Fluctuating Rates

International Monetary Fund
Published Date:
January 1971
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At one time during the decade of the fifties, it was feared that a number of countries with currencies that were important in international trade and payments might feel themselves forced to depart from the observance of their obligation under the Articles to ensure that exchange transactions within their territories were kept within the permitted margins of the par value. If a member departed from this obligation, it might allow the rates of exchange for its currency to fluctuate more or less freely, or it might allow fluctuation within margins wider than those permitted under the Articles. In either event, the rates of exchange might move up or down at more or less frequent intervals in response to the forces brought to bear on the currency.

If frequent changes in the exchange rate of a member’s currency do occur, it does not follow as a consequence in law that other members are prevented from purchasing that currency from the Fund. It is true that the member is failing to observe its obligations, but there is no reason why this failure should diminish the privileges of other members.21 In order that the Fund can sell the currency, a rate of exchange for the currency has to be determined. The most appropriate rate is the going market rate at the time of a transaction. There never was any legal difficulty if this rate represented a depreciation compared with the Fund’s book rate. It was obvious that an adjustment of the Fund’s holdings of the currency could be made under Article IV, Section 8(b)(ii), on the basis of the current market rate, and that this rate could then be used in transactions. This process could be repeated as often as depreciation in the rate and the frequency of transactions made it necessary. But the market rate at the time of a contemplated transaction might represent an appreciation compared with the book rate. Therefore, it was not possible to escape decision of the question whether the Fund can adjust its holdings on an appreciation so as to employ the resulting book rate in its transactions and computations.

The Fund has decided that it does have the legal authority to take this action. One important reason for this conclusion was the principle of effectiveness. Operations of the Fund would be seriously hampered or even become chaotic if the authority did not exist. Another reason was that a reading of subsections (b) and (c) of Section 8 as exhaustive and therefore precluding adjustment in the event of an appreciation would not be possible even in connection with changes of par values. For example, if a depreciation were to occur on the basis of which the Fund adjusted its holdings, and then a new par value were established which represented a devaluation compared with the last par value but an increase in the value of the currency compared with the intervening depreciation, there would be no express power under subsections (b) and (c) to return currency in order to adjust the Fund’s holdings on the basis of the new par value. Again, the view that no powers of adjustment existed outside subsections (b) and (c) would reduce subsection (a) to the character of a preamble and even to redundancy, although the structure of Section 8 does not suggest that intention.22

The Fund has held that subsection (a) must be regarded as a substantive provision and that its effect was not exhausted by the subsequent parts of Section 8. The Fund had not found it necessary to go beyond the decision that it was permitted by Section 8(a) to adjust its holdings on an appreciation. It has been sufficient to conclude that, whether or not the exercise of the authority was mandatory, the Fund does have the authority to adjust its holdings of a currency by a return of part of them on an appreciation.

This interpretation of Section 8(a) enabled the Fund to adopt an elaborate decision on transactions and computations involving fluctuating currencies.23 Rules were established for determining the rate of exchange between the U. S. dollar and the fluctuating currency in the main financial market of the country with the fluctuating currency on a day as close as possible to the effective date of a transaction or computation. For example, for a sale by the Fund of a fluctuating currency, the rate is taken on the last business day in the main financial center of the currency before the Fund gives instructions to transfer the currency. When a rate is chosen, in accordance with the rules of the decision, for any transaction or computation involving a fluctuating currency, the Fund applies that rate to all its holdings of the currency. On the basis of this calculation, the Fund establishes an account receivable if there has been a depreciation in comparison with the former book rate, with the result that the member having the fluctuating currency must pay more of its currency to the Fund. If there has been an appreciation in comparison with the former book rate, the Fund establishes an account payable, in accordance with which the Fund will return currency to the member. Therefore, the account receivable or payable represents the difference between the amount of currency the Fund is actually holding and the amount that it should hold on the basis of the new book rate. In making calculations involving the fluctuating currency, the Fund regards its holdings of the currency as the actual holdings plus or minus the balance in the account receivable or payable and, of course, values these holdings at the current book rate. Provision is made for settlement of the account receivable or payable on the initiative of the Fund or the member, and in any event on certain specified dates.

The decision states that its rules do not constitute a formula for dealing with the currencies of members in which current transactions are conducted at multiple rates of exchange. This statement does not mean that the Fund cannot adjust its holdings of such a currency from time to time under Article IV, Section 8. The decision is itself an application of Article IV, Section 8, but the caveat was adopted partly because of the greater difficulties of determining the appropriate foreign exchange value where there are multiple rates of exchange and partly because of the fact that a currency of this kind is less likely to be in demand from the Fund.

A second qualification is stated in the decision. It is said that the Fund does not intend to apply the decision to the Fund’s “holdings of members’ currencies having fluctuating rates when there is no practical interest for the Fund or members to do so.” This qualification recognizes the fact that in some circumstances it may not be of immediate practical importance for the Fund to require the adjustment of its holdings of a currency when there is a depreciation or an appreciation of the currency, whether or not the foreign exchange value of the currency fluctuates.

If no movements occur in the Fund’s holdings of a member’s currency, there is no immediate practical need to adjust them. The financial relationship between the Fund and the member will be calculated in terms of gold on the basis of the Fund’s current book rate. Therefore, if all other facts are unchanged, the relationship will be the same whether or not an adjustment is made. The technique of accounting in terms of gold value based on the Fund’s current book rate means that the Fund’s balance sheet will show no reduction in the gold value of the Fund’s assets whether or not adjustments take place to reflect changes in the foreign exchange value of the Fund’s holdings. Moreover, this conclusion remains valid even if a member with a currency that has depreciated or appreciated wishes to purchase the currencies of other members from the Fund. It is true that if it makes the purchase, it will have to transfer an equivalent amount of its own currency to the Fund and that if the current market rate has depreciated below the book rate, the member will pay fewer units of its currency to the Fund than it would be required to pay if adjustment of the Fund’s holdings preceded the purchase. In terms of gold value, however, the relationship between the Fund and the member will be the same before adjustment as it will be when adjustment is finally made.

In some circumstances there will be a more pressing need to adjust the Fund’s holdings of a currency. The first and most obvious of these is when the currency is one that members will wish to purchase from the Fund in accordance with the Fund’s policy on the currencies appropriate for use in its transactions. It has been explained already that if the Fund’s rate for these transactions departs significantly from the market rate, either the Fund will be unable to sell the currency or the Fund will be selling it at a rate that does not contribute to orderly exchange arrangements. Second, it will be important to adjust the Fund’s holdings of a currency promptly when the currency enters into the calculations of monetary reserves under the Articles on which the accrual of repurchase obligations depends.24 The higher the monetary reserves, the larger the repurchase obligation that may accrue. If the currency is convertible and held by other members, their holdings of it will be included in the Fund’s calculation of their monetary reserves, and the calculation will be affected by the rate at which the currency is valued. If currency X has depreciated below the book rate, the absence of an adjustment of the Fund’s holdings of currency X to reflect the depreciation would mean that the Fund’s calculation would show larger monetary reserves for members holding currency X. This result would follow from the use of a book rate which showed a higher value for X’s currency than the market rate. Distortions of an opposite character could be demonstrated for the calculations of monetary reserves when the market rate appreciates above the book rate.

If a currency is convertible, it may be of practical importance to adjust the Fund’s holdings of it for another reason. Provided that the Fund’s holdings of it are not above the level of 75 per cent of quota, a convertible currency may be used by other members in repurchase of their own currency from the Fund. If the Fund were to value the convertible currency at a book rate that represented a higher value than the market rate, members using the currency in repurchase would get a windfall advantage in the sense that they could use less of it in order to repurchase their own currency from the Fund than would have been required if the Fund had adjusted its holdings of the convertible currency. If it were assumed that the convertible currency had appreciated, members would not use it willingly in repurchase, because this use would involve them in a loss. It would follow that, to the extent that members refrained from using this currency in repurchase, the Fund’s holdings of it would not be restored.

It is possible to draw the broad conclusion from the foregoing discussion that, generally speaking, there will be a more pressing need to make an immediate adjustment of the Fund’s holdings of a currency when it depreciates or appreciates significantly if the currency (1) is in demand by other members, or (2) is held in the monetary reserves of other members, or (3) is convertible and can be used in repurchase. This is a broad generalization, and there might well be other circumstances making prompt adjustment advisable.25

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