Public Information Notice: IMF Executive Board Adopts New Decision on Bilateral Surveillance Over Members' Policies

IMF News, June 21, 2007

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Published: June 21, 2007

Background and purpose

Public Information Notice (PIN) No. 07/69: On June 15, 2007, the Executive Board adopted a new Decision on Bilateral Surveillance over Members' Policies, repealing and replacing the 1977 Decision on Surveillance Over Exchange Rate Policies.
The Decision updates and modernizes the Fund's bilateral surveillance to reflect developments in economic and financial globalization and to align with the IMF's Medium-Term Strategy.
The Decision does not create new obligations for members; it provides guidance to the Fund and to members regarding existing obligations under Article IV.

Key changes and updates from the 1977 Decision

Introduces "external stability" as an organizing principle for bilateral surveillance, encompassing both the current account and the capital account of the balance of payments.
Expands surveillance coverage to include exchange rate policies and relevant domestic economic and financial policies.
Clarifies the concept of exchange rate manipulation related to gaining an unfair competitive advantage and links it to "fundamental exchange rate misalignment."
Recommends that members avoid exchange rate policies that result in external instability, regardless of purpose.
Specifies modalities of effective modern surveillance: collaborative approach, dialogue and persuasion, candor, evenhandedness, attention to country circumstances, and a multilateral and medium-term perspective.
Clarifies guidance for members in the context of currency unions, noting that indicators in paragraph 15 apply at the level of the currency union.

Chairman's summing up of Board discussions (June 15, 2007)

Adoption reflects major changes since 1977 and updates guidance regarding obligations under Article IV.
The Decision focuses on bilateral surveillance (Part I: guidance to the Fund; Part II: guidance to members; Annex: guidance on Article IV, Section 1(iii)).
Directors endorsed the use of the Companion Paper paragraphs 3 through 11 for the meaning of "external stability."
Directors endorsed Principle PGM D guiding members to avoid external instability from exchange rate policies.
The Executive Board endorsed the definition of "fundamental exchange rate misalignment" in paragraph 6 of the Companion Paper, while stressing measurement uncertainties and the need to give the benefit of any reasonable doubt to authorities.
Directors noted market sensitivity of misalignment estimates and the need for care in communication.
The Board emphasized that protracted large-scale intervention in one direction, especially when accompanied by sterilization, merits special scrutiny (see paragraphs 41-42 of the Companion Paper).
Exchange market intervention and capital controls can take many forms; these instruments are not stigmatized per se when used legitimately.

Part I — Scope and modalities of bilateral surveillance (high-level findings)

Surveillance is based on members' obligations under Article IV, Section 1 and focuses on policies that significantly influence present or prospective external stability.
External stability is assessed principally at the level of each member, except where currency unions require assessment at the union level.
The Fund will assess exchange rate, monetary, fiscal, and financial sector policies (including macroeconomically relevant structural aspects).
The Fund will examine other policies only to the extent they significantly influence external stability.
Surveillance modalities emphasize:
- Frank and open dialogue and mutual trust.
- Evenhanded treatment across members in similar relevant circumstances.
- Due regard to members' circumstances and implementation capacity.
- A multilateral framework that accounts for global and regional economic environment and cross-country linkages.
- Placement of assessments in a medium-term perspective with contingency planning.
Balance of payments evaluation includes size and sustainability of capital flows, reserves, external assets and liabilities, and access to international capital markets.

Part II — Principles for the guidance of members (A through D)

Principle A (obligation): 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.
Principles B–D (recommendations):
- B. A member should intervene in the exchange market if necessary to counter disorderly conditions.
- 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.
When surveillance raises questions about consistency with these Principles, the Fund will give the member the benefit of any reasonable doubt, including regarding assessments of fundamental exchange rate misalignment.
Where the Fund determines inconsistency with the Principles, it will consider disruptive impacts of excessively rapid adjustment on the member's economy.

Developments that require thorough review (paragraph 15 indicators)

The Fund will consider the following developments among those that 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

(iii)(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 (key timelines and procedures)

New members: notify the Fund within thirty days of membership of the exchange arrangements intended to fulfill Article IV, Section 1 obligations.
Members: consult with the Fund regularly under Article IV; in principle consultations shall take place annually and include consideration of observance of the Principles.
Executive Board conclusions: Not later than sixty-five days after termination of discussions between the member and staff the Executive Board shall reach conclusions and complete the consultation, except for members eligible under the Poverty Reduction and Growth Facility where the Board shall reach conclusions no later than three months from termination of discussions between the member and staff.
Ad hoc procedures:
- The Managing Director shall initiate informal and confidential discussions with a member when important developments are likely to affect exchange rate policies or behavior.
- A staff report circulated to Executive Directors under cover of a Secretary's note will specify a tentative date at least 15 days after circulation; the Secretary's note will set out a draft decision completing the ad hoc consultation without discussion unless an Executive Director or the Managing Director requests placement on the Executive Board agenda.
- The draft decision will be adopted upon expiration of the two-week period following circulation unless the report is placed on the agenda for Board discussion, in which case the Board will discuss and reach conclusions reflected in a summing up.
Review cycle: 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 appropriate.

Annex — Article IV, Section 1(iii) and Principle A (clarifications)

A finding of inconsistency with Article IV, Section 1(iii) requires two determinations by the Fund:
- (a) the member is manipulating its exchange rate or the international monetary system, and
- (b) such manipulation is being carried out for one of the two purposes identified in Article IV, Section 1(iii).
Manipulation is confined to policies that are targeted at—and actually affect—the level of an exchange rate; it may cause the exchange rate to move or prevent such movement.
A member is considered to be manipulating to gain an unfair competitive advantage only if the Fund determines both that:
- (A) the member is pursuing policies to secure 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.
The Fund is responsible for an objective assessment based on all available evidence, including consultation with the member; representations by the member regarding purpose will be given the benefit of any reasonable doubt.

INTERNATIONAL MONETARY FUND