THE FINANCIAL STRUCTURE of the Fund is based upon the quotas of its member countries. The quota—a sum of money expressed in U.S. dollars and related to the economic circumstances of the member—is thus of vital importance both to the member and to the Fund itself. Yet although Schedule A of the Fund Agreement specifies the quota of each country participating in the Bretton Woods Conference, there is no detailed information in the Proceedings of the Conference as to how the quotas were established. The draft outlines of the proposals, made by the British and U.S. Governments and by Canadian experts, however, indicate that it was intended from an early stage to determine each member’s quota by some agreed formula. The British proposal provided for quotas established by reference to a three-year average for exports and imports; other proposals provided that national income, gold and foreign exchange, and fluctuations in the balance of international payments should also be taken into account. The formula eventually used was suggested by the Division of Monetary Research of the U.S. Treasury Department and comprised
Mr. Kroc, who is a graduate of the Graduate School of Commerce in Prague, is Assistant Treasurer for Operations. He joined the Fund in 1947 and was previously with the National Bank of Czechoslovakia.
- (a) 2 per cent of national income;
- (b) 5 per cent of gold and dollar balances;
- (c) 10 per cent of average imports;
- (d) 10 per cent of maximum variation in exports;
- (e) the sum of (a), (b), (c), and (d) increased by the percentage ratio of average exports to national income.
Data for calculations under this formula were assembled and at Bretton Woods discussions were held among technicians and individual delegations with the aim of checking and correcting them. These discussions were not recorded; the results emerged as one final figure.
It was this formula (not altogether clear as to origin) that—with the insertion of the year 1940 in (a), 1934-38 in (c), (d), and (e), and the date July 1, 1943 in (b)—became known as the Bretton Woods formula and that figured until 1963 in the establishment of quotas of new members. It had obvious shortcomings, but it also had sufficient practical merit to continue for many years at least as a basis in discussions between the Fund and a prospective member about that member’s possible quota—even if the result arrived at often differed from a result based upon that formula exclusively. The calculations on occasion produced several results when statistics for the base year were not available and estimates had to be used, or when there was no fixed exchange rate and various rates were applied, or when the territory of the prospective member had undergone changes from the time for which statistics were available. In order to overcome some of these difficulties, quota calculations have been made more recently with the latest available data. Other calculations have been based on experimental versions of the Bretton Woods formula reweighted to give greater importance to trade and the variability of trade. In the next periodic review of quotas, there will be an opportunity for these calculations to be further examined.
At the Inaugural Meeting in 1946 applications for membership had already been received from some countries that had not participated in the Bretton Woods Conference, but the applicant countries were treated as if they had been original members, that is, countries named in Schedule A of the Fund Agreement, and their quotas were calculated on the same basis and agreed with the respective governments. As was to be expected from the views expressed at Bretton Woods, the quotas of several members were increased at their request in the first two years of the Fund. There followed almost ten years in which there were no requests for quota increases. During this time the quota of one member was decreased at its request; this is the only instance in the Fund’s history of a decrease in a quota, and even this quota was restored, again at the member’s request, a few years later.
The quotas of members such as the United Kingdom, France, and the Netherlands remained unchanged when territories in respect of which they had accepted membership—such as Indonesia—became separated. There was also a general quota increase of 50 per cent in 1959, with some special increases beyond 50 per cent, and further quota increases began in 1963, after the adoption of the decision on compensatory financing. On March 1, 1947 the Fund had 40 members with quotas of $7.5 billion; now it has 102 members with quotas of $15.5 billion.
The history of quotas is worth tracing, because it is to quotas that the student of the Fund’s structure and operations must constantly refer. The quota represents the member’s financial participation in the Fund, i.e., its subscription. It also determines in broad outline the voting strength of a member and its drawing rights. Moreover, when a member has drawn from the Fund, it is not required to repurchase its currency from the Fund to the extent that this step would reduce its reserves below the quota. In addition, although the charges imposed by the Fund are normally payable in gold, this requirement is modified if the member’s reserves are less than half its quota.
Quotas and Subscriptions
The Fund Agreement provides that in paying its subscription a member shall pay (a) in gold, as a minimum, either 25 per cent of its quota or 10 per cent of its net official holdings of gold and U.S. dollars, whichever of these two sums is the smaller, and (b) the balance of its quota in its own currency. The basic idea has been that countries with sufficient foreign exchange reserves should pay in gold an amount equal to 25 per cent of their quota, but that countries with low reserves should pay less, namely, 10 per cent of their net official holdings. Until 1958 the prospective member’s ability to pay gold was appraised on the basis of its holdings of gold and U.S. dollars, but after convertibility had been accepted by many more members the holdings of all convertible currencies were taken into account.
The Fund gold depositories at which members may pay gold to the Fund are the Federal Reserve Bank of New York, the Bank of England, the Bank of France, and the Reserve Bank of India. Under Fund practice the gold must be in the form of bars having a fineness of 0.995 or higher and weighing 400 ounces; gold coin is not acceptable. If bars of lower fineness or weight are delivered the member has to pay in gold an amount, estimated by the Fund, to cover the conversion of such gold into bars of the required weight and fineness. All gold must be received by the Fund free of charge.
The currency part of the subscription is normally payable when the par value of a member’s currency has been agreed with the Fund. In fact, the Fund does not accept a member’s currency before a par value has been agreed, and when members have attempted to pay before that time the Fund has had to ask them to cancel the entry. An exception has recently been provided by permitting exchange transactions with members before they have agreed a par value. In this case, one of the conditions would be the payment of the currency part of the subscription at a provisional rate of exchange, that is to say an agreed accounting rate.
Countries that have a central bank designate that bank as a depository for all the Fund’s holdings of the member’s currency. Where there is no central bank, the Fund and the member agree on a depository at which the Fund’s accounts will be maintained. All payments relating to the Fund’s transactions, namely, subscription, purchases, repurchases, and the payment of charges in currency, are reflected in a “No. 1 Account.” There is also a “No. 2 Account,” which is usually credited with the equivalent of about $l,000 for minor expenses. When the balance of this account becomes too low, the Fund replenishes it by a transfer from the No. 1 Account. The member has the right to substitute nonnegotiable, noninterest-bearing notes or similar obligations for any part of the member’s currency in the No. 1 Account. Under the rules now in existence an amount equal to at least 1 per cent of quota must be maintained in the No. 1 Account. It is left to the member’s discretion what amount it chooses to substitute within the aforementioned limitation, whether it desires to issue one note or more, and when it considers such substitution desirable.
The Fund’s computations in its transactions are based on the par value, expressed in terms of gold and U.S. dollars, of each currency, agreed between the Fund and the member. If the par value becomes ineffective an accounting value may be determined for that currency, and this value then governs the Fund’s computations involving the currency. If there is a depreciation, the member will have to replenish the Fund’s holdings of its currency, so that the gold value will be maintained, while if the par value of the currency appreciates the Fund returns to the member a commensurate part of the currency.
The gold and currencies paid into the Fund’s accounts are in its ownership and these assets are used in accordance with the Fund Agreement. On several occasions the Fund has sold gold to its members: in 1957, $600 million to replenish its holdings of U.S. dollars; in 1961, $500 million to replenish its holdings of U.S. dollars and eight other currencies; in 1964, $250 million to replenish its holdings of ten currencies; and a total of $800 million in 1956, 1959, and 1960 in order to acquire income-earning U.S. Government securities. Under the terms of these latter transactions, the same quantity of gold will be reacquired by the Fund upon termination of the investment.
Use of the Fund’s Resources and Charges
When a country incurs a balance of payments deficit the normal course is for it to use its reserves to bridge the gap before remedial measures can take effect. If the reserves are not adequate for this purpose, or if other reasons, such as legal provisions or considerations of distribution or yield, make it impossible or inopportune to use them, a country in this position would probably attempt to supplement its reserves by short-term external borrowing or credit.
Before the establishment of the Fund such credit facilities were provided by foreign banks —in many instances central banks—to countries in difficulties, mostly in the form of short-term accommodation with or without the pledge of gold, frequently in the form of revolving credits. At the time when most currencies were convertible, one possibility was the acquisition of foreign exchange against payment in the currency of the country having the temporary deficiency. Two central banks would arrange that the one in need of foreign exchange would purchase it directly from the central bank issuing the currency and pay for it by crediting the account of that central bank in its own currency. Another form of financing was the sale of bills of exchange in local currency by the central bank, with a commitment to repurchase them at the same exchange rate after a short period, usually three months. Whatever the arrangement, the creditworthiness of the debtor was, of course, a most important consideration, governing the rate of interest, rate of exchange, duration of credit, amount made available, commission charged, and collateral, if any.
The Fund added to the existing facilities and members were afforded a wider choice. Broadly speaking the prerequisites for a transaction with the Fund are institutionalized and are generally known to the member. For example, the member must have paid its subscription, and for this purpose it must have agreed either a par value of its currency or an accounting rate. Further conditions might be imposed by the Fund if the member requested a waiver of the limitations specified in the Articles of Agreement, for example, that the drawing will not cause the Fund’s holdings of the member’s currency to increase by more than 25 per cent of its quota in any 12-month period or to exceed 200 per cent of its quota. Even when a waiver is given there is a large measure of uniformity in the Fund’s practice, assuring members in similar circumstances of similar treatment. For instance, the Fund has announced that in approving a drawing for compensatory financing of export shortfalls, it is prepared, where appropriate, to waive the limit on Fund holdings of 200 per cent of quota.
Technically the Fund’s facilities constitute a combination of the basic features of some of the transactions mentioned earlier which were undertaken when a country had to secure from abroad the necessary means for payments. In drawing on the Fund a member purchases the currency of another member from the Fund in exchange for its own currency. Such transactions are not credits or borrowings in the legal sense, but they may for economic purposes be regarded as equivalent to borrowings. Again, the Fund’s resources are made available to a member for a limited period of time, so that there must be repayment, which usually takes the form of a repurchase of the Fund’s holdings of the member’s currency. The reversal of the transaction in this form requires that the member pay the Fund in gold or foreign exchange acceptable to the Fund, in order to reduce the amount of its currency held by the Fund.
When a member purchases the currency of another member from the Fund the Fund will instruct the depository, that is, the central bank where the Fund account in that currency is maintained, to debit that account and to credit the account designated by the purchasing member. For instance, if a member purchases U.S. dollars the Fund will instruct the Federal Reserve Bank of New York to debit the Fund’s account and to credit the account which the purchasing member has designated, in most instances the account of its central bank maintained with the Federal Reserve Bank of New York. In turn the purchasing member will arrange that the Fund’s account maintained on the books of its central bank is credited simultaneously in its own currency with the equivalent of the currency purchased.
It is one of the purposes of the Fund to give confidence to members by making its resources available to them under adequate safeguards in order to provide them with the opportunity to correct balance of payment deficits. Members have in practice had recourse to the Fund’s resources in a wide variety of circumstances, generally arising from maladjustments in the balance of payments on current account. The Fund’s resources may not, however, be used for purposes of relief or reconstruction or to deal with international indebtedness arising out of World War II.
Members are, of course, aware that it is the Fund’s policy that a purchase of another member’s currency should not remain outstanding beyond a period reasonably related to the payments problem in respect of which the purchase was made. The period involved should not normally exceed three to five years. For the purpose of relating the magnitude of its assistance to the member’s payments problems the Fund has evolved the guiding principle that the greater the assistance in relation to the member’s quota the greater is the degree of assurance required that the member’s policies will promote balance of payments equilibrium and that the member will be in a position to repurchase within the three to five year period.
We may consider next the degree of advance assurance that a member has that a drawing may be made. The Fund has announced that members will be given the overwhelming benefit of any doubt (to quote a phrase that has become customary) when the amount requested falls within the gold tranche—that is, one that would not raise the Fund’s holdings of the drawer’s currency above the member’s quota. (This amount is called the gold tranche because initially the difference between the amount of the Fund’s holdings of the member’s currency below the total of the quota and the amount of the quota corresponds to the portion of the subscription that has been paid in gold.) For amounts in the first credit tranche, i.e., transactions which bring the Fund’s holdings of the member’s currency above 100 per cent of its quota but not above 125 per cent, the Fund’s attitude will be liberal, provided that the member itself is making reasonable efforts to solve its problems. Requests for transactions beyond 125 per cent of quota are expected to be accompanied by substantial justification.
In addition to the currency and the amount desired and the agency to which it is to be credited, the request must also state that the currency is needed for making, in that currency, payments which are consistent with the provisions of the Fund Agreement. Requests customarily also state that the Fund’s service charge on the transaction will be paid (and indicate where payment will be made), and that the Fund’s account in the member’s currency will be credited with the counterpart of the currency purchased. Furthermore, the member is expected, and in some instances required, to state that it will comply with the principles governing the use of the Fund’s resources as enunciated by the Fund in February 1952, that require repurchase within three to five years after a drawing.
Until 1958 the currency requested was almost exclusively the U.S. dollar, but since that time there has been a movement away from dollars and into other currencies. This has been because the currencies of the other major trading countries have in the meantime become fully convertible. Before a request is made for financial assistance, the Fund staff customarily discusses with the member what currencies will be drawn. A decision was adopted by the Executive Board in July 1962 under which members consult with the Fund on the currencies to be drawn. The currencies recommended in the course of such discussions have generally been those of countries in a strong balance of payments and reserves position.
Drawings within the gold tranche (i.e., those that do not raise the Fund’s holdings of the currency of the drawing country above its quota) are available on a virtually automatic basis. Normally Fund action on a member’s request takes place on the third business day after it has been received, and if the drawing is approved the requesting member’s account is credited on the fifth business day. For purchases within the gold tranche, however, the procedure has recently been accelerated so that the transaction is completed as early as the second day.
In addition to the facility of an immediate drawing in accordance with the provisions of the Fund Agreement a member may enter into a stand-by arrangement with the Fund, by which the Fund gives the member assurance that a specified volume of foreign exchange will be available for a fixed period of time.1
When a member uses the resources of the Fund it becomes subject to certain charges which are levied by the Fund. The charges are uniform for all members. Charges provide the Fund with income; moreover, the charge discussed in paragraph 3 below serves as a deterrent to excessive use of the Fund’s resources.
1. A service charge is payable on all purchases of currency from the Fund at the time a drawing is made. Since 1951 this charge has been ½ of 1 per cent of the amount drawn. In view of the fact that, with a few minor exceptions, Fund transactions take place at the par values of the currencies involved, the effective rate at which a purchase of exchange is made from the Fund can be determined by adding ½ of 1 per cent to the par value of the currency purchased. For instance, at the par value of $2.80, sterling would be purchased from the Fund at $2,814 a pound.
2. When a member enters into a stand-by arrangement with the Fund, a stand-by charge is payable equal to ¼ of 1 per cent per annum of the amount which can be drawn under the stand-by arrangement. This charge may be compared to the commitment fee charged by banks when they grant a line of credit. In view of the Fund’s policies concerning drawings within the gold tranche, no stand-by charge is payable in respect of the part of the stand-by arrangement which allows the member to draw amounts within its gold tranche. When a member makes a purchase under a stand-by arrangement, the stand-by charge paid in respect of the amount drawn is repaid by the Fund. Thus, if a member draws one half of the amount of its stand-by arrangement, and if no part of the stand-by arrangement falls into the gold tranche, the Fund repays to the member one half of the stand-by charge paid. As explained in paragraph 1 above, a service charge of ½ of 1 per cent is payable on all purchases from the Fund, including those effected under stand-by arrangements.
3. A charge is also payable on the amount of the Fund’s holdings of a member’s currency which exceeds the level of the member’s quota. Unlike the service charge, discussed in paragraph 1 above, the charges levied on Fund holdings in excess of quota involve a time element. The applicable rate of this charge is determined on the basis of two factors: the amount by which the Fund’s holdings of a member’s currency exceed 100 per cent of the member’s quota and the period during which these holdings remain above that level.
Holdings in excess of quota are free of charge for the first 3 months; thereafter holdings up to 50 per cent above quota are subject to a charge of 2 per cent per annum for the next 15 months, holdings of more than 50 per cent and less than 100 per cent in excess of quota are subject to the 2 per cent per annum rate for 9 months, and holdings of more than 100 per cent above quota carry the 2 per cent per annum rate for 3 months. After these periods the rate rises by ½ of 1 per cent each 6 months.
When the charges payable on any part of the Fund’s holdings of a member’s currency reach the rate of 4 per cent per annum, the Fund and the member concerned are required to consider means by which the Fund’s holdings of that member’s currency can be reduced. When the Fund and the member reach agreement for the repurchase of the member’s currency within three to five years after the member’s drawing, the charges progress to 5 per cent per annum, at which point the progression of the charge ceases for all parts of the Fund’s holdings of that currency. Where the agreement reached provides for repurchase beyond five years, the Fund may adopt a maximum rate in excess of 5 per cent per annum. Where the Fund and the member do not reach any agreement for repurchase, or where an agreement has been reached but is not observed by the member, the charges continue to rise beyond 5 per cent per annum by ½ of 1 per cent per annum each six months subject to review by the Fund when the rate reaches 6 per cent.
As a consequence of the Fund’s system of assessing charges as described above, there is a large spread between the rate at which charges are levied by the Fund and the average effective rate. When the rate of charge has reached 5 per cent per annum on holdings up to 50 per cent above quota, which would be in the period four to four and a half years after a drawing in the first credit tranche, the average effective rate amounts to 3.17 per cent per annum. This figure is derived from the total charges payable by the member including the service charge, expressed as a percentage and divided by the number of years of the period.
In computing charges, the Fund treats repurchases as canceling the portions of the Fund’s holdings of the member’s currency that it has most recently received (i.e., those resulting from the member’s most recent drawing). Thus the Fund applies the “last in, first out” principle. If it did not do this, the member could in effect obtain very cheaply a continuously revolving drawing from the Fund. The effect of this procedure is that charges on the portions of a member’s currency that the Fund has held longest continue to rise in accordance with the scale of charges, even though for the purpose of repurchases to which the “first in, first out” principle applies, those holdings are considered to have been repurchased. Not until the Fund’s holdings of a currency are reduced to the equivalent of the member’s quota for at least one calendar month is the progression of charges broken. Once that has been done, any subsequent increase in the Fund’s holdings attracts charges at the lowest end of the scale once more.
The Fund’s charges are payable in gold.
The requirements about the quality of gold bars acceptable, mentioned earlier for gold subscription payments, do not apply to the payment of charges. If a member’s monetary reserves, as defined in the Fund Agreement, are below one half of its quota, the charges due by that member may be paid partly or wholly in the member’s currency. It is left to the member’s discretion whether or not it wishes to avail itself of this facility. The stand-by charge may also be paid in U.S. dollars.
The charges on balances in excess of quota are the Fund’s main source of income, which, in the last financial year, amounted to $31.5 million. Total income has exceeded expenditure since 1957 and the surplus has been transferred to the General Reserve, which at the end of December 1964 exceeded $136 million.
An article on stand-by arrangements appeared in the last issue of Finance and Development (Vol. 1, No. 3).