Public Information Notice: IMF Executive Board Adopts New Decision on Bilateral Surveillance Over Members' Policies
June 21, 2007
Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.
June 21, 2007
On June 15, 2007, the Executive Board of the International Monetary Fund (IMF) adopted a new Decision on Bilateral Surveillance over Members' Policies, concluding a year-long review of the 1977 Decision on Surveillance Over Exchange Rate Policies, and repealing and replacing that Decision.
The adoption of the 2007 Decision on Bilateral Surveillance is a keystone of the effort to upgrade the foundations of the IMF's bilateral surveillance—the activity whereby the IMF monitors the economic and financial policies of its member countries, in the interest of international monetary stability. Modernizing surveillance is a central element in the IMF's Medium-Term Strategy, which has reexamined the future directions of the IMF in light of economic and financial globalization. The new Decision crystallizes a common vision of the best practice of surveillance, as it has evolved over the last 30 years, for greater clarity, and hence more accountability. By setting clear expectations for the practice of surveillance, the new Decision should help improve the quality, evenhandedness, and effectiveness of the IMF's surveillance. The new Decision also brings greater clarity and specificity to what exchange rate policies countries should avoid and when these policies may be of concern to the international community.
The adoption of the 2007 Decision is the culmination of a long and thorough effort to analyze gaps in the 1977 Decision, to distill the best practice of surveillance, and to crystallize a common vision of modern surveillance in a comprehensive statement.1 The1977 Decision was crafted shortly after the collapse of the Bretton Woods system, in the midst of considerable uncertainty as to how the new system would work. It focused exclusively on surveillance over exchange rate policies, and its coverage was relatively narrow even in that area. The Decision was expected to be revised with experience. However, it remained virtually unchanged even as the practice of surveillance evolved (including to encompass domestic policies as a key element), and a disconnect developed between the Decision and the best practice of surveillance.
The 2007 Decision is a comprehensive statement on bilateral surveillance. It does not create new obligations for members, but updates the 1977 Decision in a number of important ways:
• In order to help focus surveillance on issues crucial to international monetary and financial stability, the new Decision introduces a concept of external stability as an organizing principle for bilateral surveillance. (External stability encompasses both the current account of the balance of payments—and thereby also issues of exchange rate misalignment—and the capital account of the balance of payments.) In this connection, the new Decision also elaborates on the scope of bilateral surveillance in the context of currency unions.
• The new Decision specifies the essential modalities of effective modern surveillance. It underscores the collaborative nature of surveillance, the importance of dialogue and persuasion, and the need for candor and evenhandedness. It also emphasizes the importance of paying due regard to country circumstances and the need for a multilateral and medium-term perspective.
• The new Decision clarifies the concept of exchange rate manipulation in order to gain an unfair competitive advantage over other members, which is prohibited under Article IV and referred to in the previous Decision. In particular, the new Decision relates such behavior to the concept of fundamental exchange rate misalignment.
• The new Decision provides more complete guidance to members for the conduct of their exchange rate policies, so as to cover all major causes of external instability rooted in these policies. The 1977 Decision enjoined members to avoid exchange rate manipulation for specific purposes, in particular to gain an unfair competitive advantage over other Fund members. The new Decision adds a principle recommending that members avoid exchange rate policies that result in external instability, regardless of their purpose, thereby capturing exchange rate policies that have proven to be a major source of instability over the past decades.
• Overall, the 2007 Decision is better aligned with current practices, covering both exchange rate policies and relevant domestic economic and financial policies.
Chairman's Summing Up of June 15, 2007 Board Discussions
Following extensive discussions over recent months, the Executive Board has adopted a new Decision on bilateral surveillance over members' policies. Reflecting the momentous changes in the world economic and financial system since the previous Decision on surveillance over members' exchange rate policies was adopted in 1977, the new surveillance Decision updates guidance to both the Fund and its members regarding their obligations under Article IV of the Articles of Agreement. The discussions leading up to the Decision have served to build a broadly shared understanding of its purpose and its key elements. I am particularly grateful that in arriving at this agreement on a new surveillance Decision, members with a spectrum of views have made their best efforts to meet the dual objective of commanding the broadest support and achieving the best outcome possible. Today's decision is also an important step forward in the implementation of the Fund's Medium-Term Strategy, and helps pave the way for positive outcomes on its other elements, including quota and voice reforms and the Fund's income model.
The new surveillance Decision focuses on bilateral surveillance, and provides guidance both to the Fund in the conduct of surveillance—in Part I of the Decision—and to members in the conduct of their exchange rate policies—in Part II of the Decision—including through an Annex that provides guidance with respect to the meaning of Article IV, Section 1 (iii). In their discussions on the text of the Decision, Directors reaffirmed the understanding, consistent with the Fund's legal framework, that references to the "Fund" in a Board decision are generally understood to mean the Executive Board, supported by management and staff as appropriate. A few Directors would have preferred that the Decision also cover multilateral surveillance—that is, the Fund's responsibility to oversee the international monetary system, under Article IV, Section 3(a)—and expressed the hope that this would be included at a later stage. Most Directors agreed that a number of sections of the Companion Paper identified below would provide particularly important guidance as to how the Fund should apply the Decision.
Looking ahead, Directors generally viewed the adoption of the Decision as an important starting point, but not by any means the end of the road, in the Fund's efforts to discharge its surveillance responsibilities effectively and in an evenhanded manner. It will be important that the adoption of the Decision is followed up by ensuring that both staff and national authorities are fully familiar with the new framework and that they deepen their shared understanding of how surveillance can be effectively enhanced.
Under the new Decision, the concept of external stability becomes an overarching organizing principle of surveillance. In that regard, the Executive Board endorsed the meaning ascribed to this term in paragraphs 3 through 11 of the Companion Paper, with many Directors emphasizing that, in applying the Decision, the text of those paragraphs will provide particularly useful guidance.
Directors considered that the adoption of a new principle for the guidance of members' exchange rate policies, PGM D, is an important step forward for the Fund. They noted that this principle should guide members in avoiding external instability arising from their exchange rate policies.
The Executive Board endorsed the definition of fundamental exchange rate misalignment as set forth in paragraph 6 of the Companion Paper. Directors underscored, however, that this needs to be applied with appropriate caution. They stressed, in particular, that it should be used with due acknowledgement of the considerable measurement uncertainties involved, and that estimates of misalignment require the exercise of careful judgment. In practice, an exchange rate would only be judged to be fundamentally misaligned if the misalignment is found to be significant. Directors also attached considerable importance to the provisions of the Decision whereby the benefit of any reasonable doubt would be given to the authorities in establishing whether fundamental misalignment is present. Directors noted that any judgment on misalignment should be applied in an evenhanded manner irrespective of the nature of the exchange rate regime and the size of the economy. Also, a number of Directors emphasized the potential market-sensitivity of estimates of misalignment and the need for care in communicating them.
With regard to the indicator in paragraph 15 of the Decision on protracted large-scale intervention in one direction in the exchange market, Directors noted that such intervention is worthy of special scrutiny when it is accompanied by sterilization. Of course, sterilization—often appropriately engaged in to promote domestic stability—may very well be perfectly justified. The Executive Board endorsed the discussion contained in paragraphs 41-42 of the Companion Paper.
With respect to the guidance which the Board has provided in the Annex to the Decision on the meaning of Article IV, Section 1 (iii), Directors recognized that exchange rate manipulation can take many different forms, including intervention in the exchange markets and the imposition of capital controls for the purpose of directly targeting the exchange rate. They noted that, as explained in the Annex to the Decision, under Article IV, Section 1 (iii), a member is only required to avoid exchange rate manipulation when such manipulation is engaged in for one of the purposes identified in that provision. A number of Directors stressed that the above mention of intervention and capital controls should not be construed as stigmatizing the use of these legitimate policy options per se, or removing them from the toolkit of members.
Today's discussion completes the review of the 1977 Decision, which is now replaced by the 2007 Decision on Bilateral Surveillance over Members' Policies.
INTERNATIONAL MONETARY FUNDBilateral Surveillance over Members' Policies
Executive Board Decision—June 15, 2007
Since the adoption in 1977 of the Decision entitled "Surveillance over Exchange Rate Policies" (the "1977 Decision"), there have been significant developments in the global economy, characterized by growing trade and financial integration. In light of these developments and in recognition of the increasingly important international dimensions of surveillance and of cross-country spillovers, the Fund is of the view that, by incorporating existing best practice in the area of surveillance, an update of the 1977 Decision would play an important role in providing guidance to both the Fund and its members regarding their mutual responsibilities under Article IV. The Fund emphasizes that the guidance being provided to members in this Decision relates to the performance of their existing obligations under Article IV; no new obligations are created for members by this Decision. Moreover, the Fund recognizes that members have legitimate policy objectives that are beyond the scope of Article IV and, accordingly, beyond the scope of this Decision, although when adopting policies to achieve these objectives, members need to ensure that such policies are consistent with their obligations under Article IV. Part I of this Decision is designed to give guidance to the Fund in its exercise of surveillance; Part I of this Decision does not, and cannot be construed or used to, expand or broaden the scope—or change the nature—of members' obligations under the Articles of Agreement, directly or indirectly. The principles for the guidance of members set forth in this Decision regarding their exchange rate policies respect the domestic social and political policies of members and will be applied in a manner that pays due regard to the circumstances of members and the need for evenhandedness in the practice of surveillance. Finally, looking forward, flexibility should be maintained to allow for the continued evolution of surveillance.
1. This Decision provides guidance to the Fund in its oversight over members' policies pursuant to Article IV, Sections 3 (a) and (b), and guidance to members in the conduct of their exchange rate policies pursuant to Article IV, Section 3 (b). It does not deal directly with the Fund's responsibility to oversee the international monetary system in order to ensure its effective operation, referred to in Article IV, Section 3 (a).
2. Part I of this Decision sets out the scope and modalities of the Fund's oversight of members' obligations under Article IV, Section 1, including the Fund's exercise of firm surveillance over the exchange rate policies of members (such oversight of members' obligations is hereinafter referred to as "bilateral surveillance"). Part II establishes principles for the guidance of members in the conduct of their exchange rate policies as required under Article IV, Section 3 (b); it also identifies certain developments which, in the Fund's assessment of a member's observance of the principles, would require thorough review and might indicate the need for discussion with the member. Part III sets out procedures for surveillance.
3. Fund surveillance over members' policies shall be adapted to the needs of the international monetary and financial system as they develop. The principles and procedures set out in this Decision, which apply to all members irrespective of their exchange arrangements and balance of payments positions, are not necessarily comprehensive and are subject to reconsideration by the Fund in the light of experience.
Part I - Principles for the Guidance of the Fund in its Bilateral Surveillance
A. The Scope of Bilateral Surveillance
4. The scope of bilateral surveillance is determined by members' obligations under Article IV, Section 1. Members undertake under Article IV, Section 1 to collaborate with the Fund and other members to assure orderly exchange arrangements and to promote a stable system of exchange rates (hereinafter "systemic stability"). Systemic stability is most effectively achieved by each member adopting policies that promote its own "external stability"—that is, policies that are consistent with members' obligations under Article IV, Section 1 and, in particular, the specific obligations set forth in Article IV, Sections 1 (i) through (iv). "External stability" refers to a balance of payments position that does not, and is not likely to, give rise to disruptive exchange rate movements. Except as provided in paragraph 7 below, external stability is assessed at the level of each member.
5. In its bilateral surveillance, the Fund will focus on those policies of members that can significantly influence present or prospective external stability. The Fund will assess whether these policies are promoting external stability and advise the member on policy adjustments necessary for this purpose. Accordingly, exchange rate policies will always be the subject of the Fund's bilateral surveillance with respect to each member, as will monetary, fiscal, and financial sector policies (both their macroeconomic aspects and macroeconomically relevant structural aspects). Other policies will be examined in the context of surveillance only to the extent that they significantly influence present or prospective external stability.
6. In the conduct of their domestic economic and financial policies, members are considered by the Fund to be promoting external stability when they are promoting domestic stability—that is, when they (i) endeavor to direct their domestic economic and financial policies toward the objective of fostering orderly economic growth with reasonable price stability, with due regard to their circumstances, and (ii) seek to promote stability by fostering orderly underlying economic and financial conditions and a monetary system that does not tend to produce erratic disruptions. The Fund in its surveillance will assess whether a member's domestic policies are directed toward the promotion of domestic stability. While the Fund will always examine whether a member's domestic policies are directed toward keeping the member's economy operating broadly at capacity, the Fund will examine whether domestic policies are directed toward fostering a high rate of potential growth only in those cases where such high potential growth significantly influences prospects for domestic, and thereby external, stability. However, the Fund will not require a member that is complying with Article IV, Sections 1(i) and (ii) to change its domestic policies in the interests of external stability.
7. This Decision applies to members of currency unions, subject to the following considerations. Members of currency unions remain subject to all of their obligations under Article IV, Section 1 and, accordingly, each member is accountable for those policies that are conducted by union-level institutions on its behalf. In its surveillance over the policies of members of a currency union, the Fund will assess whether relevant policies implemented at the level of the currency union (including exchange rate and monetary policies) and at the level of members are promoting the external stability of the union and will advise on policy adjustments necessary for this purpose. In particular, the Fund will assess whether the exchange rate policies of the union are promoting its external stability, and whether domestic policies implemented at the level of the union are promoting the domestic, and thereby external, stability of the union. Because, in a currency union, exchange rate policies are implemented at the level of the union, the principles for the guidance of members' exchange rate policies and the associated indicators set out in paragraph 15 of this Decision only apply at the level of the currency union. With respect to the conduct of domestic policies implemented at the level of individual members, a member of a currency union is considered by the Fund to be promoting the external stability of the union when it is promoting its own domestic stability. In view of the importance of individual members' balances of payments for the domestic stability of the member and the external stability of the union, the Fund's assessment of the policies of a member of a currency union will always include an evaluation of developments in the member's balance of payments.
B. The Modalities of Bilateral Surveillance
8. Dialogue and persuasion are key pillars of effective surveillance. The Fund, in its bilateral surveillance, will clearly and candidly assess relevant economic developments, prospects, and policies of the member in question, and advise on these. Such assessments and advice are intended to assist that member in making policy choices, and to enable other members to discuss these policy choices with that member. In the context of bilateral surveillance, the Fund will foster an environment of frank and open dialogue and mutual trust with each member and will be evenhanded across members, affording similar treatment to members in similar relevant circumstances.
9. The Fund's assessment of a member's policies and its advice on these policies will pay due regard to the circumstances of the member. This assessment and advice will be formulated within the framework of a comprehensive analysis of the general economic situation and economic policy strategy of the member, and will pay due regard to the member's implementation capacity. Moreover, in advising members on the manner in which they may promote external stability, the Fund shall, to the extent permitted under Article IV, take into account the member's other objectives.
10. The Fund's assessment and advice in the context of bilateral surveillance will be informed by, and be consistent with, a multilateral framework that incorporates relevant aspects of the global and regional economic environment, including exchange rates, international capital market conditions, and key linkages among members. The Fund's assessment and advice will take into account the impact of a member's policies on other members to the extent that the member's policies undermine the promotion of its own external stability.
11. The Fund's assessment and advice in the context of bilateral surveillance will, to the extent possible, be placed in the context of an examination of the member's medium-term objectives and the planned conduct of policies, including possible responses to the most relevant contingencies.
12. The Fund's assessment of a member's policies will always include an evaluation of the developments in the member's balance of payments, including the size and sustainability of capital flows, against the background of its reserves, the size and composition of its other external assets and its external liabilities, and its opportunities for access to international capital markets.
Part II - Principles for the Guidance of Members' Policies Under Article IV, Section 1
13. Principles A through D below are adopted pursuant to Article IV, Section 3 (b) and are intended to provide guidance to members in the conduct of their exchange rate policies in accordance with their obligations under Article IV, Section 1. In accordance with Article IV, Section 3 (b), these Principles respect the domestic social and political policies of members. In applying these Principles, the Fund will pay due regard to the circumstances of members. Members are presumed to be implementing policies that are consistent with the Principles. When, in the context of surveillance, a question arises as to whether a particular member is implementing policies consistent with the Principles, the Fund will give the member the benefit of any reasonable doubt, including with respect to an assessment of fundamental exchange rate misalignment. In circumstances where the Fund has determined that a member is implementing policies that are not consistent with these Principles and is informing the member as to what policy adjustments should be made to address this situation, the Fund will take into consideration the disruptive impact that excessively rapid adjustment would have on the member's economy.
14. Principle A sets forth the obligation contained in Article IV, Section 1(iii); further guidance on its meaning is provided in the Annex to this Decision. Principles B through D constitute recommendations rather than obligations of members. A determination by the Fund that a member is not following one of these recommendations would not create a presumption that that member is in breach of its obligations under Article IV, Section 1.
A. A member shall avoid manipulating exchange rates or the international monetary system in order to prevent effective balance of payments adjustment or to gain an unfair competitive advantage over other members.
B. A member should intervene in the exchange market if necessary to counter disorderly conditions, which may be characterized inter alia by disruptive short-term movements in the exchange rate of its currency.
C. Members should take into account in their intervention policies the interests of other members, including those of the countries in whose currencies they intervene.
D. A member should avoid exchange rate policies that result in external instability.
15. In its surveillance of the observance by members of the Principles set forth above, the Fund shall consider the following developments as among those which would require thorough review and might indicate the need for discussion with a member:
(i) protracted large-scale intervention in one direction in the exchange market;
(ii) official or quasi-official borrowing that either is unsustainable or brings unduly high liquidity risks, or excessive and prolonged official or quasi-official accumulation of foreign assets, for balance of payments purposes;
(iii) (a) the introduction, substantial intensification, or prolonged maintenance, for balance of payments purposes, of restrictions on, or incentives for, current transactions or payments, or
(b) the introduction or substantial modification for balance of payments purposes of restrictions on, or incentives for, the inflow or outflow of capital;
(iv) the pursuit, for balance of payments purposes, of monetary and other financial policies that provide abnormal encouragement or discouragement to capital flows;
(v) fundamental exchange rate misalignment;
(vi) large and prolonged current account deficits or surpluses; and
(vii) large external sector vulnerabilities, including liquidity risks, arising from private capital flows.
Part III - Procedures for Surveillance
16. Each country that becomes a member of the Fund after the adoption of this decision shall, within thirty days of the date of its membership, notify the Fund in appropriate detail of the exchange arrangements it intends to apply in fulfillment of its obligations under Article IV, Section 1. Each member, regardless of its date of membership, shall notify the Fund promptly of any changes in its exchange arrangements.
17. Members shall consult with the Fund regularly under Article IV. In principle, the consultations under Article IV shall comprehend the regular consultations under Articles VIII and XIV, and shall take place annually. They shall include consideration of the observance by members of the principles set forth above as well as of a member's obligations under Article IV, Section 1. Not later than sixty-five days after the termination of discussions between the member and the staff, the Executive Board shall reach conclusions and thereby complete the consultation under Article IV, except in the case of consultations with members eligible for financing under the Poverty Reduction and Growth Facility identified in Decision No. 8240- (86/56), SAF, adopted March 26, 1986, as amended, where the Executive Board shall reach conclusions no later than three months from the termination of discussions between the member and the staff.
18. Broad developments in exchange rates will be reviewed periodically by the Fund, inter alia in discussions of the international adjustment process within the framework of the World Economic Outlook. The Fund will continue to conduct consultations in preparing for these discussions.
19. The Managing Director shall maintain close contact with members in connection with their exchange arrangements and their policies under Article IV, Section 1, and will be prepared to discuss on the initiative of a member important changes that it contemplates in its exchange arrangements or its policies.
20. (a) Whenever the Managing Director considers that important economic or financial developments are likely to affect a member's exchange rate policies or the behavior of the exchange rate of its currency, the Managing Director shall initiate informally and confidentially a discussion with the member. After such discussion the Managing Director may report to the Executive Board or informally advise the Executive Directors and, if the Executive Board considers it appropriate, an ad hoc Article IV consultation between the member and the Fund shall be conducted in accordance with the procedure set out in subparagraph (b) below.
(b) A staff report will be circulated to the Executive Directors under cover of a note from the Secretary specifying a tentative date for Executive Board discussion which will be at least 15 days later than the date upon which the report is circulated. The Secretary's note will also set out a draft decision taking note of the staff report and completing the ad hoc consultation without discussion or approval of the views contained in the report; the decision will be adopted upon the expiration of the two-week period following the circulation of the staff report to the Executive Directors unless, within such period, there is a request from an Executive Director or decision of the Managing Director to place the report on the agenda of the Executive Board. If the staff report is placed on the agenda, the Executive Board will discuss the report and will reach conclusions which will be reflected in a summing up.
(c) Unless otherwise decided by the Executive Board, the conduct of an ad hoc consultation with a member will not affect the consultation cycle applicable to the member or the deadline for completion of the next consultation with the member
21. The Executive Board shall review this Decision and the general implementation of bilateral surveillance at intervals of three years, and at such other times as consideration of such matters may be placed on the agenda of the Executive Board.
22. Decision No. 5392-(77/63), adopted April 29, 1977, as amended, and paragraph 3 of Decision No. 6026-(79/13), adopted January 22, 1979, as amended, are hereby repealed.
Article IV, Section 1(iii) and Principle A
1. Article IV, Section 1 (iii) of the Fund's Articles provides that members shall "avoid manipulating exchange rates or the international monetary system in order to prevent effective balance of payments adjustment or to gain an unfair competitive advantage over other members." The language of this provision is repeated in Principle A contained in Part II of this Decision. The text set forth below is designed to provide further guidance regarding the meaning of this provision.
2. A member would only be acting inconsistently with Article IV, Section 1(iii) if the Fund determined both that: (a) the member was manipulating its exchange rate or the international monetary system and (b) such manipulation was being carried out for one of the two purposes specifically identified in Article IV, Section 1(iii).
(a) "Manipulation" of the exchange rate is only carried out through policies that are targeted at—and actually affect—the level of an exchange rate. Moreover, manipulation may cause the exchange rate to move or may prevent such movement.
(b) A member that is manipulating its exchange rate would only be acting inconsistently with Article IV, Section 1(iii) if the Fund were to determine that such manipulation was being undertaken "in order to prevent effective balance of payments adjustment or to gain an unfair competitive advantage over other members." In that regard, a member will only be considered to be manipulating exchange rates in order to gain an unfair competitive advantage over other members if the Fund determines both that: (A) the member is engaged in these policies for the purpose of securing fundamental exchange rate misalignment in the form of an undervalued exchange rate and (B) the purpose of securing such misalignment is to increase net exports.
3. It is the responsibility of the Fund to make an objective assessment of whether a member is observing its obligations under Article IV, Section 1 (iii), based on all available evidence, including consultation with the member concerned. Any representation made by the member regarding the purpose of its policies will be given the benefit of any reasonable doubt.
1 In July 2006, the Board explored the rationale for a possible revision of the 1977 Decision that would build more comprehensive links with Article IV and better align the Decision with modern best practice ("Review of the 1977 Decision on Surveillance over Exchange Rate Policies—Preliminary Considerations", "Article IV of the Fund's Articles of Agreement—An Overview of the Legal Framework", "Review of the 1977 Decision on Surveillance over Exchange Rate Policies-Background Information," and the associated Summing Up of the Executive Board discussion). In February 2007, the Board held a follow-up discussion in which Directors explored the principles on which a revised Decision should be built, and discussed illustrative text for a new Decision ("Review of the 1977 Decision on Surveillance over Exchange Rate Policies—Further Considerations" and the associated Summing Up of the Executive Board discussion). The latest staff papers made a proposal built on the approach outlined in the February staff paper, and reflecting the views expressed by the Board at that time ("Review of the 1977 Decision—Proposal for a New Decision," its more technical "Companion Paper," and its Supplement presenting a revised draft).