IMF Survey: Landmark Framework for IMF Surveillance

IMF News, June 21, 2007

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Executive Board adopted the Decision on Bilateral Surveillance on June 15 (announced in IMF Survey Online, June 21, 2007).
Decision updates guidelines for the Fund's monitoring of national economies ("bilateral surveillance") with a special focus on exchange rate policies.
Applies to the IMF's 185 member countries.
Purpose: reinforce the IMF's ability to head off risks to international monetary and financial stability and to provide up-to-date, more comprehensive "health checks" of national economies that complement multilateral surveillance.

The 2007 decision is described as "the first major revision in the surveillance framework in some 30 years" and "the first-ever comprehensive policy statement on surveillance."
Three most notable changes:
- Bilateral surveillance affirmed to be focused on the IMF's core mandate of promoting countries' external stability to avoid surveillance being spread too thin.
- Clear guidance to members on acceptable exchange rate policies and explicit spelling out, for the first time, the meaning of exchange rate manipulation.
- Clarification of expectations for surveillance to promote candor and evenhanded treatment of different countries.

Scope broadened beyond the 1977 Decision on Surveillance over Exchange Rate Policies:
- Surveillance now covers all policies that can affect a country's external stability, encompassing both current and capital accounts (see Box 1).
- External stability defined as a balance of payments position that does not, and is not likely to, give rise to disruptive exchange rate movements.
External stability requires:
- (i) An underlying current account (current account stripped of temporary factors) broadly in equilibrium — where the country's net external asset position evolves consistently with the economy's structure and fundamentals.
- (ii) A capital and financial account that does not create risks of abrupt shifts in capital flows, including avoidance of financing constraints or vulnerable external balance sheet structures.
Fundamental exchange rate misalignment defined as a deviation of the real effective exchange rate from its equilibrium level — the level consistent with a current account (stripped of cyclical and other temporary factors) in line with economic fundamentals.
Acknowledged measurement uncertainties: the IMF will exercise appropriate caution and would judge an exchange rate to be fundamentally misaligned only if the misalignment was significant.

Articles of Agreement require members to "avoid manipulating exchange rates ... to prevent effective balance of payments adjustment or to gain an unfair competitive advantage over other members."
The 2007 decision provides guidance on what constitutes exchange rate manipulation:
- A member would be "acting inconsistently with Article IV, Section 1 (iii)," if the Fund determined it was both:
- Engaging in policies that are targeted at—and actually affect—the level of exchange rate (causing it to move or preventing it from moving); and
- Doing so "for the purpose of securing fundamental exchange rate misalignment in the form of an undervalued exchange rate" in order "to increase net exports."

Clarifies implementation of surveillance in currency unions: both union-level and individual members' policies are subject to the same scrutiny as policies of all Fund members.
Member guidance:
- Retains three existing principles relating to exchange rate manipulation and intervention.
- Adds a fourth principle: "A member should avoid exchange rate policies that result in external instability," focusing on policy outcomes rather than intent.
- Elaborates on indicators that would trigger IMF review or discussions about observance of principles, updated to reflect the greater importance of international capital flows.

Updated indicators include both policy developments and outcomes, for example:
- Policy developments: protracted large-scale intervention in one direction in the exchange market.
- Outcomes: fundamental exchange rate misalignment; large and prolonged current account deficits or surpluses; large external sector vulnerabilities, including liquidity risks, arising from private capital flows.

The prior 1977 decision remained virtually unchanged despite evolution in surveillance practice, creating a disconnect between best practice and the supporting policy statement.
The 1977 principles focused on preventing manipulation for balance of payments purposes and avoiding short-term exchange rate volatility, whereas post-1977 challenges included maintenance of undervalued/overvalued pegs for domestic reasons and capital account vulnerabilities from domestic balance sheet imbalances.
The 2007 decision responds to a more integrated world economy and aims to sharpen the focus of surveillance while supporting IMF reform efforts.

IMF Survey Online, June 21, 2007 — Decision on Bilateral Surveillance (adopted June 15) — IMF's 185 member countries