News and Analysis • Volume 11 • Number 6 • October 2007
Is the IMF Closing All Paths to Trade-led Development?
The International Monetary Fund’s latest review of criteria for surveillance over member governments’ exchange rate policies threatens to dramatically reduce developing country economies’ options for growth, job creation and diversification through trade.
Last June, the IMF decided on modifications to the main guidelines on the implementation of Article IV of its Articles of Agreement.1 The guidelines, issued originally in 1977, regulate the Fund’s role in exercising surveillance over the exchange rate policies of member countries. Ironically, the revisions will reduce policy space for developing countries to successfully use a trade- and export-led growth model, exactly the type of model that the Fund – and its sister institution, the World Bank – has preached for over twenty years developing countries should pursue.
This explains the strong reaction by the Group of 24, a developing country coalition in the IMF. When plans for the new language of the decision were unveiled, the group expressed particular concern that “expanding the principles for the guidance of members in the decision would blur the distinction between surveillance over exchange rate policies and over domestic policies.”
The IMF Board stressed that the 2007 decision would ‘not create new obligations for members’. But the changes in the new document are far from inconsequential, especially for a number of countries that had been able to establish the necessary exchange rate conditions for having a shot at harnessing trade for capital accumulation and development.
The new guidelines reiterate that a “member shall avoid manipulating exchange rates for the international monetary system in order to prevent effective balance of payments adjustment or to gain an unfair competitive advantage over other members.”
But to the hitherto existing principles that should guide the Fund’s assessment of what constitutes ‘manipulation’ it has added one that reads: “A member should avoid exchange rate policies that result in external instability.”
The 1977 decision also contained a list of developments that “would require thorough review and might indicate the need for discussion with a member.” To that list, the revised guidelines add ‘fundamental exchange rate misalignment’ and ‘large and prolonged current account deficits or surpluses’.
As a result, all that is needed for an IMF member’s policies to become objectionable is that they be detrimental to some loose notion of ‘external stability’. In fact, according to the Managing Director, Mr Rodrigo Rato, the new guidelines have the intention of putting external instability at the center of the system of surveillance.
Official statements, such as those by the IMF Deputy Managing Director John Lipsky, hold that the decision had broad support. His account, however, contrasts sharply with statements by the IMF’s Executive Director for China Ge Huayong, who claims that the guidelines were passed by “a minority of developed countries which have a lot of voting rights.” News reports mention at least two nations that did not support the changes.
Targeting Developing Countries Success Stories?
The new decision follows months of US pressure on the IMF to induce the Chinese government to revalue the exchange rate of the yuan, which many Americans blame for the growing US trade deficit. It may not be a coincidence that the decision uses the expression ‘fundamental exchange rate misalignment’, which closely mirrors the language in a bill – widely seen as a response to rising resentment against cheap goods imported from China – currently under consideration in the US Congress (Bridges Year 11 No.4 page 12).
The decision represents a step backward not only for China, but for any developing country trying to develop through exports. In the last few years, and especially as a reaction to the collapse of 1997, several Asian developing countries have aimed at increasing their level of reserves so they would be insured against a speculative attack, and spared the need to resort to the IMF. Massive purchases of foreign currency by these countries had the result of favouring low real exchange rates, with the mutually reinforcing effects of enhancing their competitiveness and accumulating sizeable current account surpluses. As increased export revenues put pressure on their currencies to appreciate, further intervention in capital inflows and the exchange market to keep currencies at that same (low) level were pursued.
The same trend has been followed by some countries in Latin America, notably Argentina. After the collapse of the one-to-one dollar-peso parity peg following the financial crisis in 2002, the continued maintenance of a competitive exchange rate for exports is one of the keys to the successful growth rates that the country has managed to sustain for four consecutive years now.2 It is worth noting that Argentina could not have maintained this regime had it not been able to make early repayment of its outstanding loans from the IMF, which was insisting on flotation of the exchange rate as a condition for renewing its loan agreement.
Denying the Role of Exchange Rates as Policy Tools
The utilisation of the exchange rate as an instrument to enhance trade performance of domestic producers is based on a solid assessment of the historical experiences of those developing countries that successfully developed through trade. In the view of some economists, all countries that have done this were able to “maintain exchange rates that are attractive to exporters over long periods of time.”3 On the other hand, the revaluation of exchange rates has frequently impacted negatively on competitiveness, income and growth prospects.
Moreover, as pointed out by UNCTAD, the exchange rate is an important policy instrument to provide domestic producers profit incentives to invest in non-traditional export sectors. Thus, a low real currency price can not only help boost the volume of exports, but also diversify their composition. Some, like Dani Rodrik, go as far as saying that “a credible, sustained real exchange rate depreciation may constitute the most effective industrial policy there is.”5 Roberto Frenkel has noted that “central bank intervention in the exchange market should be oriented to signaling the long-run stability of a competitive real exchange rate in order to give proper incentives to tradable industries, reduce the uncertainty of investment and employment decisions, and prevent unsustainable balance of payments and debt trends.”6 A competitive real exchange rate level leads to higher job generation, not only in the tradable, but also in the non-tradable sector.
By definition, the type of ‘sustained’ and ‘stable’ exchange rate required for the success of the export- based development strategy is going to require a degree of government exchange rate and monetary policy intervention. This is exactly the type of intervention that the IMF is trying to ban with its new Decision on Surveillance, with the identification of ‘large and prolonged current account surpluses’ as a factor that should trigger pressure from the IMF to correct (in this case, revalue) the exchange rate.
The decision also raises a number of issues regarding the practical difficulties in interpreting the degree of discretion it accords to the IMF authorities, which is likely to expand significantly. A main difficulty is assessing what constitutes ‘manipulation’. Indeed, there is no general agreement among economists (let alone politicians) on what constitutes a currency misalignment or, for that matter, to what extent a misalignment should be tolerated. The 1977 decision’s emphasis on the existence of an intent to ‘gain an unfair competitive advantage’ throughout all these years had left space for developing countries to pursue some degree of intervention guided by development priorities. The interpretation of newly-added expressions such as ‘result[ing] external stability’ or ‘currency misalignment’, as if they were objective situations whose existence anybody can easily determine, potentially leaves their judgment to the IMF. That the IMF is the same institution where the 2007 decision was apparently approved ‘by a minority of developing countries with a lot of voting rights’ is certainly not reassuring.
At the same time, the IMF review missed a golden opportunity to tackle a crucial issue for developing countries trying to develop through trade. Just as a stable and competitive exchange rate helps countries improve trade performance, the short-term volatility of exchange rates is harmful to such performance since it hinders any efforts to sustained and predictable investments in export-oriented economic activities. In fact, providing adequate signals in this area might account for much more improvements in supply-side capacities than all the Aid for Trade agenda together can muster (certainly more than it has mustered to date).
Exchange rate misalignments among countries that issue hard currency frequently cause episodes of exchange rate overshooting in developing countries that are associated to pronounced over and undervaluation, boom and busts cycles that hurt even those whose ‘fundamentals’ are in the best of shapes. Several civil society organisations refer to this large asymmetry in a 2003 letter to the WTO Working Group on Trade, Debt and Finance: “Since the fall of the par value Bretton Woods system in the 1970s, instability and misalignments of currency exchange rates have distorted real comparative advantages and the value of concessions on tariff and price-based trade liberalisation measures agreed to in successive trade negotiations. The IMF, having lost its leverage over countries whose currencies are held as international reserves, has proved to be an inefficient instrument for exercising surveillance over the monetary policies of those countries.”
There is certainly no willingness in the IMF’s major shareholders to vest the Fund with prerogatives that may allow it to play an effective role as co-ordinator or ‘umpire’ of the exchange rates for leading hard currency-issuers. Interestingly, noting this vacuum, UNCTAD’s last Trade and Development report calls for a new code of conduct to subject real exchange rate changes to multilateral oversight.7
The review of surveillance was a key part of the IMF Medium-term Strategy that Mr De Rato masterminded in an effort to reinvigorate the shattered credibility and relevance of the institution in the global economy. It is, however, hard to believe that the credibility of the Fund as a multilateral institution will be anything but harmed by the outcome of the review. Hopes of the IMF playing an impartial role in overseeing multilateral exchange rate co-ordination are all gone in the sheer face of the extreme similarity between the US government’s objectives and the outcome of the decision. Moreover, the blatant way the decision disregarded the will expressed by the G-24 Ministers confirms, once again, how little the voice of developing countries matters at the Fund.
Paradoxically, the impact that this decision will undoubtedly have on the credibility of the Fund has a silver lining. As a stream of early repayments continues to flow into the International Monetary Fund, credibility and quality – rather than the ‘power of the purse’ – are all the IMF has left to get the attention of developing country governments. Therefore, it is very likely that the number of countries that actually have to pay attention to IMF surveillance will continue to decline.
Aldo Caliari is Director of the Rethinking Bretton Woods Project at the Center of Concern in Washington D.C.