3. The IMF’s Mandate and Rules of the Game

Louellen Stedman, John Hicklin, and Roxana Pedraglio
Published Date:
December 2017
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The 2007 IEO evaluation pointed out a lack of clarity in the 1977 Surveillance Decision and in the associated guidance for staff. It also noted the need for greater “trust and engagement with the membership on how to deal with new challenges” in order for the IMF to continue to carry out its surveillance mandate effectively (IEO, 2007).

As noted above, two successive decisions adopted since the 2007 IEO evaluation have refined the legal framework for surveillance and sought to clarify the IMF’s role with respect to exchange rate policy.

The 2007 Surveillance Decision and ensuing guidance for IMF staff aimed to increase the focus on exchange rate issues in surveillance. It did not create new obligations for members but updated the previous 1977 Decision, including by clarifying the concept of exchange rate manipulation, which it associated with “fundamental misalignment” of the exchange rate, and expanded guidance to members in the conduct of their exchange rate policy to include the recommendation that they avoid policies that result in external instability (IMF, 2007b). The Decision further specified developments that would require a special review and initiation of an ad hoc discussion with the member. Guidance for staff elucidated the requirement for a clear assessment of the exchange rate level in every Article IV staff report and spelled out the requirement that the staff report explicitly state that there was a “fundamental misalignment” causing external instability if found to be “persistent,” “significant,” and present beyond “any reasonable doubt.” The IMF defined “fundamental misalignment” as a departure of the underlying current account from the equilibrium current account, implying that the real effective exchange rate was not at the level that facilitated evolution of the net external asset position “in a manner consistent with the economy’s structure and fundamentals” (IMF, 2007b).

However, the 2007 Decision failed to bring about consensus among member countries.9 In particular, the requirement to declare “fundamental misalignment” was seen by some member countries as an unwelcome “labeling.” Further, some observers expressed concern that the Decision resulted in too narrow a focus on exchange rate policies, as opposed to other policies (e.g., fiscal) that may lead to instability.10

Persistent dissent about the 2007 Decision contributed to mixed results in increasing the focus on exchange rates. The 2008 Triennial Surveillance Review (TSR) noted long delays in completing a number of Article IV consultations and pointed to a “fear of labelling” in some cases (IMF, 2008b). Concluding that the attempt to apply exchange rate “labels” had “proved an impediment to effective implementation” of the Decision, the IMF issued new staff guidance, in an effort to make the Decision workable, with a revised approach that “recognize[d] the uncertainty involved in attributing outcomes to exchange rate policies as opposed to other policies” and dropped the “fundamental misalignment” labeling requirement (IMF, 2009).11

Nonetheless, the IMF continued to struggle to implement the 2007 Decision. The 2011 TSR found improvements in IMF analysis of exchange rates but pointed to some inconsistencies in assessments across countries and concluded that “the analysis of risks to external stability in many staff reports still focuses primarily on exchange rate levels and insufficiently on risks arising from the capital and financial account.” Interviews with authorities in the context of the 2011 TSR also found continued concerns about the balance of IMF work, with a number concerned about the increased focus on exchange rate issues and a few others expressing the view that greater focus and candor was needed in assessing exchange rates, reserve accumulation, and the challenges that these issues posed for global imbalances (IMF, 2011d). Concurrent with the 2011 TSR, the IMF undertook a review of the 2007 Decision and concluded, inter alia, that the economic framework underlying the 2007 Decision reflected an “exchange rate bias” because it understated the role of “other economic and financial policies and the overall interaction of all policies in determining economic outcomes” and gave “insufficient recognition to the full range of issues that ultimately influence the effectiveness of the international monetary system” (IMF, 2011b).

As agreed by the Board during the discussion of the 2011 TSR and review of the 2007 Decision, the institution sought a new way forward, through a series of staff papers and Board discussions. This effort was motivated by a recognition that the framework for bilateral surveillance “[did] not adequately capture economic realities, suffer[ed] from exchange rate bias, and hamper[ed] the discussion of policy spillovers across countries” (IMF, 2012a). In developing a new legal framework, staff sought to “strengthen the traction of Fund advice and the legitimacy of the legal framework by seeking to rebalance the treatment of external and domestic policies,” as well as to provide for more systematic coverage of relevant policy spillovers (IMF, 2012b).

These discussions culminated in a new Integrated Surveillance Decision (ISD), approved by consensus by the Executive Board in July 2012.12 The ISD set out a broader approach to exchange rate analysis that took into account the range of factors affecting the balance of payments position as well as the connection between domestic and external stability. In addition, the ISD provided for Article IV consultations to discuss issues relevant to multilateral surveillance, while not adding to member countries’ legal obligations. Accordingly, it specified that the selection of topics for Article IV consultations should take into account analyses of global risks and policy spillovers from the Fund’s multilateral surveillance products.

The ISD led to new expectations and instructions for staff on how to approach an assessment of balance of payments stability in Article IV surveillance.13 Guidance issued for IMF staff states that staff should provide “a clear bottom line assessment of the member’s BOP [balance of payments] stability, drawing from a broad range of perspectives,” covering the current account, capital flows and policy measures, exchange rates, reserves and foreign exchange intervention, and external balance sheets (IMF, 2015b). While staff is expected to use judgment in arriving at this assessment, rather than reporting mechanically on quantitative results, any difference between the staff assessment and the model result should be clearly explained. In addition to addressing the potential and actual impact of other countries’ policies and global developments on a member’s economy (inward spillovers), Article IV consultations are required to discuss outward spillovers “if a member’s policies are not promoting its own stability or … if the member’s policies are promoting its own stability, but they could nevertheless significantly affect global stability” (IMF, 2015b). The guidelines also note that a member country is not obligated to adjust its policies due to concerns about external spillovers as long as these policies promote its own stability, though countries are encouraged to take into account the impact of their policies for others and for the system as a whole. Moreover, the IMF may suggest alternative policy options that “while promoting the member’s own stability, better promote the effective operation of the international monetary system” (IMF, 2012c).

The ISD has provided a widely-accepted basis for surveillance of exchange rates. Interviews with Executive Directors and IMF staff conducted for this update found general familiarity with the ISD and acceptance of the centrality of exchange rate surveillance in the IMF’s mandate.14 Staff interviewed for this update also felt that guidance in executing surveillance in this area was clear and well-established within the institution, and they believed that the authorities with whom they engaged understood and accepted the centrality of external stability and exchange rates to the IMF’s mandate.

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