International Monetary Fund
Published Date:
January 1971
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Article IV, Section 8(b), provides that a member shall pay additional currency to the Fund equal to the reduction in the gold value of the member’s currency held by the Fund not only when the par value of the member’s currency is reduced but also when there is no formal change in par value, but the Fund determines that the foreign exchange value of the member’s currency has depreciated to a significant extent within the member’s territories. In this way, provision is made for the maintenance of the gold value of the Fund’s holdings of a member’s currency when there is a de facto depreciation of the currency in exchange transactions in the member’s territories. The par values of the currencies of members are fixed, directly or indirectly, in terms of gold, and therefore there is a fixed relationship between the par values of any two currencies. Exchange transactions involving the two currencies in the territories of the two members must be based on this fixed relationship and must not deviate from it by more than narrow margins that are consistent with the Articles.12 If, notwithstanding the provisions of the Articles, exchange transactions do deviate from the fixed relationship by a significant amount in excess of these margins, the deviation may occur because there has been a depreciation in the market value of one currency in relation to other currencies.

It will be observed that for the purposes of Article IV, Section 8, the depreciation of a member’s currency must be judged on the basis of the exchange rates in the market of the member itself so as to avoid the influence of any distortion that may result from special circumstances in the market of some other member. Furthermore, the deviation from the parity relationship must be “significant.” It is not intended that there should be an adjustment of the Fund’s holdings when the deviation is minor and when it is possible, therefore, that exchange rates may soon return to the appropriate margins. It may also be implied from this that some element of persistence in the divergence of rates from what is permitted by the Articles was contemplated as a condition of the adjustment of the Fund’s holdings, although not necessarily for each adjustment once it appears that there is a persistent divergence.

Although further currency has been paid to the Fund on many occasions because of a finding that the foreign exchange value of the currency has depreciated to a significant extent, the Fund has not found it necessary or desirable to establish a comprehensive policy for adjustment of its holdings. There are a number of reasons for what has been a pragmatic approach to the application of Article IV, Section 8. First, although it may be apparent that there has been a depreciation, it may be difficult to define the depreciation with precision; and clearly the Fund cannot call on the member to discharge its obligation to pay more currency without saying how much more.13 For example, it may not be easy to say what is “the” foreign exchange value of a currency when there are multiple rates of exchange, each of which applies to a substantial proportion of transactions. The problem may be further complicated by the fact that some of the rates are maintained at fixed levels by official action, while others are determined, more or less freely, by market forces. Second, a currency may depreciate steadily over time, and any determination of its foreign exchange value at any particular date will very soon lose touch with reality. Third, there is the danger in an adjustment for depreciation, and perhaps in other adjustments under Article IV, Section 8, that the rate of exchange employed for the purpose will be misunderstood as involving some economic judgment that it is the appropriate rate. No such judgment is called for, and all that the provision requires is a finding of fact, the contemporary foreign exchange value of the currency. The danger of misunderstanding should not be exaggerated, however, and the Fund often agrees that its holdings of a member’s currency shall be adjusted when the member takes the initiative in proposing adjustment.

The complexities involved in a determination that the foreign exchange value of a currency has depreciated have hitherto led the Fund to avoid automatic rules for the exercise of the power to call for the adjustment of its holdings. The Fund has understood the subjective element of opinion as authorizing it to take into account all the circumstances that it considers relevant in each case.14 Sometimes, therefore, the Fund may delay adjustment for a time after a depreciation becomes apparent. An appropriate interval is authorized, of course, by Article IV, Section 8, which refers to adjustment within “a reasonable time.” The practice in connection with depreciation is in contrast to the Fund’s practice of requiring the adjustment of its holdings of a currency immediately after a change in the par value of that currency. As to the timing of adjustments after a depreciation, it should be understood that in certain circumstances there may be no immediate need to adjust, at least for financial reasons. This point involves an understanding of certain refinements of Fund law and practice, and an explanation of them will be attempted later in connection with fluctuating rates of exchange.

If an adjustment is made because of a depreciation, the rate of exchange at which the Fund accounts for the currency after the adjustment (the “book rate”) is then substituted for the par value in the computations that are made for the purpose of applying the provisions of the Articles. The use of the book rate is not based on any express language in the Articles. On the contrary, the language of Article IV, Section 1(b)—“all computations … shall be on the basis of their par values”—appears to be categorical in requiring the use of the par value. It must be understood that neither a depreciation in the foreign exchange value of a currency nor the Fund’s adoption of a book rate based on it has the effect of abrogating the par value. Once a par value is established under the Articles, it continues to be the par value until a new one is established in accordance with the procedure of Article IV, Section 5. It has always been apparent, however, that the book rate must be substituted for the par value in all computations for the purposes of applying the Articles.

If the book rate were not used and it is assumed that the Fund could still sell the currency at the par value, the Fund would make a profit; but it has been seen that the purpose of Article IV, Section 8, is to prevent the Fund from making profits or sustaining losses as a result of changes in the value of its currency holdings. It is hardly conceivable, however, that when a currency has depreciated significantly in the market, any member will wish to purchase it from the Fund at the par value. Therefore, if the Fund is to be able to sell the currency at all and meet the requests of members for it, the Fund must be able to sell it at the book rate, and the book rate must approximate the exchange rate for the currency in the market. This suggests a refinement in formulating the objective of Article IV, Section 8. The provision is intended not only to maintain the gold value of the Fund’s currency holdings, and in this way to avoid profit or loss resulting from changes in the value of currencies, but also to enable the Fund to continue to conduct its operations.

Once the position is reached that the Fund can sell its holdings of a currency at the book rate, it follows that other computations for the purpose of applying the Articles must be at the same rate. If the Fund were to sell the currency of a member at the depreciated book rate but receive it in repurchase from other members at the par value, the Fund would sustain a loss. If the member itself were to repurchase the Fund’s adjusted holdings of the member’s currency at the par value, the Fund would make a profit. Moreover, if the par value were applied to the valuation of adjusted holdings, the member making the adjustment could have a repurchase obligation solely as the result of the adjustment. For example, assume that the member’s quota is $100 million and that the Fund’s holdings of 75 million units are equal to 75 per cent of quota. On these facts, the member is making no use of the Fund’s resources and therefore has no potential repurchase obligation. Suppose that the foreign exchange value of the currency then depreciates so that it is half of the par value. The member is now required to pay another 75 million units to the Fund. If the Fund’s holdings were computed to be equal to 150 per cent of quota on the basis of the par value, the member would be required, sooner or later, to repurchase the second 75 million units with gold or convertible currencies equivalent to $75 million. The examples can be multiplied, and it should be apparent that only the use of the book rate for all computations can avoid a chaotic series of windfall profits and losses to the Fund and members.

The basic rule is that a member is not required to pay its currency subscription to the Fund until it establishes an initial par value under the Articles,15 although nothing prevents it from paying at an agreed provisional rate before that date, and there may be other circumstances in which the currency is paid to the Fund.16 Under Article IV, Section 8, the Fund can call for the adjustment of its holdings of a member’s currency even though the member has not yet established an initial par value.

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