Wm. C. Hood
Exchange rates are an extremely sensitive point of economic contact between countries. As such, they are the focus of the Fund’s attention in its dealings with its member countries and in its concern for the stable functioning of the international monetary system. The Articles of the Fund now require that “… the Fund shall exercise firm surveillance over the exchange rate policies of members…” (Article IV, Sec. 3(b)).
There are two essential features in the exercise of surveillance. One is the definition of the norms to which economic behavior of members is expected to conform. The second is the nature of the discussions between the members and the Fund on the question of adherence to the norms. Both of these features have, of course, changed since 1973 and the passing of the par value system. Gradually, with the advent of floating rates, came a concern among the Fund’s members that it should actively pursue its function of surveillance. It does so at a multilateral level in its Executive Board meetings, in the Interim Committee, and at its Annual Meetings. It also holds frequent regular and special discussions with individual members to achieve a thorough understanding with the member of its exchange rate practices and policies, and to ensure that they are in conformity with the Articles. In fulfilling its functions, the Fund does not apply rigid criteria. Experience suggests that there is probably no unique exchange rate system suitable for all countries at any given time or even any system suitable for one country at all times. The process involves confidential dialogues between the Fund and each of its members, which contribute to the Fund’s analysis not only of the practices and policies of the individual country but also of the working of the exchange rate system as a whole. It is this analysis that forms the basis for the debate and decisions at the multilateral level.
Excerpts from Article IV of the Articles of Agreement of the IMF Obligations Regarding Exchange Arrangements
Section 1. General obligations of members
Recognizing that the essential purpose of the international monetary system is to provide a framework that facilitates the exchange of goods, services, and capital among countries, and that sustains sound economic growth, and that a principal objective is the continuing development of the orderly underlying conditions that are necessary for financial and economic stability, each member undertakes to collaborate with the Fund and other members to assure orderly exchange arrangements and to promote a stable system of exchange rates. In particular, each member shall:
- (i) endeavor to direct its economic and financial policies toward the objective of fostering orderly economic growth with reasonable price stability, with due regard to its circumstances;
- (ii) seek to promote stability by fostering orderly underlying economic and financial conditions and a monetary system that does not tend to produce erratic disruptions;
- (iii) 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; and
- (iv) follow exchange policies compatible with the undertakings under this Section.
Section 3. Surveillance over exchange arrangements
- (a) The Fund shall oversee the international monetary system in order to ensure its effective operation, and shall oversee the compliance of each member with its obligations under Section 1 of this Article.
- (b) In order to fulfill its functions under (a) above, the Fund shall exercise firm surveillance over the exchange rate policies of members, and shall adopt specific principles for the guidance of all members with respect to those policies. Each member shall provide the Fund with the information necessary for such surveillance, and when requested by the Fund, shall consult with it on the member’s exchange rate policies. The principles adopted by the Fund shall be consistent with cooperative arrangements by which members maintain the value of their currencies in relation to the value of the currency or currencies of other members, as well as with other exchange arrangements of a member’s choice consistent with the purposes of the Fund and Section 1 of this Article. These principles shall respect the domestic social and political policies of members, and in applying these principles the Fund shall pay due regard to the circumstances of members.
Throughout its history, the Fund has had responsibility for overseeing the exchange rates of its members. The responsibility was defined differently and exercised differently before 1973, when general floating of currencies set in. In that earlier period, the norms of behavior were explicitly laid down in the Articles of Agreement. In particular, members of the Fund were required to maintain a parity for the external value of their currency and to ensure that (spot) foreign exchange transactions in their countries took place at rates that did not differ from parity by more than 1 per cent. A member was to propose a change in its parity only to correct a fundamental disequilibrium and undertook to collaborate with the Fund to promote exchange stability and to maintain orderly exchange arrangements. Finally, all members—with the exception of those that felt obliged to avail themselves temporarily of postwar transition provisions—were required to forgo restrictions on current payments and discriminatory currency practices and to maintain convertibility of their currencies.
Before the Second Amendment of the Fund’s Articles, which became effective in 1978, the Fund and its members discussed the members’ performance in relation to the norms in the main during bilateral consultations. Since the norms were reasonably explicit, there was little need for more general discussion of the performance of the system. Not all members were required to consult with the Fund. Consultation was generally required only with those members who were availing themselves of the postwar transition provisions or who maintained restrictions under Article VIII. However, the practice of “voluntary” consultations with all members was well established before the Amendment of 1978 came into effect.
This situation was drastically altered by the breakdown of the par value system. (The character of the contacts between the Fund and its members between, say, mid-1973 and the adoption of the new Articles on the question of the performance of the exchange rate system was very special and is not discussed in this article.) In the amended Articles, which recognize the widespread floating of exchange rates, the obligations of the Fund to “oversee the international monetary system in order to ensure its effective operation” and to “exercise firm surveillance over the exchange rate policies of members” are made explicit for the first time. The norms of exchange rate behavior for each member country are much less explicit than they had been. On the other hand, general obligations of members regarding exchange arrangements are more elaborate. In addition, the Fund is enjoined to adopt specific principles for the guidance of members with respect to their exchange rate policies. These principles now set out in Fund decisions make the norms somewhat more explicit than do the Articles. In addition, they widen the scope for useful discussion between the Fund and the member on the member’s conformity with the norms. Moreover, there is now, more than in the pre-1973 period, a felt need for discussion by the Fund with its membership, in suitable organs of the Fund, of the performance of exchange rates looked at from a system-wide perspective.
Norms of behavior
Currently the norms of behavior of members of the Fund for exchange rate policies are set forth both in the Articles and in decisions of the Executive Board. The Articles provide guidance on the general exchange arrangements of members and on their general obligations regarding exchange rate policy. These general obligations are far-reaching. Members are required to “endeavor” to pursue the objective of economic growth and reasonable price stability in the exercise of their economic and financial policies and to “seek” to promote stability. They are required to “avoid” manipulating exchange rates so as to prevent adjustment of payments imbalances or to gain unfair competitive advantage.
Within this framework, the individual member is accorded wide freedom in the choice of its exchange arrangements. It may, for instance, maintain the value of its exchange rate within a range set in relation to the special drawing right or another currency; it may join a cooperative arrangement such as the European Monetary System; or it may allow its exchange rate to float. The Fund may also, subject to a large majority of its total voting power, make provision for general arrangements and, in particular, it may re-establish a system of stable but adjustable par values. Even in that event, however, no member would be required to adopt par value arrangements if it chose not to, provided that its exchange arrangements continued to conform to its general obligations.
These general norms for exchange rate behavior are further spelled out in principles, approved by the Executive Board, that apply regardless of the member’s actual exchange arrangements. In applying these principles, the Fund undertakes to respect the domestic social and political policies of members and to pay due regard to their economic and political circumstances. These principles enjoin members to avoid manipulating their exchange rates and to intervene if necessary in the exchange market to buy or sell their currencies to counter disorderly conditions (although in intervening a member should take into account the interests of other members).
In the 1977 decision on surveillance, the Executive Board also agreed that the Fund should consider that certain developments in particular might signal a need for discussion of exchange rate policies with a member (see box). These developments include: (1) persistent sales or persistent purchases of foreign exchange by a member’s authorities; (2) an unsustainable level of official borrowing or prolonged official lending for balance of payments (BOP) purposes; (3) the introduction, intensification, or prolonged maintenance for BOP purposes of restrictions on trade or capital flows; (4) the pursuit for BOP purposes of monetary or other domestic financial policies that provide an abnormal incentive for capital inflows or outflows; and (5) behavior of the exchange rate that appears to be unrelated to underlying economic and financial conditions.
These developments are cited not as prima facie evidence of conduct by the member country that is inconsistent with its obligations under the Articles. They are given rather as signals that warrant a discussion between the member and the Fund so that the Fund may make a full appraisal of the member’s exchange rate policies, within, of course, a comprehensive analysis of the member’s economic situation and policy.
In its exercise of surveillance, the Fund maintains contacts with members for two purposes. First, it discusses with them the developments in the multilateral exchange rate system. These discussions are held in a multilateral forum—more particularly, the Executive Board of the Fund or the Interim Committee, a ministerial committee of the Board of Governors. Second, the Fund discusses the policies of a particular member primarily at a bilateral level, but the Executive Board has occasion to review the results of most consultations.
Major Executive Board decisions on surveillance
April 29, 1977 Approved document “Surveillance over Exchange Rate Policies” and provided for a review of this document every two years. This document cited the general principles established in the Articles of Agreement and upon which the Fund’s authority rests and then outlined the specific principles for the guidance of members with respect to their exchange rate policies and the Fund’s surveillance over these policies. That would become effective with the Second Amendment. The document also set forth procedures for the exercise of surveillance by the Fund (Decision No. 5392–(77/63), pp. 10–14).
January 22,1979 Reviewed the procedures relating to the Fund’s surveillance over members’ exchange rate policies and established a supplemental surveillance procedure. Under this supplemental surveillance procedure the Managing Director may initiate informal and confidential discussions with a member when a change in that member’s exchange rate arrangements or policies or the behavior of the exchange rate is considered important or could have important effects on other members (Decision No. 6026–(79/13), p. 15).
The texts of these decisions are on pages 10-15 of the Fund’s Selected Decisions of the International Monetary Fund and Selected Documents, Ninth Issue, June 15, 1981.
Many issues may be raised in multilateral discussions concerning the working of the exchange rate system in current circumstances. One perennial topic is whether exchange rate movements are conforming to shifts in the basic determinants of exchange rates or whether they are responding unjustifiably and uncontrollably to evanescent or perverse influences. Another is whether exchange rate movements, especially of the major currencies, are subject to too wide swings or to too frequent reversals of direction. There is also the issue of harmonizing basic economic and financial policies among countries to minimize the divergences of national economic performance that contribute to instability of exchange rates. This subject is closely related to the matter of prompt adoption of suitable BOP adjustment policies by countries. Other issues that regularly appear on the agenda are the conduct of exchange market intervention by monetary authorities and the appropriateness of the existing exchange arrangements themselves.
In the Executive Board, the formal discussions of the exchange rate system are of two kinds: periodic reviews and ad hoc examinations of particular situations or events. In addition, aspects of the system may also be commented upon by Executive Directors when dealing with a variety of other topics not primarily related to Fund surveillance. The periodic reviews take place in three regular exercises involving the Executive Board: in the regular discussions of the World Economic Outlook; in discussions of the materials to be included in the Executive Directors’ Annual Report to the Board of Governors; and in the annual review of Fund activity in the general implementation of surveillance.
The World Economic Outlook is a staff document prepared at least twice a year, and the discussion of it in the Board provides the occasion for a comprehensive review of the functioning of the world economy and the exchange rate system. The discussion also sets the policy tone for Executive Directors in their consideration of the whole range of Fund matters in the ensuing period. The World Economic Outlook document and discussion also assist the Managing Director in developing the policy framework for directing the Fund’s activities, including his own specific role in surveillance.
The annual review of the performance of the international monetary and exchange rate system is published in the Annual Report of the Executive Directors and must be regarded as an integral part of the exercise of surveillance of the performance of the system as a whole. The other related periodic review in the Executive Board is the annual discussion of the implementation of surveillance by the Fund.
From time to time the Executive Directors give attention to specific developments in the exchange rate system on the basis of staff papers analyzing these developments. Examples might include the international impact of monetary policies of major countries; the exchange rate practices of developing countries; disparities in price changes and exchange rate movements; and Eurodollar developments and the exchange market. Beyond the formal meetings of the Board, seminars or other informal and off-the-record meetings are held, and some of these are devoted to the exercise of surveillance.
The Interim Committee of the Board of Governors normally meets twice a year. This group of finance ministers or central bank governors plays an essential part in the Fund’s exercise of surveillance. It reviews current and prospective economic and financial developments, the adjustment of BOP imbalances, and the working of the exchange rate system, whatever other items of Fund policy may be on the agenda. Not only do these reviews serve an educational function for those present, they also conclude with a communiqué in which the broad thrust of economic policy considered to be appropriate to the circumstances is indicated. The Interim Committee discussions take place against the background of the staff work on the World Economic Outlook, the Executive Directors’ discussion of it, and (once a year) the analyses in the Annual Report of the Directors. In addition, the Managing Director typically provides a paper to the Committee highlighting the essential features of the current scene and pointing out issues for discussion. He usually makes an oral statement as well by way of initiating discussion in the Interim Committee.
Further, the formal statements to the Annual Meetings of the Board of Governors by the Governors and by the Managing Director provide information on members’ attitudes to the working of the exchange rate system and toward improvements that might be made.
It is in the bilateral discussions of the policies and exchange arrangements of particular members that some of the most pointed aspects of the exercise of surveillance are naturally to be found. These discussions take place in the context of consultations with each member of the Fund, whether the member is actively negotiating the use of Fund resources, is in fact using them, or is in neither of these situations. (See “The consultation process of the Fund” by Eduard Brau in the December 1981 issue of Finance & Development.) Regular consultations take place at least every 18 months. These give the Fund an opportunity to review the member’s policies and exchange arrangements and to make suggestions. When a member is making extensive use of Fund resources, the Fund negotiates more or less elaborate understandings on the policies that affect exchange rates.
From time to time the Fund also holds special consultations with members that relate to the surveillance process. In connection with the preparation of the World Economic Outlook papers, for example, discussions take place with selected members to ensure that the Fund’s understanding of developments affecting them and of their recent policy changes is as comprehensive as possible. Even if a World Economic Outlook is not actively in preparation, if there are fast-breaking economic developments affecting particular members, the Fund staff will endeavor to meet with the member’s representatives so as to keep fully informed.
In addition to these consultations, the Executive Board decisions on surveillance over exchange rates provide that when the Managing Director “considers that a member’s exchange rate policies may not be in accord with the exchange rate principles” in the decision or “considers that a modification in a member’s exchange arrangements or exchange rate policies or the behavior of the exchange rate of its currency may be important or may have important effects on other members” he may initiate special procedures. In general, these procedures provide first for an informal and confidential discussion of the matter with the member and then, depending upon the outcome of the informal discussion, there may be a more formal consultation with the member, the results of which may be reported formally or informally to the Executive Board.
Several general comments are relevant to any review of the Fund’s surveillance of exchange rates. First, in exercising surveillance, the Fund must have regard to a very basic requirement embodied in the Articles that all members of the Fund must be treated equally or uniformly. This means in particular that the same degree of attention is to be given to countries that are not using Fund resources as to countries that are. It also means that equal attention is to be given to countries in surplus payments positions and countries with deficits. It means, too, that the attention given to members with major currencies must be comparable to the attention given to countries with minor currencies. In applying the uniformity principle in this latter case, it is reasonable to weigh appropriately the significance for the functioning of the system as a whole of a major as compared with a minor currency.
It is also important to note that the question as to what is the “right” exchange rate system for the world is inherently complex. There is probably no unique system that is appropriate for all times and circumstances. The par value system served the world well in a particular period. Provision is made in the Articles for a return to it should the Fund membership collectively so decide. The system that involves widespread floating was certainly generally felt to be appropriate at the time it was resorted to, even though many regretted the passing of the circumstances that would have made a par value regime more suitable.
Nor is there any absolute answer to the question of what is the “right” set of exchange rate arrangements for a given country. Again, judgment must be exercised in relation to the prevailing circumstances. Certainly there are innumerable instances through history of countries changing their arrangements as circumstances changed. The Fund in exercising surveillance must seek, with the member, to understand the member’s circumstances and then it must exercise judgment. Similarly, there is no easy answer to questions as to the “right” rate for a country at any given time nor of the pace at which the rate should move from one level to another. Such questions can be addressed only through judgment based on comprehensive analysis.
The exercise of surveillance of the practices and performance of an individual member must be exercised in a discreet and confidential manner. The Fund’s authority rests on nothing more or less than the continuing willingness of members to cooperate with it. Adverse publicity, whether warranted or not, would not contribute to the continuation of support. The Fund may bring a considerable weight of opinion to bear upon a member whose policies and practices are generally regarded within the councils of the Fund to be contrary to the general interest of the membership; by contrast, the circumstances are virtually inconceivable in which the Fund would itself actively seek to bring the weight of general public opinion to bear upon a particular member. There is a practical and basic reason for the confidentiality that surrounds the Fund’s consultations with a member. To a very considerable extent these consultations are exploratory, seeking to establish the facts and then to arrive at a meeting of minds between the Fund and the member on the implications of the facts for national policy. If all of this process were exposed to the public as it took place, the process would almost certainly have to be aborted; in addition, there would be a grave risk that the publicity would create or aggravate exchange market instability and thus be doubly counterproductive. It is inevitable, therefore, that the surveillance procedures of the Fund will have to remain like the major part of the floating iceberg—obscured from general view.
Finally, there is considerable anxiety among members of the Fund that the institution should be active in exercising its surveillance function. In recent meetings of the Interim Committee and of the Board of Governors, there have been repeated statements urging the Fund to be vigilant and resolute in the pursuit of surveillance. This concern by the membership reflects not only the very great importance of exchange rates in the international economic transactions of nations and on their domestic performance; it probably also reflects in part a feeling that, without the formality and discipline of commitment to a parity, general oversight of the system by an institution such as the Fund is warranted and essential.
The Managing Director, in his statement to the 1981 Annual Meetings of the Fund Governors, summed up the importance of the surveillance process succinctly:
The exercise of surveillance over members’ exchange rate policies is fundamental to the Fund’s functions…. Under the present conditions of sharp changes in exchange rates, coupled with widespread and uneven inflation and substantial adjustment problems facing many countries, it is essential that the Fund exercise actively its surveillance over members’ economic policies. Only in this manner will the Fund be able to contribute to the establishment of the sound underlying domestic economic conditions that are essential for achieving greater exchange rate stability.
J. de Larosière, “The Fund and Surveillance,”address to the Chicago Committee, November14, 1978, as quoted in IMF Survey (November20, 1978).
International Monetary Fund, Annual Report, 1977; 1978; 1979; 1980; and 1981.
“Interim Committee Supports New Facility, Approach to Exchange Rate Surveillance” and “Decision on Surveillance of Exchange Rates Taken,”IMF Survey (May2, 1977).
J.J. Polak, “The Fund after Jamaica,” Finance & Development (June1976).