Global imbalances, tanking dollar, and the IMF's surveillance over exchange rate policies.

• Author: Pattanaik, Sitikantha
• Position: Company overview

The exchange rate policies of the member countries of the International Monetary Fund could come under more intrusive scrutiny because of the June 15, 2007, decision of the IMF Executive Board on bilateral surveillance. This article highlights why the IMF decision cannot help in addressing the problem of global imbalances, even if it succeeds in delivering further appreciation of the exchange rates of surplus countries against the U.S. dollar. Moreover, there could be enormous challenges for effective implementation of the decision, which may further erode the credibility of the IMF. Even though disorderly correction of global imbalances remains a concern for every country, shifting the burden of adjustment entirely to surplus countries could have potentially damaging implications for international cooperation on global economic challenges. Past experiences of international cooperation to deal with global imbalances and currency misalignments suggest that countries rarely sacrifice their domestic economic priorities. Without appropriate macroeconomic adjustment measures, neither the high and growing U.S. current account deficit nor the savings glut of several surplus countries can be corrected solely by removing exchange rate misalignments.

The IMF's New Surveillance Decision

The IMF's new decision on bilateral surveillance over its members' exchange rate policies replaced the 30-year-old decision that was adopted in 1977 (De Rato 2007). The new decision clearly anchors the focus of bilateral surveillance of the IMF under Article IV to the goal of external stability, explains the concept of exchange rate manipulation with more clarity, and outlines the contours of the surveillance process, including the fundamental factors that could be taken into account for assessing the appropriateness of the exchange rate levels (IMF 2007). "External stability," for this purpose, would refer to balance of payments positions that are not likely to give rise to disruptive exchange rate movements. Manipulation of the exchange rate would cover actions aimed at influencing the level of the exchange rate--either to cause the exchange rate to move or to prevent the rate from moving--that could prevent effective balance of payments adjustments or lead to unfair competitive advantage for a country. The actual surveillance process for a member country under the Article IV discussions would become more intrusive, focusing on factors such as the direction and magnitude of exchange market interventions, restrictions or incentives used for influencing current account or capital account flows, monetary and financial policies used for encouraging or discouraging capital flows, external vulnerabilities, current account surpluses, government and quasi-government foreign liabilities and assets, and even the very ambiguous concept of fundamental exchange rate misalignment.

The new decision comes in the face of several important developments in the world economy. On the one hand, increasingly unsustainable global imbalances and the falling dollar suggest clearly the need for a multilateral cooperative approach to correct exchange rate misalignments, given the growing interdependence of nations under the force of globalization. On the other hand, the disappearance of borrowers from the IMF and the waning credibility of the IMF among the emerging market economies have made IMF policy advice under Article IV bilateral surveillance a mere routine zero-value exercise. Every country wants to retain absolute freedom on the choice of its exchange rate regime, and any amount of external influence or persuasion or pressure can only be responded to with stiff resistance. The atmosphere for international cooperation has also been vitiated by the general perception that it is the U.S. unilateralism that guides multilateral institutions like the IMF on issues like global imbalances and exchange rate misalignment, as is evident from one of the recent bills introduced in the U.S. Senate.

On June 13, 2007, a bill was introduced in the Senate ("The Currency Exchange Rate Oversight Reform Act of 2007"), which proposes to identify and punish countries that may be found by the U.S. Treasury to be maintaining exchange rates that are "fundamentally misaligned." The legislation requires Treasury's biannual report to identify two categories of currencies: a general category of "fundamentally misaligned currencies" based on observed objective criteria, and a select category of "fundamentally misaligned currencies for priority action" that reflects misaligned currencies caused by clear policy actions of the concerned governments. While the Treasury must engage in consultations with all countries cited in the report, as regards the "priority" currencies, the Treasury would seek advice from the IMF as well as key trading partners.

For priority currencies, if consultations fail to result in the adoption of appropriate policies to eliminate the misalignment, immediate action could involve opposition to IMF governance changes that may benefit a country whose currency is designated for priority action. After 180 days of failure to adopt appropriate policies, the Treasury could request the IMF to engage the designated country in special consultations over its misaligned currency, use anti-dumping measures for products produced or manufactured in the designated country, prohibit federal procurement of goods and services from the designated country unless that country is a member of the World Trade Organization's Government Procurement Agreement, forbid Overseas Private Investment Corporation from financing or insuring projects in the designated country, and oppose new multilateral bank financing for projects in the designated country. If the misalignment is not corrected even after 360 days, the legislation would require the U.S. Trade Representative to request dispute settlement consultations in the WTO with the government responsible for the currency manipulation. IMF intervention, thus, is a key instrument proposed in the bill for correcting misalignment, and the Treasury will use its voice and vote at the IMF to that end.

Who Wants the IMF's Bilateral Surveillance?

IMF Article IV discussions with the policy authorities of member countries on issues concerning exchange rates have mostly reflected the mere exchange of ideas, with no compulsive obligation on the members to pay any heed to the recommendations of the Article IV reports on exchange rates. It is a general presumption that each country should be free to choose its own exchange rate regime and that no country would stick to a regime if it realizes that an alternative could be more beneficial. External influence without any accountability has to be deflected by listening to the advice with a deaf ear.

The IMF's emphasis on publication of the Article IV reports in the name of enhancing transparency has also led to a situation under which the IMF, instead of offering confidential advice to members on sensitive issues like the exchange rate regime, would make its assessment public. It is as if the Fund's Article IV process is a "fault finding mission" and, by highlighting weaknesses in policies openly in the public domain, the IMF is in the race of gaining some market credibility. In some sense, therefore, it is like a "credibility gaining exercise" for the IMF. What the market feels about it is more important to it than the member country authorities' need for quality unbiased confidential advice from it.

From the standpoint of the IMF, the perception, however, could be completely different. As underscored by Aylward (2007:2), under Article IV discussions,

IMF staff are expected to provide an accurate description of the country's exchange rate regime (whether the currency is floating, pegged, or fixed), a candid appraisal of the regime's appropriateness and consistency with underlying policies, and a forthright assessment of the exchange rate level (the currency's value compared to other currencies) through the systematic use of a broad range of indicators and analytical tools to evaluate external competitiveness. IMF staff are also expected to assess policy spillovers ... operating through exchange rate policies.... In performing this task, IMF staff face longstanding challenges, reflecting a combination of technical uncertainties and political sensitivities.... [E]xchange rate policy can be politically controversial as well as market-sensitive. This can constrain the depth and candor of the dialogue between the IMF and its members. It can also affect the reporting in documents that are subsequently published. To mitigate this risk and preserve the IMF's ability to serve as a trusted advisor to its members, its transparency policy includes safeguards to maintain the appropriate balance between transparency and confidentiality. This policy allows for deletions of highly market-sensitive material in country reports before they are made public. Published Article IV reports, thus, are at best negotiated documents, and in that sense they are no different from the plethora of country reports that are being manufactured every year by different private and public agencies. Even if the bilateral surveillance over exchange rate related issues from now on becomes more rigorous and intrusive for every member country as per the June 15 decision, the end result is not going to be very different from what has been happening so far. The IMF is attempting to assume a new role in a very complex area at a time when its credibility among a majority of its members may not be as high as it may possibly be assuming.

The most difficult challenge to the IMF in implementing the June 15 decision would be the internal analytical differences that may be persisting within the IMF on exchange rate related issues. As noted by Aylward (2007: 3), in the past few years "the IMF has on average issued over 30 working papers a year on...