom to make payments for and enjoy the proceeds of current trade and other transactions deemed for one reason or another to be current international transactions would promote the general welfare, but the drafters did not hold the same view of freedom to transfer capital across boundaries. Even if some forms of capital transfer would be beneficial to the transferor and transferee countries, freedom to transfer capital could not be elevated to a principle of the Articles because the exercise of that freedom could produce disequilibrium.5
Article VI, Section 3, reserves to members the right to control capital transfers, but Article VIII, Section 3, requires members to avoid discriminatory currency arrangements except as authorized by the Articles or approved by the Fund:
Section 3. Avoidance of discriminatory currency practices
No member shall engage in, or permit any of its fiscal agencies referred to in Article V, Section 1, to engage in, any discriminatory currency arrangements or multiple currency practices except as authorized under this Agreement or approved by the Fund. If such arrangements and practices are engaged in at the date when this Agreement enters into force the member concerned shall consult with the Fund as to their progressive removal unless they are maintained or imposed under Article XIV, Section 2, in which case the provisions of Section 4 of that Article shall apply.
The question arose, therefore, whether approval must be sought for capital controls of a discriminatory character. The Fund decided that Article VIII, Section 3, did not derogate from the right of members to control capital movements. It is, therefore, not part of the obligations of convertibility that members must refrain from discriminatory capital controls.6
Under Article VIII, Section 2(a), a member must avoid restrictions on the making of payments for current international transactions. In accordance with that obligation, it must permit its residents to use its currency for that purpose, but in addition, it must not impede its residents, by prohibition, limitation, or delay, from obtaining any of the currencies of other members that its residents may need for making payments to other members or their residents for current international transactions. Surrender requirements (i.e., measures adopted in order to centralize foreign exchange by compelling residents to surrender their accruals of foreign exchange to their monetary authorities) are not restrictions within the meaning of Article VIII, Section 2(a).7 The obligation of a member to avoid measures that restrict its residents when they wish to acquire or use domestic or foreign currency in order to make payments for current international transactions shows the fallacy in regarding that provision as establishing no more than what is sometimes called “external” or “non-resident” convertibility.
When commentators have spoken of Article VIII, Section 2(a), as establishing “external” or “nonresident” convertibility, they have had in mind the effect of the provision on the proceeds of current international transactions in the hands of nonresident payees. It would not be very comforting to a payee, or conducive to the freeing of payments for current international transactions, if a member were to permit its currency to be paid to a nonresident, who then found that the proceeds were blocked in his hands. Therefore, the provision requires that a member must allow freedom for “transfers” as well as “payments.” The rule that a member must not restrict transfers means that nonresidents who have received its currency in payment for current international transactions must be allowed to dispose of those proceeds in return for other currencies within a reasonable period. If they refrain from disposing of the proceeds long enough, they may find that those proceeds have become subject to the member’s power to control capital transfers. Subject to that possibility, however, the issuer of a currency must permit nonresident payees to convert balances of the currency that accrue to them from current international transactions, or, of course, to use those balances to make payments for other current transactions. The theory on which payees must be allowed to convert is that in this way they can use the proceeds of current transactions in one country to engage in current transactions in other countries. For example, if an exporter resident in Patria earns a balance of the currency of Terra in a current transaction with a resident of Terra, and can convert that balance into the currency of Patria, the exporter will then be able to use the proceeds in Patria to acquire the currency of Regio to make a payment for a current transaction with a resident of that country. By not restricting transfers, members avoid an impediment to the freedom of parties to buy and sell in the markets of their choice and contribute to “a multilateral system of payments in respect of current transactions between members.”
Article VIII, Section 2(a), does not prevent members from prescribing the currencies that their residents may accept in payment for current international transactions. The obligation of members is to avoid restrictions on the making of payments and not on their receipt. It was not intended that the provision should interfere with the use of traditional or convenient currencies in current international transactions. Therefore, a member may prescribe that its residents shall receive only particular currencies, which need not include the member’s own currency, and a free regime of payments will nevertheless be assured to the extent that other members observe their obligation under the Articles to avoid restrictions on the making of payments. In other words, Patria may require its residents to receive payments for current international transactions in the currency of Terra, but this will not interfere with a multilateral system of payments if the residents of all other member countries are permitted to make payments to the residents of Patria in the currency of Terra.
It is necessary at this stage to explain, so far as this is possible in general terms, what is meant by “restrictions” on payments and transfers under Article VIII, Section 2(a). The guiding principle in determining whether a legislative or administrative measure is a restriction within the meaning of the provision is whether the measure involves a direct governmental limitation on the availability or use of exchange as such.8 That is to say, the determination depends on the nature of the technique involved. Thus, although a measure formulated as a quantitative limitation on imports will have the indirect effect of limiting payments, it is not for that reason a restriction on payments within the meaning of the provision. Similarly, the motive with which measures are adopted is not an element in the determination. Restrictions on trade do not become restrictions on payments within the meaning of Article VIII, Section 2(a), because they are imposed for balance of payments reasons. The obverse of this is the proposition that measures are not deprived of their character as restrictions on payments under the provision because it can be shown that they are adopted for reasons not connected with the balance of payments, such as the protection of national or international security.9
So far, the analysis of the convertibility established by Article VIII, Section 2(a), has described in broad terms the freedom that members must permit for the making of payments and transfers for current international transactions, and conversely the restrictions on this freedom that they must avoid. These obligations, however, are subject to a number of qualifications. The first is that in certain circumstances members are authorized to impose restrictions on payments and transfers without the need for specific Fund approval. Under Article VII, Section 3, the Fund may make a formal declaration of the scarcity of a currency as a result of finding that the demand for a particular currency seriously threatens the Fund’s ability to supply that currency to its members. In that event, each member is authorized, after consultation with the Fund, to impose limitations on the freedom of exchange operations in the scarce currency.10 The Fund has never made a formal declaration of the scarcity of a currency.
The second qualification is that the Fund may approve restrictions on payments and transfers for current international transactions. No rules are laid down for the exercise of this power to approve restrictions, other than the rule in Article I: “The Fund shall be guided in all its policies and decisions by the purposes set forth in this Article.” The Fund gave some indication in a decision of the Executive Directors of June 1, 196011 of its attitude toward requests for the approval of the introduction of restrictions under Article VIII, Section 2(a), by members that have convertible currencies under Article VIII. This decision reads in part:
If members, for balance of payments reasons, propose to maintain or introduce measures which require approval under Article VIII, the Fund will grant approval only where it is satisfied that the measures are necessary and that their use will be temporary while the member is seeking to eliminate the need for them. As regards measures requiring approval under Article VIII and maintained or introduced for nonbalance of payments reasons, the Fund believes that the use of exchange systems for nonbalance of payments reasons should be avoided to the greatest possible extent, and is prepared to consider with members the ways and means of achieving the elimination of such measures as soon as possible.12
Acceptance of the obligations of Article VIII, Sections 2, 3, and 4, is not rescinded by the adoption of restrictions on payments and transfers for current international transactions. Once a member accepts these obligations, it gives up the privileges of Article XIV, Section 2, to maintain, adapt, or introduce restrictions on payments and transfers for current international transactions without the approval of the Fund. It is possible that by the time a member accepts the obligations of Article VIII, Sections 2, 3, and 4, the actions it can take under Article XIV, Section 2, have been whittled away to little or even nothing. Whatever remains, however, of the privileges of Article XIV, Section 2, in the particular circumstances of the member are surrendered forever by acceptance of the obligations of Article VIII. The route cannot be retraced from Article VIII to Article XIV by cancellation of the notice of acceptance of the obligations of Article VIII, Sections 2, 3, and 4. Once a member gives the notice, its currency remains a “convertible” one for the purposes of the Articles forever, even if the Fund were to approve the member’s adoption of widespread restrictions for a time.
The convertibility that is established by Article VIII, Section 2(a), applies only to transactions between member countries (which means the residents, government agencies, and fiscal agencies of members). Article I(iv) makes this clear when it refers to a multilateral system of payments in respect of current transactions “between members.” The obligation of members to avoid the imposition of restrictions does not extend to transactions with nonmember countries. Members retain the right to impose restrictions on exchange transactions with nonmembers or with persons in their territories unless the Fund finds that such restrictions prejudice the interests of members and are contrary to the purposes of the Fund.13 The Fund has found that it would be prejudicial to the interests of members and contrary to the purposes of the Fund for a member to impose restrictions on exchange transactions with nonmembers of the Fund that have entered into special exchange agreements under the General Agreement on Tariffs and Trade, or with persons in their territories, which the member would not be authorized in similar circumstances to impose on exchange transactions with other members or persons in their territories.14 It follows that a member cannot impose restrictions on exchange transactions with the nonmember, or with persons in its territories, unless there is authority in the Articles to take similar action in relation to members or unless the member has obtained the approval of the Fund.
Convertibility of Official Balances
The convertibility established by Article VIII, Section 2(a), is available to all parties, whether private or governmental. For example, if the governmental authorities of Patria hold balances of the currency of Terra as a result of recent current transactions, they must be allowed to transfer those balances through the exchange markets, even though Article VIII, Section 4, prescribes another form of convertibility to which the monetary authorities of members, and only those authorities, may have recourse. There were various reasons for the adoption of this provision. One was the assumption that members might have surrender requirements by which they would centralize the foreign exchange receipts of their residents. It was felt that conversions through the market might be moderate, but that the amounts involved under Article VIII, Section 4, might be enormous, particularly if conversion was requested of balances accumulated over time. This form of conversion might be impossible, therefore, without the use of the Fund’s resources. Another reason for the provision was the possibility that a member would acquire the currencies of other members by intervening in the market as an “appropriate measure” to maintain the exchange rate for its currency.15 It might also have been assumed that in some countries there might not be adequate exchange markets through which to make transfers under Article VIII, Section 2(a). For these and perhaps other reasons, a mechanism was established for the conversion of balances between monetary authorities. Under Article VIII, Section 4, if Patria holds Terra’s currency, Terra has a closely defined obligation to convert Patria’s holdings if Patria presents them for conversion. In converting Patria’s holdings of Terra’s currency, Terra has an option in connection with the way in which it will discharge this obligation: Terra can provide either gold or Patria’s own currency.
Article VIII, Section 4, provides that:
(a) Each member shall buy balances of its currency held by another member if the latter, in requesting the purchase, represents
(i) that the balances to be bought have been recently acquired as a result of current transactions; or
(ii) that their conversion is needed for making payments for current transactions.
The buying member shall have the option to pay either in the currency of the member making the request or in gold.
(b) The obligation in (a) above shall not apply
(i) when the convertibility of the balances has been restricted consistently with Section 2 of this Article, or Article VI, Section 3; or
(ii) when the balances have accumulated as a result of transactions effected before the removal by a member of restrictions maintained or imposed under Article XIV, Section 2; or
(iii) when the balances have been acquired contrary to the exchange regulations of the member which is asked to buy them; or
(iv) when the currency of the member requesting the purchase has been declared scarce under Article VII, Section 3(a); or
(v) when the member requested to make the purchase is for any reason not entitled to buy currencies of other members from the Fund for its own currency.
Two main conditions must be satisfied before Terra is bound to convert Patria’s holdings under Article VIII, Section 4. First, Patria must represent that the balances it is presenting for conversion have been recently acquired as the result of current transactions, or that their conversion is needed for making payments for current transactions. If Patria makes the first representation, it is unnecessary to represent that conversion is for the purpose of making payments for current transactions. If Patria makes the second representation, it is unnecessary to represent that the balances have been obtained in recent current transactions. If, however, Terra has restricted the convertibility of the balances in conformity with Article VIII, Section 2(a), because a restriction on transfer is authorized or approved, or in conformity with Article VI, Section 3, because Terra has applied capital controls to the balances, Terra is not required to convert the balances under Article VIII, Section 4. As a result, if private holders cannot get the conversion of balances by means of transfers because the convertibility of them has been restricted consistently with the Articles, conversion cannot be obtained by transferring the balances to the monetary authorities of the private holders. It would be illogical to permit a member to restrict transfers under Article VIII, Section 2(a), or Article VI, Section 3, and compel it to convert under Article VIII, Section 4. By approving the restriction under Article VIII, Section 2(a), the Fund has recognized that the member has a balance of payments problem, and presumably this is the reason for the capital controls under Article VI, Section 3. The member will need to protect both its reserves and its rights to use the Fund’s resources. The drafters considered these rights to be a member’s second line of reserves, and the member should not be compelled to use them to make conversions under Article VIII, Section 4, if it was in difficulties as evidenced by the adoption of restrictions.
Second, before Patria can claim the conversion of its holdings of Terra’s currency under Article VIII, Section 4, Terra must be entitled to make purchases of exchange from the Fund. This is one reason for the emphasis on current transactions in the first condition. The drafters considered that the main purpose, though not the only one, for which the Fund’s resources were to be available was to help finance deficits on current account.16 However, Terra may not be entitled to make purchases from the Fund for any one of a number of reasons. For example, Terra may be formally ineligible to engage in exchange transactions with the Fund because the Fund has declared Terra ineligible under one of the provisions under which the Fund can take that action,17 or because Terra has become ineligible under a provision which requires no decision for the purpose.18 Even if Terra is not ineligible to purchase exchange from the Fund, it may not be entitled to make purchases because it has utilized all the rights to make purchases that are available to it for the time being.19 In brief, if Terra is for any reason not entitled to purchase currencies from the Fund, the monetary authorities of Terra are not bound to convert balances of its currency under Article VIII, Section 4. The fact that Terra is not entitled to purchase exchange from the Fund has no legal effect on the obligation of Terra to refrain from impeding transfers under Article VIII, Section 2(a). Under that provision, Terra must go on permitting the convertibility of its currency through the market.
The second condition brings into high relief the novelty of the kind of convertibility established by Article VIII, Section 4. It is a form of convertibility which did not exist before the Fund came into existence because the theory of it is convertibility through the mechanism of the Fund. Each member of the Fund is able to purchase the currencies of other members from the Fund, in accordance with the conditions of the Articles,20 in stated amounts and up to a maximum which is defined in terms of the Fund’s holdings of the member’s currency.21 When a member makes a purchase of exchange from the Fund, it transfers an equivalent amount of its own currency to the Fund. Therefore, if Patria presents balances of Terra’s currency for conversion by Terra and Terra purchases Patria’s currency from the Fund for this purpose, the effect is to increase the Fund’s holdings of Terra’s currency and decrease the Fund’s holdings of Patria’s currency. Thereafter, the amount of purchases that Terra can make from the Fund is decreased, and the amount that Patria can purchase is increased. Patria is able to obtain the currencies of other members from the Fund by exercising the right it gains by this operation, and Terra gives up a corresponding right. It is apparent, therefore, why Article VIII, Section 4, establishes a form of convertibility for Terra’s currency, why it is convertibility through the Fund, and why the conversion is not mandatory when Terra cannot engage in exchange transactions with the Fund.
Although conversion under Article VIII, Section 4, is mandatory only when Terra can purchase Patria’s currency from the Fund, it does not follow that Terra must purchase that currency from the Fund in order to convert Patria’s holdings. Terra has the option of using its reserves outside the Fund instead of using the Fund’s resources. Moreover, it is free to use its reserves outside the Fund in order to convert its currency even though it is not entitled to use the Fund’s resources. In practice there has been only one explicit use of the Fund’s resources for the purpose of a conversion of the kind governed by Article VIII, Section 4.22 The world has not developed as the drafters expected, although they would not be disappointed by what has happened. Section 2(a), and not Section 4, of Article VIII has become the main mechanism for conversion. The Fund has supported the maintenance of this form of convertibility with its resources. It has done this not by specifically purporting to facilitate conversions under Article VIII, Section 4, but by helping members to deal with balance of payments difficulties in a more general way.
Exchange Rates
The third element in the concept of the convertibility of a currency is some assurance of the exchange rate at which the currency can be used and exchanged. A member is required to establish a par value for its currency, directly or indirectly in terms of gold,23 and to adopt appropriate measures consistent with the Articles to permit within its territories exchange transactions between its own currency and the currencies of other members only within the limits prescribed by the Articles.24 Although this exchange rate regime is a primary objective of the Articles, it has not been attained or is not being observed by many members. Some members have not yet established an initial par value under the Articles or under membership resolutions, and others have established a par value that is not serving as the basis for any exchange transactions or for broad categories of them. The par value may have lost its effectiveness because the member is not taking appropriate measures to permit transactions only within the prescribed margins and is allowing market forces to determine exchange rates; the member may have adopted a new fixed rate of exchange without establishing it as a par value under the Articles; or the member may have adopted multiple currency practices for most or all exchange transactions.
These brief comments on exchange systems are intended to preface an aspect of convertibility under Article VIII which often surprises the observer. It is that this central concept of convertibility includes no requirement that the exchange rate provisions of the Articles are being observed in respect of the currency. The obligations which a member accepts when its currency becomes convertible under Article VIII are the obligations of Sections 2, 3, and 4 of that Article, and nothing in those sections requires a member to observe the exchange rate provisions of the Articles. This fact does not mean that a member is entitled to neglect those provisions, and it will be subject to all the actions that the Fund may take for failure to perform the exchange rate obligations if the member is in default. A member is not necessarily violating any obligations, however, because it does not have an effective par value. An obvious example is the situation in which the Fund has not yet called on the member to begin the procedures leading to the establishment of a par value under the Articles or a membership resolution. Another example is the situation in which the Fund has approved multiple currency practices with the result that no exchange transactions take place on the basis of the par value. Whether or not a member is in default of any exchange rate obligations of the Articles, the absence of an effective par value will not prevent a currency from being convertible under Article VIII.
Two propositions are implicit in the last statement. First, a currency does not cease to be convertible under Article VIII because the member does not have an effective par value for the time being, whether legally or illegally, although it had one when it accepted the obligations of Article VIII, Sections 2, 3, and 4. The drafters did not want a member to be released from its other obligations, and particularly the obligations of convertibility, because it was not observing its exchange rate obligations for the time being. This proposition is in conformity with the general principle which has been mentioned and which may be expressed in capsule form as “once a convertible currency, always a convertible currency.” Second, a member’s currency may become convertible under Article VIII at a time when it does not have an effective par value. In fact, the currencies of three members became convertible under Article VIII at a time when the members were not observing their exchange rate obligations.25
A member is entitled to give notice at any time that it is prepared to accept the obligations of Article VIII, Sections 2, 3, and 4; and the Fund has no option but to recognize that the member’s currency is then a convertible currency under Article VIII. If the member retains any exchange practices that require approval under Article VIII, the Fund has a discretion to approve or to withhold approval, but it cannot reject the notice. The Fund has given a warning in the passage already quoted from paragraph 2 of its decision of June 1, 1960 26 that members should not be precipitate in giving the notice because if a member has accepted the obligations of Article VIII, the Fund might be less likely to approve measures for which approval must be sought than it would be if the member were still availing itself of the transitional arrangements of Article XIV, Section 2. This warning is not applied in a mechanical way. For example, it does not follow that the Fund will readily approve measures for a member merely because it has not accepted the obligations of Article VIII. There may be no good reason why the obligations have not yet been accepted.
A point to notice in connection with the paragraph in the decision is that some exchange rate regimes cannot be approved under Article VIII, and are therefore necessarily inconsistent with the Articles. An exchange rate regime which the Fund cannot approve is one that consists of a unitary fluctuating rate. The Fund does have legal authority, however, to approve multiple currency practices. This power does not indicate any preference for multiple rates of exchange. The drafters of the Articles considered both multiple currency practices and a unitary fluctuating rate as incompatible with the ideal exchange system contemplated by the Articles, but they thought that when a member eliminated the temporary aberrations of multiple currency practices, it would be in a position to establish a par value. Whatever the reason for the apparent anomaly, the Fund has authority to approve multiple currency practices, and even discriminatory currency arrangements, under Article VIII, Section 3, but not unitary fluctuating rates. If a member with a convertible currency engages in any of these practices, its currency continues to be convertible whether or not its practices can be approved and, if they can be approved, whether or not they have been approved.
It can be assumed from Article VIII, Section 3, that the drafters expected that normally a member with a convertible currency would have an exchange rate regime that was consistent with the purposes of the Fund. The Fund would approve practices under the provision if the member made a case for them as temporary deviations. If the member could not convince the Fund that they were necessary, the member would not proceed to adopt them. There was even less reason to assume that members would initiate practices that the Fund had no authority to approve. Although these assumptions seem reasonable as the ones on which the convertibility obligations of Article VIII, Sections 2, 3, and 4, were drafted, there is no provision which declares that a currency cannot be convertible if the assumptions prove to be unfounded in the case of that currency.
If a member with a currency convertible under Article VIII has an exchange rate regime that is consistent with the purposes of the Fund, the member will have a par value established in accordance with the Articles and will be taking appropriate measures to permit exchange transactions in its territories involving its own currency and the currencies of other members only within the prescribed margins around the par value. These exchange transactions will include those that are involved in payments and transfers for current international transactions under Article VIII, Section 2(a), or conversions under Article VIII, Section 4. Of course, if the Fund has approved multiple rates of exchange, the member will not be violating its obligations if it permits these rates in the transactions for which they have been approved.
Convertibility Under Article VIII—a Résumé
With this outline of the main features of convertibility under Article VIII, it is possible to see how far it differs from the maximum convertibility which was posited as a standard of comparison in the Introduction. But first it must be said that it would be misleading to assume that members are meticulous in confining the convertibility of their currencies within the boundaries of their obligations under Article VIII. Although their practices vary with their fortunes, most members that have accepted the obligations of Article VIII, Sections 2, 3, and 4, permit a convertibility that is broader than the requirements of those provisions.
If the draftsman of an international agreement was engaged in drafting a clause that would assure him of the receipt of currency that met the three criteria of usability, exchangeability, and exchange value, he might consider the following situations as shortcomings of the convertibility of Article VIII, Sections 2, 3, and 4:
(1) The issuer of a currency that is convertible under Article VIII may impose controls on the outward or inward transfer of capital, and may discriminate in the application of those controls.
(2) The member must not restrict the availability of its own or other member currencies for making payments for current international transactions as defined by the Articles, and it must permit the transfer of the proceeds of such transactions. The member is entitled, however, to prescribe the currency in which it or its residents are to receive payment, and it need not accept or permit the acceptance of its own currency. Moreover, the Fund may approve restrictions on payments and transfers that ordinarily must be free from restriction.
(3) The member is bound to convert balances of its currency when conversion is sought by another member, but only if the balances have been recently acquired as the result of current transactions or conversion is needed for making payments for current transactions, and only if the member which is approached for conversion is entitled to make purchases from the Fund for this purpose.
(4) The member may not have an effective par value on the basis of which exchange transactions, including those involved in payments, transfers, and official conversions, are being conducted. This situation may be consistent or inconsistent with the member’s obligations. In addition, the Fund may approve multiple currency practices and discriminatory currency arrangements for the member’s currency. If the member does have an effective par value, exchange transactions may be carried out at any rate within the prescribed margins. Ordinarily, this feature would not be a shortcoming, but it will be seen that when the concept of “currency convertible in fact” was created for the purposes of special drawing rights, it was thought desirable to improve this feature of convertibility.
2. “De Facto” Convertibility
The only currencies that are declared to be “convertible” for the purposes of the Articles are the currencies of members that have given the Fund notice that they are prepared to accept the obligations of Article VIII, Sections 2, 3, and 4. It does not follow, however, that a member that has not given the notice is in no way bound by the obligations of Article VIII. All the obligations of Article VIII are binding on all members from the date that they join the Fund, but these obligations are modified if members elect to take advantage of the transitional arrangements of Article XIV. Article VIII, Section 1, declares that:
In addition to the obligations assumed under other articles of this Agreement, each member undertakes the obligations set out in this Article.
Article XIV, Section 2, confers certain privileges on members “not-withstanding the provisions of any other articles of this Agreement.” As a result of these provisions, therefore, while members are taking advantage of the transitional arrangements of Article XIV, Section 2, they are absolved from the duty to observe Article VIII, Sections 2, 3, and 4, but only to the extent authorized by Article XIV, Section 2.
The provisions of Article XIV, Section 2, are said by the Articles to apply “during the post-war transitional period,” but that period is not of defined duration. In particular, it is not limited to the periods of three years or five years mentioned for specific purposes in Article XIV, Section 4. In the practice of the Fund, members can still avail themselves of the transitional arrangements if they wish, and many are doing so.
The basic provision of Article XIV, Section 2, is that a member availing itself of the transitional arrangements may maintain and adapt to changing circumstances, without the approval of the Fund, restrictions on payments and transfers for current international transactions so long as the member is satisfied that the retention of these restrictions is necessary for the defense of its balance of payments. Members never had a right to introduce new restrictions of this kind under Article XIV, unless they were members whose territories had been occupied by the enemy during World War II. This exceptional privilege of introduction under Article XIV would be regarded as exhausted now. It was adopted in order to give members an opportunity to introduce their own exchange controls in lieu of those forced on them during occupation in the course of that war. Members are unable to adapt or introduce multiple currency practices, even when these practices are also restrictions on payments and transfers for current international transactions, without the advance approval of the Fund.27
Whether an action by a member is an “adaptation” or an “introduction” of restrictions may require fine judgment, but with the steady elimination of restrictions in the course of time, this judgment has become easier. The attrition of the privileges of Article XIV has led to a broader application of the obligations of Article VIII, Sections 2, 3, and 4. Under Article XIV, a member may continue to adapt its remaining restrictions without the approval of the Fund, but for any introduction of restrictions the member will require the advance approval of the Fund under Article VIII, Section 2. Moreover, approval will be necessary even for the maintenance of restrictions without adaptation if the member declares that it is satisfied that they no longer serve balance of payments needs.
The process thus described may reach the point, and has done so for a number of members, at which no further action can be taken under Article XIV, Section 2. In such circumstances, the member continues to be formally availing itself of the transitional arrangements of Article XIV, Section 2, and its currency does not yet rank as “convertible” for the purposes of the Articles. Nevertheless, the member that has removed all restrictions on payments and transfers for current international transactions has reached the point at which its currency has the full de facto convertibility of Article VIII, Section 2(a). Indeed, it will have reached the somewhat anomalous position in which the de facto convertibility of its currency will be broader than the convertibility of the currency of a member which has given notice of the acceptance of the obligations of Article VIII, Sections 2, 3, and 4, but for which the Fund has approved restrictions under Article VIII, Section 2. Of course, there continues to be the difference that a member that has not yet given the notice is not obligated to convert balances of its currency under Article VIII, Section 4, for the benefit of the monetary authorities of other members, but these holders may still convert their holdings through the market.
The anomaly of the broad similarity between de facto convertibility and the convertibility undertaken by a member which has given notice that it is prepared to accept the obligations of Article VIII, Sections 2, 3, and 4, is less striking when considered in relation to the Fund’s policies. Reference to paragraph 2 of the Fund’s decision of June 1, 1960,28 indicates that the Fund may be more reluctant to approve restrictions, multiple currency practices, or discriminatory currency arrangements under Article VIII for a member that has given the notice than for a member that has not yet taken that step.
3. Convertibility of Certain Balances—Article XIX(g) and (h)
The de facto convertibility that has been discussed in the preceding section may be defined as the convertibility of the currency of a member which has not yet given notice that it is prepared to accept the obligations of Article VIII, Sections 2, 3, and 4, but which can do nothing further under the transitional arrangements of Article XIV, Section 2. A member in this position will not be applying any restrictions on payments and transfers for current transactions. It is likely, therefore, that it is also avoiding multiple currency practices and discriminatory currency arrangements affecting current international transactions because normally these measures involve restrictions as well. The member will not be able to introduce restrictions on payments and transfers for current international transactions, discriminatory currency arrangements affecting those transactions, or multiple currency practices without obtaining the prior approval of the Fund under Section 2 or Section 3 of Article VIII. The member will be able to introduce capital controls without seeking approval, and it will not be bound to convert balances of its currency under Article VIII, Section 4. Finally, it may or may not have an effective par value for its currency.
The Fund has recognized various forms of convertibility that more or less resemble de facto convertibility as described in the preceding paragraph. It cannot be said that the resemblance is more than approximate because these other concepts of convertibility have not been defined. They are all united, however, by the underlying idea that a currency may have a high degree of convertibility in practice, even though the currency is not a “convertible” one under Article VIII.
This less formal kind of convertibility is recognized by the Articles. The provisions are not of great practical importance at this time and are not likely to increase in importance, but they have a certain interest in connection with other concepts of convertibility. The first provision to be noted in this category is Article XIX(g), which reads as follows:
The Fund, after consultation with a member which is availing itself of the transitional arrangements under Article XIV, Section 2, may deem holdings of the currency of that member which carry specified rights of conversion into another currency or into gold to be holdings of convertible currency for the purpose of the calculation of monetary reserves.
Under this provision, it is possible for the Fund to “deem” balances of a member’s currency when held by other members to be balances of convertible currency under Article VIII, even though the currency itself does not have that status. The “deeming” relates only to those balances that carry specified rights of conversion, and it will be seen that the convertibility of the balances of a currency, in contrast to the convertibility of the currency itself, has become a familiar legal idea. At the same time, the specified rights of conversion may attach to a broad range of balances—and even to all of them—so that the distinction between balances and currency becomes more technical than practical in these cases.
The last comment raises the question of the purposes for which balances may be deemed under Article XIX(g) to be balances of convertible currency. The provision declares that they are to be treated in this way for the purpose of the calculation of monetary reserves. Although this sounds narrow, these balances will have the same effect as balances of a currency that is convertible under Article VIII in the calculations that are made for certain purposes connected with repurchases,29 charges,30 and subscriptions.31
The balances of an inconvertible currency that may be deemed to be balances of convertible currency are balances that carry “specified rights of conversion into another currency or gold.” The broadest discretion has been conferred on the Fund because the Article does not define the other currency in any way, and in particular does not declare that it must be the currency of a member that has given notice that it is prepared to accept the obligations of Article VIII, Sections 2, 3, and 4. However, the “rights of conversion” must be “specified.” This means that there must be some reasonable basis for expecting that conversion will be available, and therefore that it does not rest on the whim of the issuer. The words “specified rights of conversion” occur in Article XIX(h), and in that context they have been understood to mean that the right of conversion may be exercised at the option of the holder of the currency and not at the option of the issuer.32 The words would have the same meaning in Article XIX(g). The option of the holder might result from an agreement, or it might be based on a statute or regulation promulgated by the issuer even though the statute or regulation might be abrogated.
Although there is no record of the reasons that led to the power given to the Fund by Article XIX(g), it is not difficult to deduce what they might have been. One reason might have been to prevent members from reducing repurchase obligations under Article V, Section 7(b), by holding convertible balances of a currency that was not convertible under Article VIII instead of holding convertible currencies. Repurchase obligations under Article V, Section 7(b), are largely determined by holdings of and movements in monetary reserves, and the only currencies that could be included in calculations of monetary reserves would be convertible currencies33 were it not for Article XIX(g), under which balances of other currencies may be included. Another objective of Article XIX(g) might have been to empower the Fund to give support to a member by recognizing that its currency has attained a broad de facto convertibility, even though it is still short of the convertibility of Article VIII. But it is also possible that the provision was intended to enable the Fund to make it clear to a member that no longer could do anything under the transitional arrangements of Article XIV, Section 2, that, in the opinion of the Fund, the member should give notice that it was prepared to accept the obligations of Article VIII, Sections 2, 3, and 4. Although the Fund is required by Article XIX(g) to consult a member before deeming any holdings of its currency by other members to be holdings of convertible currency, the Fund is not required to get the consent of the member. The Fund has not exercised the power conferred on it by Article XIX(g), but there are good reasons for this, including the fact that there are very few reserve currencies. Moreover, all the members that have a large role in international trade and payments have established the convertibility of their currencies under Article VIII.
The second provision which recognizes the convertibility of certain balances for particular purposes is Article XIX(h), which reads:
For the purpose of calculating gold subscriptions under Article III, Section 3, a member’s net official holdings of gold and United States dollars shall consist of its official holdings of gold and United States currency after deducting central holdings of its currency by other countries and holdings of its currency by other official institutions and other banks if these holdings carry specified rights of conversion into gold or United States currency.
Under Article III, Section 3, an original member of the Fund might pay as its gold subscription an amount equal to 10 per cent of its net official holdings of gold and U.S. dollars if that amount was less than 25 per cent of quota. Article XIX(h) permits a deduction in the calculation of a member’s net official holdings of gold and U.S. dollars for this purpose. In the negotiation of the Articles, the United States had proposed a provision based on holdings of gold and “gold-convertible exchange,” but Lord Keynes thought that no satisfactory definition could be found of gold-convertible exchange. At Bretton Woods, a committee of technicians agreed with Lord Keynes’ view because of the many gradations of practice under which various currencies could be used to buy gold. The United Kingdom was interested in a net concept of holdings because of its obligation to convert certain sterling balances into gold or U.S. dollars. This interest was recognized by Article XIX(h), in which, however, U.S. dollars were substituted for “gold-convertible exchange.” The history of the provision explains why the deduction was not confined to balances held by members or to balances that had to be converted at some particular date.34 The right to conversion had to attach to specific balances, which were distinguished therefore from other balances for which the issuer might be prepared without obligation to provide gold or U.S. dollars.
4. “External” Convertibility
That a currency may not be convertible under Article VIII but widely convertible in fact for current international transactions has been recognized in the practice of the Fund in the legal effect it has given to “external” convertibility.
As from December 29, 1958, most of the countries of Western Europe adopted what has been called “external” or “nonresident” convertibility for their currencies. The same step was taken soon thereafter by a number of other countries, most of which were in the monetary areas of the Western European countries. In general terms, the countries taking this step permitted current earnings of their currencies by nonresidents to be exchanged into foreign currencies at rates of exchange within the official margins.35 Except for one member, these countries did not grant unrestricted freedom for residents to make payments and transfers for current international transactions, so that external convertibility in this respect was narrower than the convertibility of Article VIII, Section 2, or the de facto convertibility described above, and it did not include freedom for residents to make capital transfers.
Although it has been the usual practice to describe this convertibility by the single adjective “external” or “nonresident,” the concept was a unified one only in the broadest sense. There were considerable variations in the scope and institutional features of the convertibility covered by these adjectives. For example, the scope of convertibility varied with a member’s definition of nonresidents and with the number of bilateral payments arrangements it had with other countries. Many of the limitations imposed by these definitions and by bilateral payments arrangements constituted restrictions on the making of payments and transfers within the meaning of Article VIII, Section 2(a).
External convertibility was associated with greater freedom for commercial banks to operate in the exchange markets in convertible or externally convertible currencies. The members permitting this greater freedom, however, felt that there should be greater flexibility in establishing exchange rate margins, and particularly the margins within or at which a member would intervene in the market with the use of monetary reserves in order to maintain the stability of its currency. Under the Articles, a member must take appropriate measures to ensure that spot exchange transactions between its currency and any other member’s currency taking place within the member’s territories will not deviate from the par value by more than 1 per cent.36 The margins of 1 per cent above and below par are not confined to exchange transactions involving a member’s currency and its intervention currency. With the broad move to external convertibility, many members felt that it was desirable to establish a maximum margin of about ¾ of 1 per cent for exchange transactions between their own currency and the U.S. dollar, and to allow the rates for transactions between their own and another externally convertible currency to be determined by market arbitrage. The result of such a system would be that the margin from par in these latter transactions would be the sum of the prevailing margins for each currency against the U.S. dollar, and it could thus be as much as 1½ per cent from the par value whenever market quotations for each currency against the U.S. dollar were at ¾ of 1 per cent from par.
The system as thus envisaged countenanced the possibility that rates for exchange transactions involving a member’s currency and the U.S. dollar or another convertible or externally convertible currency would be kept within the 1 per cent margins, and rates for transactions involving the member’s currency and other externally convertible currencies adopting the same system would take place outside those margins. There was, therefore, legal authority for the Fund to approve this practice as a multiple currency practice under Article VIII, Section 3. Feeling that the extension of exchange arbitrage through well-organized markets would contribute to the maintenance and promotion of convertibility, the Fund adopted the following decision on July 24, 1959:
The Fund does not object to exchange rates which are within 2 per cent of parity for spot exchange transactions between a member’s currency and the currencies of other members taking place within the member’s territories, whenever such rates result from the maintenance of margins of no more than 1 per cent from parity for a convertible, including externally convertible, currency.37
This decision, which was adopted without express limitation of time, is still operative. It has not been affected by the fact that a number of currencies for which external convertibility was adopted have since become convertible under Article VIII or de facto convertible. The decision continues to apply to these currencies as well as to any other currencies that are still only “externally convertible.” Therefore, although external convertibility has been overtaken in many instances by a broader convertibility, the concept continues to influence Fund practice because it led to the decision of July 24, 1959, which still moderates the rigidity of exchange rate margins under Article IV, Section 3.
5. Convertibility “in Fact”—Borrowing
The Fund has established a concept of convertibility in the General Arrangements to Borrow38 which is not coterminous with convertibility under Article VIII.
Article VII, Section 2, empowers the Fund to replenish its holdings of member currencies when it deems this action appropriate.39 After negotiations with ten industrial member countries, the Fund adopted a decision on January 5, 1962, to which eight of these members and the central banks of the other two were invited to adhere and under which these ten participants would stand ready to lend their currencies to the Fund in certain circumstances. This is not only a decision of the Fund but also an agreement between the Fund and the ten participants, which became effective on October 24, 1962 and remains in effect today. The Group of Ten was formed in connection with the General Arrangements to Borrow and consists of the members that have become participants in the General Arrangements or have consented to the participation of their central banks.
The General Arrangements include detailed provisions on repayment by the Fund of any loans to it by any of the participants under the decision. According to Paragraph 11(a),
Repayment under this Paragraph 11(a) or under Paragraph 11(c) shall be, as determined by the Fund, in the participant’s currency whenever feasible, or in gold, or, after consultation with the participant, in other currencies that are convertible in fact.40
Under Paragraph 11(f),41 a participant may receive accelerated repayment when it has a balance of payments need for repayment, and
Repayment shall be made after consultation with the participant in the currencies of other members that are convertible in fact, or made in gold, as determined by the Fund.
The novel concept in these sentences was currency “convertible in fact.”
There were various reasons for the creation of a new concept of convertibility. One reason was that when the General Arrangements were adopted, the currency of one participant, Japan, was not convertible under Article VIII, although it was broadly convertible in the market. There was an implicit understanding that, in principle, all of the ten currencies should qualify as currencies in which repayment might be made, although this was not written into the General Arrangements. Nor did the General Arrangements prescribe that the currencies convertible in fact had to be confined to those of the participants. A second reason was the realization that even if a currency was convertible under Article VIII, it might be subject to restrictions on the making of payments and transfers for current international transactions. It was intended that the Fund should not be able to repay loans in a currency of that character. Again, the repurchase provisions of the Articles might operate in such a way that the participant for the benefit of whose transaction the Fund borrowed under the General Arrangements was required to repurchase in currencies other than those that the Fund had borrowed. It was not possible, therefore, to provide that repayment should be made exclusively in gold or the currency borrowed, and some further means of repayment had to be included. Moreover, if a participant requested early repayment because it had a balance of payments need, there had to be some assurance that it would receive currencies that would meet its need.
For all of these reasons the General Arrangements provide that repayment can be made in a currency only if it is actually convertible. The words “de facto convertible” were not used because these could have been understood to exclude currencies that were convertible under Article VIII. Therefore, the new term “convertible in fact” was coined, but it was not defined in the General Arrangements or in any collateral document. It was felt that it would be easy to recognize a currency convertible in fact without the guidance of a definition. After all, if a lender were repaid in a currency which it could not convert in fact, the terms of the General Arrangements would not have been observed, the currency could be returned to the Fund, and the Fund would have to substitute another currency that was convertible in fact. The concept of currency convertible in fact was incorporated in the repayment provisions of the bilateral loan agreement between the Fund and Italy, which was entered into on August 11, 1966 and in which a number of provisions followed the precedent of the General Arrangements.42 The term “convertible in fact” has had a somewhat curious history as will be seen from the discussion of its connection with special drawing rights.
The concept of convertibility in fact in the General Arrangements contains no element of assured exchange value. The value of any loan, however, is calculated, as of the time when it is made, in gold or U. S. dollars of fixed gold content, and the Fund is obligated to repay an equivalent value. The equivalent in any currency of that value is calculated at the rate of exchange at which the Fund holds the currency at the date for which the calculation is made, and normally this will be the par value of the currency.43 Claims to repayment are guaranteed as to value but not as part of the concept of currency convertible in fact. It will be seen later that when applied to special drawing rights, this term does involve an essential element of assured exchange value.
6. Free Purchase and Sale of Gold
Although the drafters of the original Articles eliminated any reference to “gold-convertible currency,” they introduced into the Articles the concept of a currency that is convertible into gold. It has been seen that a member is bound to take appropriate measures to ensure that exchange transactions in its territories involving its own and another member’s currency take place only within certain defined margins from par. According to the second sentence of Article IV, Section 4(b),
A member whose monetary authorities, for the settlement of international transactions, in fact freely buy and sell gold within the limits prescribed by the Fund under Section 2 of this Article shall be deemed to be fulfilling this undertaking.
In conditions of convertibility, the normal method by which monetary authorities observe the obligation to take appropriate measures is to intervene in the exchange market by dealing at certain rates within the margins. A member is deemed to fulfill the obligation, however, without intervention in the market if it buys and sells gold in accordance with the second sentence of Article IV, Section 4(b). The theory of the provision seems to be that the member maintains the value of its own currency in relation to gold by standing ready to engage in gold transactions for its currency with other members. It is entitled to say, therefore, that it is not responsible if exchange rates emerge outside the permitted margins in transactions involving its own currency. The Fund has not adopted a definitive view of the meaning of the second sentence of Article IV, Section 4(b), and therefore it may be necessary at some future date to give greater precision to the free purchase and sale of gold within the meaning of the provision.
The Fund has decided that at least one practice will be regarded as incontestably meeting the requirements of the provision, but with one exception, which will be noted later, it has not decided that the provision can be satisfied by practices that meet less exacting standards. It has been decided that a member satisfies the provision without question if it meets two tests. First, the member stands ready to buy gold from and sell it to the monetary authorities of other members in return for its own currency at prices based on the par value for its currency. The theory is that other members are then able to intervene in their markets and maintain the appropriate margins because any amounts of the intervention currency that they need for intervention or acquire as a result of intervention can be obtained or exchanged for gold in transactions with the member that is freely buying and selling gold. Second, the member has no restrictions either on the making of payments and transfers for current international transactions or on capital transfers. If the tests are met, it is safe to say that any exchange transactions in the member’s territories involving its currency at rates outside the margins are not attributable to its actions but to some circumstance incidental to the other currency in the transaction. If the member had imposed restrictions, it could not be said with certainty that the development of rates outside the margins must be attributed to the other currency. On the contrary, it would be possible that the rates were the result of the restrictions because of the efforts of residents to evade them.
To comply with the provision regarding the free purchase and sale of gold, a member need not go beyond transactions with the monetary authorities of other members. There is no need for the member to engage in gold transactions with private parties, because it is transactions between monetary authorities that will determine the margins for exchange rates. Nor is there any need for the member to engage in gold transactions with nonmembers, because the obligations of Article IV, Sections 3 and 4(b), with respect to rates for exchange transactions apply only to exchange transactions involving the currencies of members.44 In recent years, it has been suggested that other limitations on gold transactions might not be incompatible with the free purchase and sale of gold within the meaning of the provision. For example, it has been suggested that some limitation might inhere in the phrase “for the settlement of international transactions,” but the Fund has not taken a position on this question.
When it was said in an earlier paragraph that there were no decisions on whether lesser practices might constitute the free purchase and sale of gold within the meaning of Article IV, Section 4(b), one exception was noted. The Fund has decided that although the provision speaks of the free purchase and sale of gold, a member can be regarded as following that practice if, in return for its own currency, it freely buys and sells the currency of another member that is freely buying and selling gold within the meaning of the provision.45 It is of course necessary that all other aspects of Article IV, Section 4(b), are being observed. For example, although a member can be deemed to be freely buying and selling gold indirectly in the way that has been explained, the combined costs of the exchange transaction involving the two currencies and the gold transaction must not exceed the margins prescribed by the Fund for gold transactions.46
What relation does the convertibility involved in the free purchase and sale of gold bear to the convertibility of Article VIII, Sections 2, 3, and 4? In some important respects, the former convertibility is more rigorous. First, on the basis of one view, a member is not freely buying and selling gold within the meaning of Article IV, Section 4(b), unless it has no restrictions on the making of payments and transfers for current international transactions. A currency continues to be convertible under Article VIII, however, even if it is subject to such restrictions. Second, on the basis of the view that has been referred to, the free purchase and sale of gold by a member means that it has no restrictions on capital transactions. It has been seen that the obligations of Article VIII, Sections 2, 3, and 4, do not prevent a member from restricting capital transfers. Third, a member freely buying and selling gold stands ready to provide gold for its own currency, whereas there is no such obligation under Article VIII. Under Article VIII, Section 2(a), a member is not required to permit transfers into gold in the market, and under Section 4 a member has the option to convert its currency for the benefit of the monetary authorities of other members with gold or the currency of the member seeking the conversion. This option may not exist for a member that has a convertible currency under Article VIII and is also freely buying and selling gold. The member must provide gold for its currency if this is requested by the holder and the member wishes to continue freely buying and selling gold. Fourth, the obligation of a member to convert its currency for the benefit of the monetary authorities of other members under Section 4 must be performed only when the member is entitled to use the resources of the Fund, whereas the free purchase and sale of gold involves no comparable qualification. Lastly, a member freely buys and sells gold in accordance with Article IV, Section 4 (b), only if its transactions with the monetary authorities of other members are within the margins from par prescribed by the Fund for gold transactions. It has been seen that a member’s currency can be convertible under Article VIII even though the member is not performing its obligation with respect to the margins for exchange transactions.
In one respect, convertibility under Article IV, Section 4(b), can be less rigorous than convertibility under Article VIII. A member is not legally bound to buy and sell gold freely. Whether it does so is a question of fact, as the language of Article IV, Section 4(b), indicates, and it can decide at any time to terminate the practice. Once a member has given notice to the Fund that it is prepared to perform the obligations of Article VIII, Sections 2, 3, and 4, however, there is no legal possibility of retreat.
Legally, a member can be freely buying and selling gold under Article IV, Section 4(b), whether or not it has given the Fund notice that it is prepared to accept the obligations of Article VIII, Sections 2, 3, and 4.47 On the basis of the tests recognized so far for the free purchase and sale of gold within the meaning of the provision, the member will have given up all exchange restrictions, and therefore if it decided to cease the practice of freely buying and selling gold, it would not be able to introduce restrictions on the making of payments and transfers for current international transactions without the approval of the Fund under Article VIII, Section 2, although it would be free to adopt restrictions on capital transfers. In these respects, its position would be the same whether or not it had a convertible currency under Article VIII. There would be a difference, however, in connection with Article VIII, Section 4. The member would be bound to convert balances of its currency under that provision for the benefit of the monetary authorities of other members only if it had given notice that it accepted the obligations of Article VIII, Sections 2, 3, and 4.
7. “Currency Convertible in Fact”—Special Drawing Rights
The most recent convertibility concept in the Fund is the concept of “currency convertible in fact” which is associated with special drawing rights. The central transaction in special drawing rights is the transfer of them between participants in the Special Drawing Account when the transferor decides to use them to meet balance of payments needs or in the light of developments in its reserves and transfers them to a transferee designated by the Fund.48 The transferee must provide the transferor with “currency convertible in fact.”49 The phrase was adopted early in the drafting of the amendments of the Articles dealing with special drawing rights, and its adoption was inspired by the conviction that the transferor of special drawing rights in the central transaction in them should receive a currency that met certain standards of convertibility that were not involved in the concept of convertibility under Article VIII. It was because these standards were intended to be stricter in some respects in order to ensure a more effective convertibility that the phrase “currency convertible in fact” was taken from the General Arrangements to Borrow, in which it had been incorporated for much the same purpose.
One reason for the feeling that the convertibility provisions of the Articles were not ideal was related to the experience of the Fund in connection with its exchange transactions. It had become the practice of the Fund to sell the currencies of members that were in strong balance of payments and reserve positions and for a member to convert its currency into its main reserve currency for the benefit of the member that had made the purchase from the Fund.50 Members had collaborated in this practice and were willing to convert their currencies, but some held the view that if there was any obligation to convert in these circumstances, it would be under Article VIII, Section 4. On this thesis, the purchase could be rendered nugatory, because if Patria purchased Terra’s currency and presented it to Terra for conversion, Terra could purchase Patria’s currency from the Fund with which to make the conversion.51 This, in effect, would deprive Patria of the benefit of its purchase. One purpose of the adoption of the concept of “currency convertible in fact” for the central transactions in special drawing rights was to ensure that the user of special drawing rights would be able to obtain the currency which it wanted and that there would be an obligation to convert the currency which the transferee provided if it was not the currency wanted.
As the drafting of the amendments dealing with special drawing rights progressed, the concept of “currency convertible in fact” became more sharply defined. In its final form it has no relevance to the General Arrangements. That is to say, the definition of “currency convertible in fact” which now appears in the Articles is not the definition that would apply to the General Arrangements. In the decision of the Fund that constitutes the General Arrangements, the concept continues to be undefined, and if any definition were adopted, the currencies that met the definition would not have to be the same as those covered by the definition that applies to special drawing rights. Moreover, if a definition were formulated, it would have to be different in character because some of the elements in the definition that applies to special drawing rights have no connection with the General Arrangements. Indeed, at least one element would be inconsistent with the provisions of the General Arrangements. It will be seen that an element in the definition of “currency convertible in fact” for the purposes of special drawing rights is designed to ensure that the transferor of special drawing rights receives “equal value.” There is no requirement that the rates of exchange that are applied for this purpose shall be applied for repayment under the General Arrangements, and there are likely to be differences between them. Market rates are applied for “equal value,” except that the par value is used for the U.S. dollar, whereas the rate at which the Fund is holding a currency, which normally is the par value, is applied for repayment under the General Arrangements.
The repayments that have been made to lenders under the General Arrangements have not yet produced a precise definition of “currencies convertible in fact” for the purposes of the General Arrangements, but practice has shown that they may be the currencies of nonparticipants in the General Arrangements or of members that have not yet accepted the obligations of Article VIII. It has been noted that the ten potential lenders and the Fund probably assumed that the currencies of the participants were within this language provided that they remained convertible in practice. It is not legally impossible for all ten currencies of the participants in the General Arrangements to be included among currencies convertible in fact for the purposes of special drawing rights, but this is not yet the position. Moreover, the latter already include the currency of one member of the Fund that is not a participant in the General Arrangements, but it has been seen also that there is no legal impediment to repayment under the General Arrangements in the currency of a nonparticipant in the General Arrangments.
The similarity between the language of the General Arrangements and the amendments dealing with special drawing rights is accidental. If it were decided to amend the language of the General Arrangements in order to avoid any confusion, amendment would require a majority of the votes cast by executive directors52 and the concurrence of all ten participants in the General Arrangements.53
The definition of “currency convertible in fact” for the purposes of special drawing rights appears in Article XXXII:
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(b) Currency convertible in fact means:
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(1) a participant’s currency for which a procedure exists for the conversion of balances of the currency obtained in transactions involving special drawing rights into each other currency for which such procedure exists, at rates of exchange prescribed under Article XXV, Section 8, and which is the currency of a participant that
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(i) has accepted the obligations of Article VIII, Sections 2, 3, and 4, or
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(ii) for the settlement of international transactions in fact freely buys and sells gold within the limits prescribed by the Fund under Section 2 of Article IV; or
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(2) currency convertible into a currency described in paragraph (1) above at rates of exchange prescribed under Article XXV, Section 8.
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The analysis of the definition can begin by pointing out that it embraces two categories: the currencies of certain participants in the Special Drawing Account and the balances of the currencies of certain other participants. The difference between currencies that are convertible in fact qua currencies and the balances of other currencies that are convertible in fact qua balances is responsible for calling the concept itself “currency convertible in fact” without an article. It is also responsible for the contrast between “a participant’s currency” in Article XXXII(b)(1) and “currency” in Article XXXII(b)(2). (Although the first category refers to “a participant’s currency,” it will be seen on closer analysis that only certain balances of the currency are within the definition. But it will also be seen that the rules for determining which balances are within the definition are not the same for the two categories.)
Only the currencies of participants in the Special Drawing Account can be included in the definition and not the currencies of members that are not participants or the currencies of nonmembers of the Fund. There is, therefore, nothing comparable to the power of the Fund in Article XIX(a) and (d) to specify that the holdings of a non-member’s currency shall be treated as the holdings of a convertible currency for certain purposes under the Articles.
Currency will not be convertible in fact, either in the first or in the second category, unless the issuer informs the Fund that it wants its currency or certain balances to be regarded as convertible in fact. The Fund decides whether the currency or the balances meet the criteria for convertibility in fact. A participant may establish that its currency or certain balances of it are convertible in fact but at a later date may give notice to the Fund that the currency or the balances will cease to be convertible in fact. The Fund itself may come to this conclusion, after consulting the issuer, even though the participant has not given notice.54 The possibility that convertibility in fact under Article XXXII(b) may be terminated is one of the ways in which it differs from convertibility under Article VIII. It has been seen that once a member gives notice that it is prepared to perform the obligations of Article VIII, Sections 2, 3, and 4, the member’s currency remains convertible under Article VIII for all time thereafter whatever happens to the usability, exchangeability, or exchange rate of the currency.
The two categories of convertibility in fact under Article XXXII(b) will be discussed in turn.
Article XXXII(b)(1)
There are a number of components in the definition of the first category of currency convertible in fact: (1) convertibility under Article VIII, Sections 2, 3, and 4, or Article IV, Section 4(b); (2) interconvertibility; (3) equal value; and (4) official conversion.
Convertibility under Article VIII or Article IV, Section 4(b).
One condition that a participant’s currency must satisfy in order to be a currency convertible in fact of the first category is that the currency is convertible under Article VIII or that the participant is freely buying and selling gold within the meaning of Article IV, Section 4(b). In view of the further condition of interconvertibility, it may be asked why the first condition was necessary. It will be seen that interconvertibility ensures that there will be conversion into any currency of the first category which the transferor of special drawing rights wants if the transferee has provided some other currency convertible in fact of the first category. The transferor may request any currency of the first category which it wants and is entitled to receive that currency. The transferee is not required to provide the currency of the first category which the transferor wants, but it must provide currency convertible in fact that will be convertible, directly or indirectly, into the currency which the transferor wants.55 The condition that a currency of the first category must be convertible under Article VIII or Article IV, Section 4(b), was not essential, but it increases the likelihood that the transferee will be holding a currency that is convertible in fact and therefore will have no difficulty in providing such a currency from its reserves when it is designated by the Fund as a transferee. Experience has confirmed the assumption that one or more reserve currencies would become currencies convertible in fact now that the U.S. dollar, sterling, and the French franc have been recognized as currencies convertible in fact of the first category.
Interconvertibility.
On the basis of the legal analysis of Article VIII, Sections 2, 3, and 4, alone (i.e., without the condition of interconvertibility), a transferor of special drawing rights could not have been assured that if it received a currency convertible under Article VIII, it would be able to convert that currency into the currency which it wanted. It has been seen that a currency convertible under Article VIII may be subject to restrictions on the making of payments and transfers for current international transactions that have been approved by the Fund, and to restrictions on capital transfers, which may be imposed without the need for the Fund’s approval. Even if there were no restrictions of either kind, the transferor might not have been able to convert the currency that it received into the currency it wanted. That currency might not have been available in the market even though there were no restrictions on transfers into it. The monetary authorities of the issuer of the currency received by the transferor might have had no obligation to convert it for the benefit of the transferor under Article VIII, Section 4. For example, the question might have been raised whether the balances received by the transferor were among those that must be converted under Article VIII, Section 4(a)(i) or (ii).
The questions that had been raised in connection with the conversion of balances purchased in an exchange transaction with the Fund gave notice that the uncertainties of Article VIII, Section 4, were not merely hypothetical. Even if problems of interpretation had been resolved in favor of an obligation to convert, there might have been circumstances in which the issuer of the currency received by the transferor would have had no obligation to convert under Article VIII, Section 4, because the issuer was not entitled for some reason to make purchases from the Fund. If the monetary authorities of the issuer had been willing to convert in accordance with the provisions of Article VIII, Section 4, the transferor might still have been frustrated in its wish to get a particular currency with the currency provided. If the issuer had provided gold, the monetary authorities of the currency wanted by the transferor would have had no obligation to provide their currency for gold. (This would be true even if the currency wanted was the currency of a member freely buying and selling gold because no member is under an obligation to continue that practice.) If the issuer had decided to provide the transferor with the transferor’s own currency, the issuer would not have been bound to acquire it through the Fund. If the issuer had obtained the transferor’s currency from the Fund, the transferor would have acquired rights to purchase an equivalent amount of the currency that it wanted from the Fund, subject to compliance with the Fund’s tranche policies. If the issuer had not purchased the transferor’s currency from the Fund and had provided the currency from its own holdings, currency liabilities of the transferor would have been extinguished, but this would not have supplied the transferor with the currency it wanted.
The absence of any assurance based on the law alone that the transferor could get the currency it wanted can be demonstrated even if the transferee had provided the currency of a member that was freely buying and selling gold within the meaning of Article IV, Section 4(b). If the transferor tendered that currency to the issuer and received gold, the issuer of the currency which the transferor wanted would not have been obligated to provide its currency for gold. It has been noted already that there is no general obligation under the Articles, or in public international law, for a member to purchase gold in transactions with other members.56
Obviously, many difficulties of conversion that have been mentioned in the analysis of the law relating to convertibility under Article VIII or Article IV, Section 4(b), are not reflected to any great extent in current practice. Nevertheless, they were difficulties that had to be considered in the drafting of a charter that sought to give effect to certain objectives not only in the present but also in the unforeseeable future. This consideration led to the adoption of the condition of interconvertibility.
The word “interconvertible” was not incorporated in the Articles, but it was used in the Report of the Executive Directors to the Board of Governors on the proposed amendments.57 The word refers to a requirement that balances of a currency of the first category obtained in a transaction involving special drawing rights must be convertible into any other currency of the first category which the transferor of special drawing rights wants. For example, if Patria wishes to use its special drawing rights, it informs the Fund of the currency of the first category that it wishes to receive as a result of the transfer if it has a preference.58 If Patria wants to transfer special drawing rights for U.S. dollars, and Terra, the transferee, provides sterling, the United Kingdom must convert the sterling into U.S. dollars. If Terra had provided French francs, France would have to convert them into U.S. dollars. Any necessary conversion takes place at the time of the transfer.59 If Patria informs the Fund that it is content to receive sterling, Patria is not entitled to have the balance provided by Terra converted by the United Kingdom under the interconvertibility procedures at a later date. This rule does not mean that the balance cannot be converted by Patria, but only that conversion will have to rest on some principle or practice not related to interconvertibility.
Before the Fund decides that a currency is convertible in fact of the first category under Article XXXII(b), the Fund consults members on the procedures that exist for the conversion of that currency into all other currencies of the first category. Unless these or other satisfactory procedures exist at all times, the Fund will withdraw its finding that a currency is convertible in fact. Effective procedures to ensure interconvertibility depend on appropriate arrangements under which the other interconvertible currencies will be available to an “interconvertible” participant if it has to convert its own currency into another interconvertible currency. These arrangements can be referred to as background arrangements because their purpose is to ensure that the procedures for interconvertibility will work satisfactorily. The choice of these procedures is left to participants, and they need not be uniform. They may consist of special understandings between central banks, but conversion conducted through the market is not precluded, at least if no objection is raised by the participant whose currency is obtained in this way. Whatever background arrangements are made, they must enable a participant that has a currency convertible in fact of the first category to make prompt conversion of any of its currency obtained in a transaction involving special drawing rights into all other currencies of the first category.60
The necessity of procedures for interconvertibility relates only to balances obtained in a transaction involving special drawing rights. Any limitations on the convertibility of other balances of the currency that are inherent in the concepts of convertibility under Article VIII or Article IV, Section 4(b), or any restrictions on the convertibility of a currency that may exist at any time, do not prejudice the status of the currency as convertible in fact of the first category provided that the procedures for the interconvertibility of balances obtained in transactions involving special drawing rights are not affected. It is because these other forms of convertibility may involve limitations or restrictions that the requirement of interconvertibility was adopted. Therefore, if a transferor transfers its special drawing rights to a designated participant, and receives a currency that is to be converted in order to provide the transferor with the currency of the first category which it wants, the conversion cannot be refused on the ground that the transferor would not be entitled to obtain it under Article VIII.
If a transferor of special drawing rights receives currency in a transaction with a designated transferee that for some reason cannot be converted into the currency convertible in fact of the first category which the transferor wants, it may return the currency to the transferee, which must then substitute other currency convertible in fact.61 Once the transferor receives the currency convertible in fact of the first category which it wanted, the currency will be subject to whatever limitations on usability and exchangeability that are consistent with the Articles.
It is worth repeating that with the requirement of interconvertibility there was no legal necessity for the condition that the currency provided in return for special drawing rights should be convertible under Article VIII or Article IV, Section 4(b). The reason for that condition has been explained: the condition is likely to limit the currencies to those held in reserves and therefore to make it easy for participants to provide a currency convertible in fact when they are designated as transferees.
Exchange rates: equal value.
In the discussion of the exchange rate aspects of convertibility under Article VIII, it was seen that when a member buys balances of its currency under Article VIII, Section 4, the member may make the conversion at any rate of exchange within the margins from parity that are consistent with the Articles. The practice in connection with a different category of conversions was even more influential in determining the exchange rate feature of convertibility in fact. These were the conversions of currency purchased from the Fund through what is now the General Account. It is normal now when a member’s currency is purchased from the Fund for that currency to be converted into the main reserve currency of the member, which is usually the main reserve currency of the purchasing member as well. The conversion may be made through the market or between the central banks of the two members involved in the transaction. Neither conversion will be under Article VIII, Section 4, if only because that provision deals with conversions between monetary authorities in which the issuer of a currency converts balances of its currency with gold or the holder’s currency and not with a third currency. The Fund sells currencies at par, but once again the conversion by the issuer of balances of its currency sold by the Fund may be made at any rate within the margins that are consistent with the Articles. The result, of course, is that often purchasing members will get the benefit of a rate prevailing in the market that is at a premium compared with par, but sometimes the rate may be at a discount. In the former case, the purchasing member receives a benefit and in the latter incurs a detriment. Sometimes, however, a member may prefer to apply the par value when converting balances of its currency purchased from the Fund whatever the rate of exchange may be in the market.62
In order to avoid the differences in treatment that have been referred to and to prevent a transferee of special drawing rights from deliberately providing a currency that is at a discount in the market, it was decided that a condition relating to exchange rates should be incorporated in the definition of convertibility in fact and that the condition should ensure uniformity of treatment. This purpose was achieved by the addition of the phrase “at rates of exchange prescribed under Article XXV, Section 8,” in Article XXXII(b)(1). Article XXV, Section 8, provides that:
(a) The exchange rates for operations or transactions between participants shall be such that a participant using special drawing rights shall receive the same value whatever currencies might be provided and whichever participants provide those currencies, and the Fund shall adopt regulations to give effect to this principle.
(b) The Fund shall consult a participant on the procedure for determining rates of exchange for its currency.
(c) For the purpose of this provision the term participant includes a terminating participant.
The purpose of what has been called the requirement of “equal value” in Article XXV, Section 8(a),63 is to ensure that the transferor of special drawing rights will neither incur a detriment nor receive a benefit because the transferee provides one currency convertible in fact instead of another. This is done by making it a condition of the status of a currency as a currency convertible in fact that satisfactory procedures exist under which the return to the transferor will not vary with the identity of the transferee or with the currency that it provides.
The technique by which the requirement of equal value has been made effective in the Fund’s Rules and Regulations is by prescribing that when currency is provided in a transaction between participants or is converted in connection with such a transaction, certain specified rates of exchange shall be applied. For the U.S. dollar, the exchange rate is the par value. For the currency of a participant that has an exchange market in which the Fund finds that there is a “representative rate” for spot delivery for the U.S. dollar, that representative rate applies. For other currencies, a cross rate is calculated on the basis of representative rates; and if this cannot be done, the Fund determines the rate. The procedure for determining the representative rate for a currency is established in consultation with the issuer, so that a participant will be able to apply the appropriate rate without difficulty in any transaction or conversion. The appropriate rate is the rate prevailing at the date of the dispatch of the Fund’s instruction designating a transferee, or in a transaction without designation, the date on which the transferor gives notice to the Fund before the transaction is carried out.64 The choice of such a rate avoids the application of a rate that is depressed because the issuer of the currency to be converted happens to convert it through the market. In general, the system is one based on rates for currencies other than the U.S. dollar prevailing in the market shortly before the transfer of special drawing rights, and in such a way that if the transferee provides a currency other than the currency wanted by the transferor, the issuer of the currency provided will convert it into the desired currency at a rate of exchange that will yield the same amount of that currency as if the transferee had provided it in the first instance.
Official conversion.
For a member’s currency to be convertible under Article VIII, the Articles provide two procedures by which the holders of that currency can get the conversion of certain balances. Nonresident holders, whether private parties or monetary authorities, can convert through the market those balances that are the proceeds of recent current transactions. Monetary authorities, however, can get conversion of these balances by presenting them to the monetary authorities of the issuer. Moreover, other balances can be converted in this way if conversion is needed for making payments for current transactions.
If a holder of a balance of a currency convertible in fact has obtained it from another participant in return for special drawing rights, the holder can be content, if it wishes, with conversion in accordance with Article VIII or in any other way consistent with the Articles even if conversion is not obligatory under Article VIII. If, however, the transferor wants a particular currency convertible in fact as part of the transaction involving special drawing rights, it is then the responsibility of the issuer of any other currency convertible in fact that is provided by the transferee to see that an appropriate conversion is carried out. The necessity for the rule that conversion must be conducted through an official agency of the issuer follows from the requirement of equal value. Therefore, even if the conversion is conducted by the issuer through the market, the issuer remains responsible for seeing that equal value is made available. If, when the issuer makes the conversion, the rate for its currency in the market is at a discount, compared with the rate on the day that is relevant for the calculation of equal value, the issuer must bear the burden, whether or not the discount resulted from the conversion. The issuer would have the benefit of any profit, however, if the rate for its currency were at a premium.
Article XXXII(b)(2)
In order to qualify as currency convertible in fact of the second category, the balances of a currency must satisfy two conditions. First, in the opinion of the Fund, satisfactory arrangements must exist for conversion of the balances by the issuer into at least one currency of the first category. Second, the arrangements must ensure that any conversion will be “at rates of exchange prescribed under Article XXV, Section 8.” In short, the conversion must be at rates of exchange that will yield equal value under the rules already explained. Once again, the issuer of the balances is responsible for seeing that equal value is given. It is not a condition that the issuer must have accepted the obligations of Article VIII, Sections 2, 3, and 4, or be freely buying and selling gold in accordance with Article IV, Section 4(b).
According to Article XXXII(b), the difference between the two categories of convertibility in fact is that the first relates to “a participant’s currency” and the second to “currency.” The reference to “currency” was intended to allow a participant to specify that only particular balances of its currency are to be currency convertible in fact. Neither the Articles nor the Rules and Regulations contain any indication of the distinctions that may be made among balances for this purpose. It is possible to imagine distinctions in accordance with which only balances up to a certain amount or balances provided by particular participants would be convertible in fact.
Belgian francs, deutsche mark, Italian lire, Mexican pesos, and Netherlands guilders provided in return for special drawing rights have been established so far as currency convertible in fact of the second category. No limitation has been placed by the issuers on the balances of those currencies that may be provided for special drawing rights and that will be convertible by the issuer if necessary. Each participant has arranged that any conversion of its currency that may be called for will be into U. S. dollars but not into the other two interconvertible currencies. Suppose, therefore, that Patria wishes to transfer its special drawing rights and receive French francs for them and that Terra is designated as transferee. Terra provides Italian lire. Italy will then convert this balance of lire into U.S. dollars, and the United States will convert these U.S. dollars into French francs.
The distinction between a currency of the first category and balances of the second category must not obscure the fact that the participant that establishes the convertibility in fact of balances of its currency may elect not to limit the balances of its currency that may be provided in transactions involving special drawing rights as currency convertible in fact. It has been seen that no issuer of currency of the second category has adopted any limitations of this kind. Therefore, any transferee may provide, without limit, balances of any currency convertible in fact of the second category, and the issuer will convert them into U.S. dollars.
The present situation emphasizes the essential legal difference between the two categories of currency convertible in fact. The quality of convertibility in fact will attach to any balances of a currency of the first category provided in return for special drawing rights, or, to put the same proposition in other words, any transferee may provide any balances of a currency of the first category without limit. The issuer cannot prescribe that only certain balances shall be convertible in fact. The quality of convertibility in fact may attach to only some balances of a currency of the second category, or, to state this proposition also in other words, transferees may be able to provide only certain balances of a currency of the second category when they are designated to receive special drawing rights from a transferor. However, this difference need not, and so far it does not, exist in practice. But the difference remains that every currency of the first category must be interconvertible with all other currencies of the first category. Currency of the second category may be convertible into various currencies of the first category, but convertibility into a single currency of that category suffices. Interconvertibility is not necessary. That is to say, if balances of a currency of the second category (A) are convertible into currency B, a currency of the first category, there is no rule that balances of currency B shall be convertible into currency A. In addition, there is no requirement that currency of the second category be convertible into any other currency of that category.
As a result of the requirements for convertibility in fact, a transferor may not insist on receiving currency of the second category. The structure of convertibility in fact as described in the preceding paragraph makes it possible for currency of the second category to be converted into a currency of the first category, but no procedures are required for converting currency of the first category into a currency of the second category. Therefore, if a transferor wants a particular currency of the second category, the transferee may happen to provide it, but because the transferor cannot insist on this, the only formal action it can take is to express a preference for one or more particular currencies of the first category or to express no choice. It can advise the Fund informally, however, that if a balance of a particular currency of the second category were to be provided, the transferor would be pleased to retain it. The transferor would be able to retain it, because the Fund would give no instructions for conversion.
Finally, it must not be assumed that the contrast between the currencies of Article XXXII(b)(1) and the balances of Article XXXII(b)(2) means that the quality of convertibility in fact attaches to all balances of a currency of the first category. Only balances “obtained in transactions involving special drawing rights” will be convertible in fact.65 Only those balances must be interconvertible among currencies of the first category, must be convertible at rates of exchange that assure equal value, and must be provided at or converted through an official agency of the participant issuing the currency. Holders of other balances of the currency are not entitled to that treatment although they can expect treatment in accordance with another condition of convertibility in fact of the first category, namely, convertibility under Article VIII or in accordance with Article IV, Section 4(b), as the case may be.