In a move to strengthen the IMF’s ability to head off risks to the global economy, the institution’s 24-member Executive Board adopted on June 15 a landmark decision providing updated guidelines for monitoring the economic health of its 185 member countries (a process known as bilateral surveillance).
Managing Director Rodrigo de Rato, speaking in Montreal on June 18, said that the decision represented “the first-ever comprehensive policy statement on surveillance.” He called it “good news for the IMF reform program and good news for the cause of multilateralism.”
The adoption of the Decision on Bilateral Surveillance eliminates a significant gap in the IMF’s policy framework by providing an up-to-date and more comprehensive framework for the regular health checks of national economies, which complement the IMF’s oversight of the international monetary system (a process known as multilateral surveillance).
The landmark step was announced as the IMF moves swiftly on many fronts to better meet the demands of a more integrated world economy. It is also seeking to give dynamic economies (many of which are emerging markets) a bigger say in the running of the institution, reform its sources of income, sharpen the focus of its work on low-income countries, and reexamine its tools to support emerging markets.
Exchange rate policies
By crystallizing a shared vision of what surveillance is all about, the decision should ensure that the policy dialogue between the IMF and its member countries is more focused and effective. Changes are most notable in three areas.
• First, the decision affirms that bilateral surveillance should be focused on the IMF’s core mandate, namely promoting countries’ external stability. It should thus help prevent surveillance from being spread too thin.
• Second, it gives clear guidance to the IMF’s members on how they should run their exchange rate policies and on what is and is not acceptable to the international community. For the first time, the meaning of exchange rate manipulation is spelled out (see box).
• Third, by making clear what is expected of surveillance, the decision should promote candor as well as even-handed treatment of different countries.
Why new decision was needed
Until now, the main policy statement on IMF surveillance was the 1977 Decision on Surveillance over Exchange Rate Policies, which was crafted in the wake of the collapse of the Bretton Woods system of par values. At the time, uncertainty prevailed about the rules of the game—whether they related to the role of the IMF or to macroeconomic management without fixed exchange rates—and private capital flows played a more limited role in the global economy.
The expectation was that the decision would be revised with experience. In the event, while the practice of surveillance evolved, the decision itself remained virtually unchanged. As a result, a huge disconnect developed between the best practice of surveillance and the decision that purportedly supported it.
In addition, the principles included in the 1977 decision to provide guidance to member countries on the conduct of their exchange rate policies failed to address the developments that have most challenged the stability of the international monetary system over the past 30 years. Reflecting the key concerns of the period when they were drawn up, the principles focused on preventing exchange rate manipulation for balance of payments purposes, such as gaining an unfair competitive advantage, and on avoiding short-term exchange rate volatility.
By contrast, the most prevalent exchange rate-related problems since 1977 have been the maintenance of undervalued or overvalued exchange rate pegs for domestic reasons and, more recently, capital account vulnerabilities, often arising from domestic balance sheet imbalances.
Changes for IMF
Like the 1977 decision, the 2007 decision is designed to implement bilateral surveillance under Article IV of the IMF’s Articles of Agreement, under which members of the IMF commit to a code of conduct on exchange rate policies and domestic economic and financial policies. The IMF has a duty to monitor adherence to this code of conduct as a whole, but the 1977 decision covered only surveillance over exchange rate policies.
The new decision, by contrast, is much broader. It clarifies that the scope of bilateral surveillance covers all policies that can affect a country’s external stability—defined as a balance of payments position that does not, and is not likely to, give rise to disruptive exchange rate movements, and encompasses both the current and capital accounts.
The decision also clarifies how to implement surveillance in currency unions, given their specific institutional arrangements, with both union-level and individual members’ policies subject to the same scrutiny as the policies of all IMF members.
“The IMF must be prepared to deliver clear and sometimes difficult policy messages to members and to candidly inform the international community.”
The new decision also outlines the rules of the game for surveillance:
• Surveillance is a collaborative process, based on dialogue and persuasion.
• The effectiveness of this dialogue requires candor: the IMF must be prepared to deliver clear and sometimes difficult policy messages to members and to candidly inform the international community (as represented by the IMF’s membership).
• Surveillance must be evenhanded while also paying due regard to relevant country circumstances. In particular, surveillance should take into account the effects of recommended policy changes on the member government’s objectives besides external stability.
• Bilateral surveillance should be embedded in a multilateral perspective—that is, it should take into account spillovers from the global environment to a country and from a country’s policies to the stability of the international monetary system.
• Surveillance should take a medium-term view.
Changes for member countries
As for members, the new decision gives clearer guidance on how they should run their exchange rate policies. The decision retains the three existing principles, which relate to exchange rate manipulation and intervention in the foreign exchange markets.
But it adds a fourth principle: “A member should avoid exchange rate policies that result in external instability,” which focuses on the outcome of the policies at issue rather than their intent. And it elaborates on what is meant by exchange rate manipulation.
The decision also updates the indicators that may trigger a thorough review by the IMF and allow the institution to initiate discussions with a member about its observance of the principles. Most important, the indicators have been revised to reflect the greater importance of international capital flows.
They now include both policy developments (such as protracted large-scale intervention in one direction in the exchange market) and outcomes (such as fundamental exchange rate misalignment; large and prolonged current account deficits or surpluses; and large external sector vulnerabilities, including liquidity risks, arising from private capital flows).
What is Currency Manipulation?
The IMF’s Articles of Agreement state that member countries shall “avoid manipulating exchange rates… to prevent effective balance of payments adjustment or to gain an unfair competitive advantage over other members.”
But they provide little guidance on what constitutes such exchange rate manipulation. The 2007 Decision on Bilateral Surveillance fills that gap by clarifying the type of behavior that is at issue.
The decision provides that a member would be “acting inconsistently with Article IV, Section 1 (iii),” if the IMF determined it was both engaging in policies that are targeted at—and actually affect—the level of exchange rate, which could mean either causing the exchange rate to move or preventing it from moving; and doing so “for the purpose of securing fundamental exchange rate misalignment in the form of an undervalued exchange rate” in order “to increase net exports.”
Ask the Fund
The IMF has created a new mailbox on its website dedicated to debt-related issues in low-income countries, including debt sustainability and concessionality. The intent is to provide a platform to respond to policy and country-specific questions.
Creditors had urged the IMF to set up a “one-stop contact” where they could get answers to questions on such debt-related issues. Now creditors can ask the IMF questions directly through the following web pages—for debt sustainability: www.imf.org/dsa; for concessionality: www.imf.org/concessionality