It was probably not a surprise that the International Monetary Fund’s most recent revision of the rules that guide its surveillance of members’ exchange rate policies reduces policy space for developing countries. The striking irony, though, is that the revised guidelines reduce the policy space needed for developing countries to successfully grow using a trade- and export-led model, precisely the type of growth that the Fund –and its sister institution, the Bank– has preached for over twenty years developing countries should pursue. Even more ironic, is that the preaching of an export-led model was widely attributed to the influence of the same Fund member (the US government) at whose behest these latest surveillance changes are being implemented.
Last June, after over one year of review, the Fund modified its main guidelines on the implementation of Article IV of its Articles of Agreement.[i] The guidelines, issued originally in 1977, regulated the Fund’s role in exercising surveillance over the exchange rate policies of member countries.
The first notable modification is the name of the new guiding document. The old document was on Bilateral Surveillance over Exchange Rate Policies (“1977 Decision”), while the new one is called Decision on Bilateral Surveillance over Member Policies (“2007 Decision”). This initial difference may provide a clue as to why the Group of 24, a group of developing country members in the IMF, reacted so strongly when plans for the new language of the decision were unveiled. In their Communique of last April, G24 Ministers expressed to be “especially concerned that expanding the principles for the guidance of members in the Decision would blur the distinction between surveillance over exchange rate policies and over domestic policies.” In that same communiqué they essentially demanded a continuation of the status quo.[ii]
What the new Decision does on trade-led development
Although the IMF Board communiqué about the changes starts by saying that the 2007 decision “Does not create new obligations for members,” the changes do go beyond a mere adjustment of the title and are far from inconsequential. This is especially so for a number of countries that had been able to establish the necessary exchange rate conditions for having a shot at harnessing trade for capital accumulation and development.
The new decision reiterates, “A member shall avoid manipulating exchange rates for the international monetary system in order to prevent effective balance of payments adjustment or to gain an unfair competitive advantage over other members.” [iii]
But to the hitherto existing principles that should guide the Fund’s assessment of what constitutes “manipulation” it has added one that reads: “A member should avoid exchange rate policies that result in external instability.”
The 1977 Decision also contained a list of developments that “would require thorough review and might indicate the need for discussion with a member.” To the 1977 list, the 2007 Decision adds “fundamental exchange rate misalignment”[iv] and “large and prolonged current account deficits or surpluses.”[v]
As a result, the intent driving an IMF member’s currency intervention (which was a central element under the old Decision) is relativized in the new document. For a member’s policies to become objectionable all that is needed is that they be detrimental to some loose notion of “external stability.” In fact, according to the Managing Director, Mr. Rodrigo Rato, the new guidelines have the intention of putting external instability at the center of the system of surveillance.
Official statements, such as those by the IMF Deputy Managing Director, Mr. Lipsky, hold that the decision had broad support, including by China and others. His account, however, contrasts sharply with statements by the Chinese IMF ED, who claims the guidelines were passed by “a minority of developed countries which have a lot of voting rights.” News reports mention at least two more nations that did not support the changes.
Indeed, the strong direction chosen by the new decision is seen as a result of the US pressure on the IMF to take action against China’s undervaluation of the yuan. The US is known to have been pressing for some time the Chinese government to revalue the yuan, which it blames for its growing trade deficit. The very positive welcome US Secretary of Treasury Hank Paulson gave to the new Decision tends to confirm this perception. Another hint at the US influence is provided by the Decision’s “coincidental” use of the expression “fundamental exchange rate misalignment” that closely repeats the language being used by a bill that is being considered in the US Congress and that would punish trading partners that incurred in such “misalignments.” The bill is widely seen as a response to rising resent against the US market penetration by imported goods from China.
The Decision certainly represents a step backward not only for China, but for a number of developing countries and, it is not a stretch to say, for any developing country trying to develop through exports.
In the last few years, and especially as a reaction to the collapse of 1997, several Asian developing countries have aimed at increasing their level of reserves so they would be insured against a speculative attack, and spared the need to resort to the IMF. Massive purchases of foreign currency by these countries had the result of favoring low real exchange rates, with the mutually reinforcing effects of enhancing their competitiveness and accumulating sizeable current account surpluses. As increased export revenues put pressure on their currencies to appreciate, further intervention in capital inflows and the exchange market to keep currencies at that same (low) level were pursued.
The same trend has been followed by some countries in Latin America, notably in Argentina. Since 2002, after the collapse of the 1-to-1 dollar-peso parity peg following the financial crisis, the continued maintenance of a competitive exchange rate for exports is one of the keys to the successful growth rates (between 8 and 9 percent) that the country has managed to maintain for four consecutive years now.[vi] Just like in Asia, capital controls to manage sudden inflows of capital have been one of the policy tools used to manage the exchange rate. It is worth noting that Argentina could not have maintained this regime had it not been able to make early repayment of its outstanding loans from the IMF, which was insisting on uncontrolled flotation of the exchange rate as a condition for renewing its loan agreement.
There is nothing wrong with the utilization of the exchange rate as an instrument to enhance trade performance of domestic producers. Such a use of the exchange rate is based on a solid assessment of historical experiences of developing countries that successfully developed through trade. In the view of some economists, all countries that have done this were able to “maintain exchange rates that are attractive to exporters over long periods of time.”[vii] On the other hand, the revaluation of exchange rates has frequently impacted negatively on competitiveness and growth prospects.[viii]
Moreover, as pointed out by UNCTAD, the exchange rate is an important policy instrument to provide domestic producers profit incentives to invest in non-traditional export sectors.[ix] Thus, a low real currency price can help not merely the volume of exports, but also diversify their composition. Some, like Rodrik, go as far as saying that “a credible, sustained real exchange rate depreciation may constitute the most effective industrial policy there is.”[x] Roberto Frenkel states that “central bank intervention in the exchange market should be oriented to signaling the long-run stability of a competitive real exchange rate in order to give proper incentives to tradable industries, reduce the uncertainty of investment and employment decisions, and prevent unsustainable balance of payments and debt trends.”[xi] In particular, Frenkel highlights the positive impacts on exports lead to higher levels of output and employment, positive externalities these export activities generate for other sectors, and higher labor intensity. The competitive real exchange rate level leads to higher job generation, not only in the tradable, but also in the non-tradable sector.[xii]
It should be underscored that the growth of export revenue inevitably leads to current account surpluses, which will put pressure on the exchange rate to appreciate. Then, by definition, the type of “sustained” and “stable” exchange rate required for the success of the export- based development strategy is going to require a degree of government exchange rate and monetary policy intervention. This is, as explained above, exactly the type of intervention that the IMF is trying to ban with its new Decision on Surveillance, with the identification of “large and prolonged current account surpluses” as a factor that should trigger pressure from the IMF to correct (in the case, revalue) the exchange rate.
What the new Decision fails to do on trade-led development
The Decision deserves to be criticized also on the basis of what it lacks. Just as a stable and competitive exchange rate helps countries improve trade performance, the short-term volatility of exchange rates is harmful to such performance, as it hinders any efforts to sustained and predictable investments in economic activities oriented to export. In fact, providing adequate signals in this area might account for much more improvements in supply-side capacities than all the Aid for Trade agenda together can muster (certainly more than it has mustered to date).
As it is well documented, the exchange rate misalignments among countries that issue hard currency are an underlying motivation for frequent episodes of exchange rate overshooting in developing countries. Overshooting that, in turn, is associated to pronounced cycles of over and undervaluation, boom and busts cycles that hurt even countries whose “fundamentals” are in the best of shapes. In this regard, the financial system presents a large asymmetry insofar as the monetary policies of countries issuing hard currency are the ones the Fund does not have the power to address. In the words of the aforementioned G24 Communique, “if the IMF has not been more effective in its surveillance . . . it is mainly because systemically important economies have not felt the need to follow the Fund’s policy advice.”[xiii]
As mentioned by several civil society organizations in a Statement to the WTO Working Group on Debt, Trade and Finance: “Since the fall of the par value Bretton Woods system in the 1970s, instability and misalignments of currency exchange rates have distorted real comparative advantages and the value of concessions on tariff and price-based trade liberalization measures agreed to in successive trade negotiations. The IMF, having lost its leverage over countries whose currencies are held as international reserves, has proved to be an inefficient instrument for exercising surveillance over the monetary policies of those countries.”[xiv]
This same idea is squarely reflected in the complaint by the Chinese Executive Director who, in criticizing the new Decision, mentioned that the IMF’s supervision of “reserve currency-issuing countries” had been inadequate and that “the issue of fairness is not addressed.” There is certainly no willingness in the IMF’s major shareholders to vest the IMF with prerogatives that may allow it to play an effective role as coordinator or “umpire” of the exchange rates for leading hard currency-issuers,[xv] even though some analysts say that would be desirable.[xvi]
Strengthening the IMF: So it can take on the weakest countries?
What magnifies this asymmetry is that the smaller and less diversified the economy of a developing country is, the higher the impact from misalignments among major currency issuers on its economy. It is precisely the absence of a response to such asymmetry in the current financial system what more compellingly justifies leaving ample room for developing countries to manage their exchange rates and capital flows at the national and regional level. But the Fund’s Decision represents a movement in exactly the opposite direction, creeping into the hitherto available space for developing countries’ monetary and exchange rate policy.
For instance, notions about the adequate amount of reserve accumulation (a usual consequence of maintaining low real exchange rates) may change dramatically in the face of the fact that countries know there is no effective safety net against a speculative attack. It may also represent a legitimate judgment about the convenience of having to resort to a formally existing safety net, as the Fund itself.
The Decision also raises a number of issues regarding the practical difficulties in interpreting the degree of discretion it accords to the IMF authorities, which is likely to expand significantly. A main difficulty is assessing what constitutes “manipulation.” Indeed, there is no general agreement, in the economics profession (let alone politically) on what constitutes a currency misalignment or, for that matter, to what extent a misalignment should be tolerated. The 1977 Decision’s emphasis on the existence of an intent to “gain an unfair competitive advantage” throughout all these years had left space open for developing countries to pursue some degree of intervention guided by development priorities. The interpretation of newly-added expressions such as “result[ing] external stability” or “currency misalignment”, as if they were objective situations whose existence anybody can easily determine, potentially leaves their judgment to the IMF. That the IMF is the same institution where the 2007 Decision was apparently approved “by a minority of developing countries with a lot of voting rights” is certainly not reassuring.
IMF credibility’s poor shape: the silver lining
The review of surveillance was a key part of the IMF Medium-Term Strategy that Mr. De Rato masterminded in an effort to reinvigorate the shattered credibility and relevance of the institution in the global economy. The IMF authorities, consistent with this, have gone to great lengths to explain that the 2007 Decision should not be read as a statement about China, and that it is “a triumph for multilateralism.” But it is hard to believe the credibility of the Fund as a multilateral institution will be anything but harmed by the outcome of the review. On the contrary, if there were any hopes of the IMF playing a credible role in overseeing multilateral exchange rate coordination it is all gone in the sheer face of the extreme similarity between the US government’s objectives and the outcome of the decision. Moreover, the blatant way the Decision disregarded the will expressed by the Ministers of the G24 confirms, once again, how little the voice of developing countries matters at the Fund.
The impact that this Decision will undoubtedly have on the credibility of the Fund leads, however, to what may be a silver lining. A stream of early repayments continues to flow into the International Monetary Fund (reportedly, the last large IMF borrower that is left, Turkey, is analyzing doing it soon). Absent the “power of the purse”, credibility and quality are all the IMF has left to get the attention of developing country governments, so the number of countries that actually have to pay attention to IMF surveillance will continue to decline. It is, however, a sad thing that developing countries have good reason to celebrate the irrelevance of an organization that should have been helping them overcome one of the greatest asymmetries they face in developing through trade.
 The Public Information Notice regarding the new Decision can be found at http://www.imf.org/external/np/sec/pn/2007/pn0769.htm
 G24 Communique, 2007, April 13 (“[The Ministers] remain doubtful that the revision of the 1977 Decision on Surveillance over Exchange Rate Policies is necessary to pursue the objective of more focused and effective surveillance.”)
 IMF, Bilateral Surveillance over Members’ Policies, June 15 2007 (2007 Decision), Part II, 14.D
 IMF 2007 Decision, Part II, 15.v
 IMF 2007 Decision, Part II, 15.vi
 Frenkel, Roberto 2007. Argentina’s Monetary and Exchange Rate Policies after the Convertibility Regime Collapse.
 Agosin and Tussie, 2003. Trade and Growth: New Dilemmas in Trade Policy.
 UNCTAD 2004, Trade and Development Report
 Rodrik, Dani 2004. Growth Strategies. Harvard University
 Frenkel, Roberto 2004. “Right” Prices for Interest and Exchange Rates, in Diversity in Development – Reconsidering the Washington Consensus, FONDAD
 Frenkel 2007
 G24 Communique, 2007
 Letter to the WTO Working Group on Debt, Trade and Finance, signed by 30 NGOs and Networks, 2003 (available at http://www.coc.org/index.fpl/1267/article/1923.html)
 For expansion on this statement, see Caliari, 2007 “The IMF’s Multilateral Consultations: Were the Skeptics Right ?”, available at http://www.coc.org/index.fpl/1267/article/10636.html
 E.g., Goldstein, M. “Exchange rates, fair play and the ‘grand bargain’”, in Financial Times, April 21 2006