Transcript of a Conference Call: Strengthening Framework for Exchange Rate Surveillance

November 30, 2006

Wednesday, November 29, 2006
Washington, D.C.

Conference call with:
Jonathan Ostry, Deputy Director, Research Department
Gian Maria Milesi-Ferretti, Division Chief, Research Department
Carlo Cottarelli, Deputy Director, Policy Development and Review Department
Hervé Ferhani, Deputy Director, Monetary and Capital Markets Department
Christian Mulder, Deputy Division Chief, Monetary and Capital Markets Department

MS. LOTZE: Thank you very much. Good morning, and welcome to this conference call on strengthening exchange rate surveillance. I am Conny Lotze of the External Relations Department (, and with me here are experts from three Fund departments involved in this issue. They are Jonathan Ostry, Deputy Director, and Gian Maria Milesi-Ferretti, Division Chief, both of the Research Department; Carlo Cottarelli, Deputy Director of the Policy Development and Review Department; Hervé Ferhani, Deputy Director, and Christian Mulder, Deputy Division Chief, both of the Monetary and Capital Markets Department.

This conference call will be on the record. As you have seen, we are today releasing a paper on the methodology employed by the Fund's Consultative Group in Exchange Rate Issues. This group will be referred to in the conference call as CGER. We want to take this opportunity to draw your attention to the work that the Fund has been undertaking on exchange rate surveillance.

As part of the Medium-Term Strategy, the Fund is strengthening its core responsibility of surveillance, including on exchange rates, and we have a collection of papers and reports which we mentioned in the press release. If you have any questions on those documents, please do not hesitate to ask.

I will now turn the floor over to Mr. Ostry of the Research Department for some introductory remarks, and then we will take your questions. Mr. Ostry?

MR. OSTRY: Thank you, and good morning. Thank you for participating in this conference call on the IMF's strengthened framework for exchange rate surveillance. I will say a few words about the just released CGER-Consultative Group on Exchange Rate Issues-paper. As our press release makes clear, this paper is complementary to a number of other recent or ongoing efforts, including a stock taking exercise on the treatment of exchange rate issues in bilateral consultations, and to a possible review of the 1977 Surveillance Decision. My colleagues and I will be happy to answer your questions on the CGER and the related papers after my remarks.

As you know, exchange rate surveillance has always been at the core of the IMF's responsibilities, but its analytical underpinnings have necessarily evolved over time. The current approach to exchange rate analysis in the Fund dates to the 1990s when the CGER was charged with providing assessments of the consistency of exchange rates with medium-term fundamentals for a number of advanced economies with the aim of informing the country-specific analysis of Article IV Staff Reports.

The key goal of the CGER approach was to foster multilateral consistency in exchange rate assessments. In simple terms, this implies taking into account that if some currency is assessed to be overvalued, then it must be the case that some other currency is assessed to be undervalued.

The approach involved two methodologies. The first consisted of estimating equilibrium current account positions or norms, comparing these norms to projected underlying current account balances expected to prevail over the medium-term, and calculating the changes in exchange rates needed to close the gap between projected current account balances and the norms. The second approach consisted of directly evaluating deviations of the real exchange rate from its medium-term trend level.

Even as this work became well integrated into the Fund's bilateral consultations with advanced countries, the rapid growth of emerging market countries in global trade, finance, and of course more recently their contribution to the global imbalances, made integrating the emerging market countries into the CGER exercise a priority. The revised approach being released today is the result.

Relative to the earlier version of CGER, there are three main differences. First, a richer set of fundamentals now determine current account norms in order to capture behavior in both advanced and middle-income countries. Second, the equilibrium real exchange rate approach has been strengthened by evaluating the medium-term trend in real exchange rates on the basis of a wider set of fundamentals. Third, a new external sustainability approach has been introduced which is complementary to the other two.

It is important to stress that using these three approaches can be useful in establishing robustness of the underlying results. Since the three approaches focus on different aspects, flow quantities, stock quantities, and relative prices, and thus on different fundamental determinants, when they point in a similar direction, this is a powerful signal that economically relevant aspects of exchange rate misalignment are being captured. This in turn should lead to more balanced judgments about how currencies may ultimately need to adjust as the present global imbalances are narrowed.

As the paper makes clear, however, we are under no illusion that the estimates of exchange rate misalignment resulting from the CGER approaches are very precise. The uncertainty relates to a number of factors such as potential instability of underlying macroeconomic links, differences in these links across countries, measurement problems, as well as the imperfect fit of the models themselves. Some of these problems may be even more severe in the case of the emerging market countries where structural change may be playing a greater role and where limitations in terms of data availability and length of sample are more acute. But I would emphasize that it is important not to throw the baby out with the bathwater. It is indeed remarkable that despite the different focus of the three methodologies, they do in practice tend to yield similar results in many cases, again highlighting the importance of the fundamentals captured by the different approaches.

My colleagues and I would be happy to take your questions.

QUESTIONER: Thank you. I was wondering, I have taken a quick look at the paper and you offer some current account norms. I didn't see any of the equilibrium exchange rates published, so it is difficult to tell how your estimates of equilibria match what we see in The Economist at the moment.

MR. OSTRY: You are correct. What we published in the paper that was released are the estimates from the regression rather than the point estimates from this approach. And you will also have noticed that we have not published the country-specific norms that you saw published for regions as a group in Table 2. We provided enough information for the reader hopefully to gain a perspective on how the methodologies work, but we are not publishing the actual point estimates for equilibrium real exchange rates.

QUESTIONER: May I ask why that is?

MR. OSTRY: Basically, this is an approach that we are just releasing today and it is relatively novel, and as I said in my opening remarks, there is a significant amount of uncertainty surrounding the estimated coefficients from the different approaches, so we would like to gain experience of working with this methodology over time before coming to a view of where to go next in terms of the information that gets released.

QUESTIONER: So it is about your confidence in your own estimates than about the political sensitivity of those estimates?

MR. OSTRY: It is about the fact that this is a novel approach where there is significant statistical and economic uncertainty surrounding the estimates and the desire to gain more experience with it as we move forward.

QUESTIONER: I don't want to use up too much of your time, but if I could be permitted to continue, would you be happy for these numbers to be used in the high-level ministerial meetings that are supposed to take place as part of IMF multilateral surveillance, provided that they remain confidential. Provided that journalists like me don't get a hold of them, you would be happy for politicians themselves to use these numbers to guide their decisions, or are you not confident in them enough yet?

MR. OSTRY: The main function that we see at present for these is to actually inform the bilateral and multilateral surveillance that we are doing. So we interact with the teams doing work on countries and we interact with the teams producing the multilateral surveillance documents such as the World Economic Outlook. So clearly country authorities will be very well aware of the estimates and the assessments that the CGER makes and we see this very much as a way to engage with country authorities on the issue of exchange rate misalignment. So we would of course be very happy for this work to feature in these discussions.

MR. COTTARELLI: Can I add something? As Jonathan was saying, the CGER point estimate or ranges are not published. They inform the work of our other departments in discussing these issues with country authorities and they are used as an input for writing our staff reports. It is interesting to note that one of the other papers that is mentioned in the press release, the Stocktaking of the Treatment of Exchange Rate Issues in staff reports, shows that for almost all of the 30 economies that we have reviewed in these studies, the staff reports do include the IMF staff views on levels of exchange rates. These views typically become public when the staff report is published. In some cases the exchange rate assessment is expressed in qualitative terms, in other cases some quantitative ranges are published. The work of CGER will help us to strengthen the quality of these assessments.

MR. OSTRY: I would just add one other thing. As you saw in the press release, one of the important advantages now is that we are really covering so much more of global trade in these assessments, and so the goal of achieving multilateral consistency in the estimates, we are much closer to that goal than we were when we were simply focusing on the advanced economies. So we think this is a step forward in the goal of establishing multilateral consistency in these misalignment estimates and shows really that we are taking the emerging market countries and the advanced countries together in arriving at these assessments.

QUESTIONER: That is quite interesting. So in enforcing your consistency constraints-are there many examples of exchange rates having to change quite a bit in order to fit that constraint, that is, what you get from calculating each country in turn doesn't add up? I guess what I'm getting at is does adding in this need for multilateral consistency alter your view a great deal or not very much?

MR. MILESI-FERRETTI: The requirement of multilateral consistency is essential if you cover a very significant fraction of world GDP and world trade because exchange rates are basically relative prices and measure the exchange rate of one country vis-à-vis its trading partners. So we need to ensure that when we say that a number of currencies are above equilibrium or are overvalued, then a number of currencies have to be on the other side to ensure that basically things are consistent.

MR. OSTRY: Let me just add that obviously the adjustments that we would need to make to achieve multilateral consistency are smaller now that we are covering I think something on the order of four-fifths of global trade relative to the situation when we were focusing just on the advanced countries-we were covering something on the order of I think less than two-thirds or between a half and two-thirds at that time. So there are significant gains from having the greater country coverage.

If your question was in part sort of technical about how we go about making the adjustments, we can provide you with more details on that. But the gist of it is basically the goal of multilateral consistency is better served by having this broader country coverage.

QUESTIONER: I guess I am just trying to give content to this innovation, this move toward multilateral as opposed to bilateral surveillance, and the way it is often explained to me is that, for example, it is all very well telling Hong Kong that its exchange rate suits its purposes right now, but then if you go and tell China that it needs to devalue, then perhaps those two pieces of advice while they might be right, holding everything else constant, they are not going to be right if both pieces of advice are taken.

So I am just sort of wondering how big a change in the way we think about the world results from having to think about everything together rather than each country in turn.

MR. OSTRY: I think you have hit the nail on the head there. It doesn't make sense to be giving bilateral advice to a range of countries saying they are all on the same side of either overvaluation or undervaluation because there is this adding up constraint that you are referring to. So if your question is really does the bilateral advice on exchange rate policy that is provided through Article IV, is it informed by this analysis, this is very much the case. It is an input, and going forward we would expect it to become an input for the emerging market countries which was not the case when the exercise was confined to the advanced countries.

MR. COTTARELLI: If I can clarify one issue, it is clear that we have always taken into account the need for multilateral consistency in providing our exchange rate assessment. What the paper does is to do this in a more rigorous way, in a more formal and strengthened way than in the past.

QUESTIONER: I understand from what you're saying that you are not publishing specific estimates, specific figures for exchange rate here. But can you talk in general terms about how misaligned you think the Chinese renminbi would be in relation to the dollar? And just on an institutional point, could you tell us if this is a working paper, so what will be the status going forward? Does it then need to be adopted by the IMF directors and then to become sort of institutional policy?

MR. OSTRY: Let me say a few words on the issues that you raised. We are not going to really speak to the issue of individual countries' exchange rates. I think that was clear from the opening remarks. But for the Fund's view on the renminbi or any other exchange rate rates, I would refer you to the bilateral Article IV documents. In the case of China, as you know, this is a published document and there is an assessment of how the Fund sees the renminbi in relation to its equilibrium. That is in the public domain and there is nothing really that I would add to that.

On the issue of what we can say about undervaluation or overvaluation I would again just mention this Table 2 in the CGER paper where there are groups of countries where you can get an idea based on the macro balance approach of whether they are undervalued or overvalued, there are statements in the paper about the emerging markets as a whole, et cetera. So I have nothing really that I would add to what is in Table 2.

In terms of its status, the paper is a methodological paper and it was discussed at a seminar at the IMF's Board in early September. The sense from the Board was that there was value added in these approaches and we are going to be over the next six months or so doing outreach with country officials to hear back from them how they view these approaches and these innovations and any concerns that they may have.

QUESTIONER: It might be a bit of a technical question, but is it possible that you can actually go ahead without the changes made to the 1977 decision or does that have to go through first before you can actually really start implementing this? Because I know there are some concerns among emerging economies who have problems with changing that decision. So it is more of a technical question.

MR. COTTARELLI: I think the answer is that we are reviewing the 1977 decision, but at the same time, the Board over the last few years has clearly indicated what we are supposed to do in the area of exchange rate assessments. You know that every two years we review our surveillance policy. Both in the last two reviews in 2002 and in 2004, the Board underscored that it is important that in assessing developments in countries we look at the level of the exchange rate and we express views in our staff reports on competitiveness and on exchange rate levels. This again has been even very recently reiterated in the Public Information Notice that was published together with the publication of our Stocktaking Paper on Exchange Rate Issues. In this PIN, the Board, most of the directors underscored that we need to strengthen even further our assessment of exchange rate issues. So we are reviewing the 1977 decision, but the work on exchange rate issues is proceeding anyway.

QUESTIONER: The concerns by the emerging markets is that this process has to be done on a level playing field and that the Fund can't just go out and point at the emerging market countries, particularly those in Asia, and not point at the developed countries. How do you ensure that there is a level playing field?

MR. COTTARELLI: Can you clarify your question? Does your question refer to the review of the 1977 decision?

QUESTIONER: No, it refers to generally the work of taking this process to a multilateral level, how do you ensure that there is a level playing field? Emerging markets have said that they are worried that fingers will be pointed more at them and not at developed countries. So how do you ensure that level playing field and the confidence of all the countries involved?

MR. COTTARELLI: I think you asked a technical question and I would answer in a way that is technical also. As was underscored by Jonathan Ostry, this work on ensuring consistency of the exchange rates in itself should lead to a more evenhanded treatment of exchange rate issues. Consistency itself implies that you don't provide an assessment of a single exchange rate, but you provide an assessment of an exchange rate in the context of the world economy.

MR. OSTRY: Let me add one thing. Just from a technical standpoint, the work of the CGER insofar as it bears on the Fund's work on assessing exchange rates, the same methodology now is applied to both advanced and emerging market countries, and you see in Table 2 in the paper the estimates by region and advanced and emerging market countries, those estimates are arrived at going through the same number crunching, as it were, independent of whether the country is an emerging market country or an advanced country. I would also add that we are much more transparent I think in the paper than we perhaps have been in the past about how precisely we use this information in the estimates in arriving at the assessments. Although we don't present these assessments, we provide information to basically set out how we arrived at these assessments, and as you will see there, there is no difference between the advanced and emerging market countries. So in terms of evenhandedness, I would say that it is really not an issue at this point.

MS. LOTZE: Thank you very much for participating. We will conclude this conference call here.


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