IMFSurvey Magazine: Policy
Exchange Rate Surveillance
Getting It Right
By IMF staff
IMF Survey online
May 17, 2007
- China consultation seen as example of good practice in exchange rate surveillance
- Report highlights both the authorities' views and those of IMF staff
- Analysis covers exchange rate level, regime choice, and impact on other countries
Exchange rates affect many aspects of a country's economy and its relations with the rest of the world.
For this reason, exchange rate issues occupy a central place in the IMF's analysis and advice to its 185 member countries—a process known as surveillance (see "IMF Exchange Rate Advice Under the Spotlight"). The report for the 2006 IMF Article IV consultation with China (published in October 2006) provides an example of what IMF staff considers to be good practice in exchange rate surveillance. The report contains extensive coverage of key exchange rate issues, including the exchange rate regime, the level of the exchange rate, and the implications of China's exchange rate policies for other countries. The report highlights both the authorities' views and those of IMF staff. The excerpts below are all from the IMF's 2006 report on China.
Description of the exchange rate regime. The report noted that "since July 2005, the authorities have undertaken several reforms to improve the functioning of the exchange market" (paragraph 23). After discussing these reforms in detail (see Box 3 in the report, entitled "Recent Measures to Liberalize the Foreign Exchange Market"), it concluded that "while ... important for the development of the exchange market, they have not had a significant impact on exchange rate movements."
Assessment of the exchange rate level. The report noted that "movement in the renminbi's real value over a considerable period of time has not been in line with most fundamental factors that are generally considered to be important in determining the exchange rate's real value." After reviewing these factors (including reserve accumulation, China's productivity relative to partner countries, its current account surplus, and developments in savings-investment balances), the report concluded that "all of these developments point to the currency as being undervalued and that this undervaluation has increased further since last year's Article IV consultation" (paragraph 24).
The report also conveyed the authorities' concern about "the substantial problems in making an assessment of the level of the exchange rate, particularly in China's case where there were large uncertainties over the underlying savings-investment balance, the implicit debt the economy faced in reforming the banking sector and social services, and possible speculative current and capital account inflows because of expectations of a renminbi revaluation" (paragraph 26). Difficulties in estimating an equilibrium exchange rate for China were assessed in an analysis done by the staff for the Article IV consultation that was subsequently published as an IMF Working Paper (WP/06/220).
Effect of exchange rate appreciation on the economy. The report noted that the authorities were concerned that significant exchange rate appreciation could have an adverse impact on employment, rural incomes, and the stability of the financial sector. In response, IMF staff argued that "the overall impact on the economy of a moderate, but significant, appreciation would be manageable, and any adverse effects on rural incomes could be mitigated through budgetary measures." IMF staff also noted that the impact on the financial sector would be small, given the limited foreign exchange exposure of banks and their clients.
Adequacy of the exchange rate regime. "[T]he authorities agreed that greater flexibility was needed over the medium term" but stressed that exchange rate reform would have to proceed gradually (paragraph 27). IMF staff "stressed the need to utilize more fully the flexibility provided by the current exchange rate system to allow greater movement in the renminbi-dollar rate and a further significant appreciation of the currency" (paragraph 28). IMF staff pointed out that greater flexibility would help remove the conflict in monetary policy that was containing, to a substantial extent, "expansionary impulses of reserve accumulation on domestic monetary conditions" through financial repression. Other arguments in support of increased flexibility were discussed, including "improving the allocation of investment and its efficiency by giving the right price signals to investors" (paragraph 29).
Effect of China's exchange rate policies on other countries. IMF economists argued that exchange rate flexibility would also "contribute to an orderly process for resolving global current account imbalances" (paragraph 31). The authorities noted that dealing with these imbalances required "a concerted effort on the part of all countries." While acknowledging this, IMF staff argued that an appreciation of China's exchange rate "in combination with other measures to rebalance China's growth and necessary policy actions in other major economies would make a major difference."
Other examples of what IMF staff considers to be good exchange rate surveillance, and which are broadly representative of the issues faced by other member countries in this area, can be found in country reports and selected issues papers for the Economic and Monetary Community of Central Africa (CEMAC), Chile, Columbia, Hungary, New Zealand, Russia, South Africa, and Spain.