G. G. Johnson
“Surveillance” entered the international monetary lexicon in 1978 when the Second Amendment of the Fund’s Articles of Agreement came into effect. The international monetary system, as it is now constituted, allows Fund member countries great latitude in their choice of exchange rate regime—in fact, they may choose virtually any regime other than pegging their currencies to gold. Members nonetheless have obligations regarding their exchange rate policies—and the Fund is required to exercise “firm surveillance” over those policies.
The introduction of surveillance gave the Fund broader responsibilities with respect to oversight of its members’ policies than existed under the par value system. Under that system, a member was required to consult with the Fund regarding its exchange rate policy only when it proposed a change in the par value of its currency, and the Fund’s role was limited to concurrence in, or objection to, the change. By contrast, to exercise surveillance, the Fund engages in a continuous review of members’ exchange rate policies, and its appraisal must consider the extent to which members’ economic policies in general—not only their exchange rate policies—are compatible with the objectives set out in Article IV of the Fund Agreement (see box on Article IV). The Fund’s purview has thus been broadened under the new system but, by the same token, its members are no longer obliged to seek its concurrence in changes in exchange rates.
Since Fund surveillance began, its effectiveness has repeatedly been questioned. The continuing volatility of exchange rates, and their prolonged divergence from levels that appear to be sustainable over time, have been matters of growing concern. Some have concluded that a new exchange system is needed—one that circumscribes the range of exchange arrangements that the Fund’s members may adopt, or that specifies more precisely the types of policies that members may pursue (see Morris Goldstein, “Whither the exchange rate system?” Finance & Development, June 1984).
Others would argue that it is neither feasible nor desirable to move to a more defined system, at least under present circumstances. They acknowledge the shortcomings of the present system, but consider that any corrections should be made within the context of that system—that is, by enhancing the effectiveness of surveillance. After outlining the main elements and recent improvements in the Fund’s surveillance procedures, this article reviews current proposals for enhancing effectiveness.
The general obligations of Fund member countries regarding exchange arrangements are spelled out in Article IV of the Fund Agreement. The principles and practices of surveillance were reviewed by William C. Hood in “Surveillance over exchange rates,” Finance & Development, March 1982. While the principles underlying surveillance have remained unchanged since their adoption in 1977 by the Fund’s Executive Board (see box on principles of surveillance), the implementation of surveillance has evolved considerably, as explained below.
World Economic Outlook and other general studies. An essential backdrop to surveillance over the policies of individual members is the Fund’s review of developments in, and prospects for, the world economy. The World Economic Outlook exercise continues year-round, culminating in a major review early each year and a supplementary review prior to the Fund’s Annual Meeting (which normally takes place in late September). Besides analyzing developments and considering prospects at the global level, the WEO assesses the policies of member countries, particularly the major industrial countries, that impinge on the world economy. In recent years this assessment has increasingly been carried out in a medium-term context, and the WEO now includes medium-term scenarios for the world economy that permit the implications of alternative national policies to be analyzed.
Preparation of the Fund’s Annual Report provides another occasion for review of issues of international economic policy. The Fund also produces studies of developments in particular policy areas, such as external debt, international capital markets, and international trade, and is a major compiler and publisher of international economic statistics. All of these activities have greatly expanded since the inception of surveillance.
Besides providing a basis for review and discussion of policy issues within the Fund and the official international community, these aspects of the Fund’s work provide an opportunity for the Fund to focus public attention on the issues involved. In recent years, the Fund has published the World Economic Outlook and many of its studies in these areas, as part of an expanding program of public information. (Those published in 1984-85 included Exchange Rate Volatility and World Trade; Formulating Exchange Rate Policies in Adjustment Programs; International Capital Markets: Developments and Prospects, 1984; Issues in the Assessment of Exchange Rates of Industrial Countries; and The Exchange Rate System—Lessons of the Past and Options for the Future, all in the Occasional Paper series.)
Article IV consultations. These consultations between the Fund and member countries are the basic vehicle for the Fund’s exercise of surveillance. The process of consultation was described in an article by Eduard Brau, “The consultation process of the Fund,” in the December 1981 issue of Finance & Development. As noted in that article, the consultation process includes preparatory work by country authorities and Fund staff, discussions in the country between the authorities and the Fund staff team, the preparation of staff reports for the Fund’s Executive Board, the discussion of reports in the Board, and the conclusion of the consultation through the Chairman’s summing up.
The policy focus of Article IV consultations evolves as new issues come to the fore. In recent years, for example, external debt and protectionism have received increasing attention; currently there is a major emphasis on fiscal imbalances and the need for structural adjustment. The techniques of analysis used for Article IV consultations have also evolved over time; as in the WEO, for example, considerable attention is now given to the medium-term implications of policy choices.
The surveillance principles specify that Article IV consultations with each member are to take place annually. This proved difficult to achieve in practice, and up to 1983 the intervals between consultations tended to lengthen. This gave rise to the present system of specifying, at the end of each consultation, the date by which the next one is to be concluded. Under this system the one-year cycle applies to a large majority of members. Longer cycles of up to two years may be specified for countries that are small enough for their policies not to have a substantial impact on other countries, that do not have Fund-supported programs in effect, and whose balance of payments viability over the medium term is not substantially in doubt.
Besides regular Article IV consultations, the surveillance principles provide for supplemental consultations when requested by the Fund. There has been some reluctance to single out member countries in this way, and the resulting rarity of supplemental consultations has itself reinforced this reluctance.
Monitoring. Under the amended Articles, members are required to notify the Fund promptly of changes in their exchange arrangements. This requirement includes, for members that peg their currencies, any changes in the level of the peg. For members that maintain more flexible exchange rate arrangements, such as individual or joint floating, small day-to-day changes in exchange rates are not subject to a notification requirement. In practice many such currencies, which include those of the major industrial countries, have experienced large cumulative changes in exchange rates over a few weeks or months, and as a result it was decided in 1983 that the Fund’s Executive Board should be kept informed of changes in exchange rates for all member countries.
In a world where the major currencies change continuously against each other, it was considered more useful to monitor indices of effective exchange rates (which measure changes in the value of a currency against a weighted average of the currencies of trading partners) than bilateral exchange rates. In view of the large differences in rates of inflation among countries, it was also considered that each country’s effective exchange rate index should be adjusted for inflation differentials (thus giving real effective exchange rates). Information is provided to the Board through comprehensive quarterly reports and through special reports when the rate of an individual country shows a large cumulative change since the country’s exchange rate policies were last reviewed by the Board.
Surveillance by the Fund
Article IV of the Fund’s Articles of Agreement provides that:
Section 1. General obligations of members
…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.
Reflecting the growing concerns about protectionism, the practice of providing information to the Board on important trade policy developments in member countries as they occur is also being developed.
Principles of surveillance over exchange rate policies
In 1977 the Fund’s Executive Board adopted the following principles governing the Fund’s performance of its functions under Article IV Section 3 (b) of its Articles of Agreement:
Principles for the Guidance of Members’ Exchange Rate Policies
A. 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.
B. A member should intervene in the exchange market if necessary to counter disorderly conditions which may be characterized inter alia by disruptive short-term movements in the exchange value of its currency.
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.
Principles of Fund Surveillance over Exchange Rate Policies
1. The surveillance of exchange rate policies shall be adapted to the needs of international adjustment as they develop. The functioning of the international adjustment process shall be kept under review by the Executive Board and Interim Committee and the assessment of its operation shall be taken into account in the implementation of the principles set forth below.
2. In its surveillance of the observance by members of the principles set forth above, the Fund shall consider the following developments as among those which might indicate the need for discussion with a member:
(i) protracted large-scale intervention in one direction in the exchange market:
(ii) an unsustainable level of official or quasi-official borrowing, or excessive and prolonged short-term official or quasi-official lending, 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
(b) the introduction or substantial modification for balance of payments purposes of restrictions on, or incentives for, the inflow of capital:
(iv) the pursuit, for balance of payments purposes, of monetary and other domestic financial policies that provide abnormal encouragement or discouragement to capital flows; and
(v) behavior of the exchange rate that appears to be unrelated to underlying economic and financial conditions including factors affecting competitiveness and long-term capital movements.
3. The Fund’s appraisal of a member’s exchange rate policies shall be based on an evaluation of the developments in the member’s balance of payments against the background of its reserve position and its external indebtedness. This appraisal shall be made within the framework of a comprehensive analysis of the general economic situation and economic policy strategy of the member, and shall recognize that domestic as well as external policies can contribute to timely adjustment of the balance of payments. The appraisal shall take into account the extent to which the policies of the member, including its exchange rate policies, serve the objectives of the continuing development of the orderly underlying conditions that are necessary for financial stability, the promotion of sustained sound economic growth, and reasonable levels of employment.
Multilateral aspects. The Fund collaborates with various other international organizations on matters relating to surveillance. The European Community, the Organization for Economic Cooperation and Development, and the Bank for International Settlements all address many of the issues with respect to industrial countries that are of concern in Fund surveillance. Joint statistical working parties are one example of the collaboration among these bodies. The Fund collaborates particularly closely with the General Agreement on Tariffs and Trade on trade policy issues, with the GATT supplying information on trade policy developments and the Fund, besides helping to concentrate members’ attention on key trade policy issues, providing the GATT with needed information on balance of payments developments. The World Bank and the Fund, which have similar broad objectives and complementary responsibilities, maintain continuous close consultation. In each of these cases the areas of collaboration have been greatly extended in recent years.
Fund management or staff participate in various forums of the Fund’s membership where surveillance issues are discussed. The Managing Director participates in meetings of the Ministers of the G-5—the five largest members of the Fund. The Fund also plays a role in forums such as aid consortia and the Paris Club, which deal with the flow of resources to individual developing countries and the resolution of external debt problems, respectively.
Fund’s public role. One aspect of surveillance not specifically addressed by the surveillance principles is the Fund’s role in informing interested public opinion on key policy issues, a role that has grown considerably in recent years. Public statements by the Managing Director have focused attention on such issues, including the identification of policy problems in individual member countries that are particularly important for the international community. The Fund’s publication program has already been mentioned.
Issues in effectiveness
The current process of analysis and discussion means that the Fund and the member usually have a good understanding of each other’s views, so that the obligation to consult, which is inherent in surveillance, is fully met. Often, moreover, the process of consultation leads to a convergence of views.
Concerns about the effectiveness of surveillance, however, focus on the fact that at any time the policies of a member may diverge to some extent from those advocated by the Fund, and that often these divergences persist for long periods. As already indicated, under the Fund’s Articles, a member has the procedural obligation to provide information and undertake consultation at the request of the Fund. There is no requirement that the Fund and the member reach agreement on the appropriateness of actions taken or not taken. In that sense, the effectiveness of surveillance rests on the ability of the Fund to persuade members of the desirability of changing their policies, and the willingness of members to take the international interest into account. Many countries have, in fact, demonstrated a willingness to take actions consistent with the views expressed by the international community.
Surveillance also can have a less direct impact through keeping international economic issues before the eyes of domestic policy makers, so that international implications are always considered, at least to some degree, in policy decisions. In this sense, surveillance has helped to prevent a retreat from the considerable progress made toward greater international economic integration since the Fund was founded, despite the severely strained economic environment of recent years. In some areas, particularly financial integration, further progress has been achieved. Moreover, following the spurt of inflation in the early 1980s, inflation rates in most countries have come down to levels not seen since before the advent of floating. The external debt crisis, if not resolved, has at least been contained.
Other developments must be considered as failures of surveillance. The debt crisis could be seen as resulting from the failure of surveillance to discourage many developing countries from taking on too much external debt in the 1970s and early 1980s. The consequences of that failure were exacerbated by a second major failure of surveillance—the severe imbalance of macroeconomic policies in a number of industrial countries, notably the United States, compounded in some instances by structural rigidities, particularly in Europe. It is such failures that have led to the widespread calls for more effective surveillance.
To provide effective surveillance, the Fund must focus its members’ attention on the key policy issues and maintain an adequate flow of information on developments and policies in member countries. This is important both for the dialogue the Fund has with its members and for the exercise of “peer pressure” by member countries on each other.
Effective surveillance requires, in the first instance, cogent analysis by the Fund. Significant advances have taken place since surveillance was introduced, particularly in evaluating country policies in terms of their medium-term implications and their international consequences, and further work is under way in these areas. While there will always be room for improvement in analytical techniques, current concerns about effectiveness focus on other aspects of surveillance—in particular, the means by which countries can be persuaded to act on the conclusions reached through consultation.
G-10 and G-24 views on Fund surveillance
At its meeting in June 1985, the Group of 10 (the industrial countries participating in the Fund’s General Arrangements to Borrow) called for “a general strengthening of international surveillance” to help achieve greater stability in exchange rates. To this end, the Group asked the Fund to consider specific proposals prepared by their Deputies, for improving the effectiveness of IMF surveillance that had been recommended. These include:
(i) increasing the ability of the Managing Director and the staff to bring international concerns to the attention of members by the following measures:
(a) a confidential exchange of views between the Managing Director and the Finance Minister should be envisaged at the end of the consultation process in the case of industrial and developing countries whose policies and performance are of greatest concern for the world economy;
(b) participation in Article IV consultations should be at an appropriate high level, and the IMF report and summing-up should be brought to the attention of key economic policy-makers;
(ii) making more candid assessments and proposals for policy changes and, when necessary, follow-up reports to the Executive Board on actions taken by the member to respond to IMF suggestions;
(iii) broadening the scope of Article IV documents to provide certain additional information and analysis;
(iv) making greater use of the supplemental surveillance procedures in the face of exchange rate and other developments that may be important or may have important effects on other members, or that have implications for the operation of the international monetary system. The Deputies invite the IMF to review the relevant decisions for invoking these procedures;
(v) continuing to develop ‘enhanced’ surveillance procedures to be applied on a case-by-case basis at the request of members, with the aim of facilitating non-IMF financing in connection with multi-year debt rescheduling or in cases where IMF assistance and advice improve the member’s limited access to external finance.
The Deputies also proposed that:
(i) the IMF periodically prepare as a special chapter of the World Economic Outlook (WEO) an expanded analysis of the international repercussions of national policies of G-10 countries and of their interaction in influencing exchange rate developments and international adjustment:
(ii) the G-10 Ministers and Governors contribute to the process of multilateral surveillance by cooperating with the IMF in reviewing, under appropriate procedures, the policies and performances of G-10 countries as well as the policy recommendations of the special chapter of the WEO.
Recommendations on surveillance were also made by the Intergovernmental Group of 24 on International Monetary Affairs (a group of developing countries) at a meeting of its Deputies in August 1985. Their report argues that “The surveillance function…of the IMF…has so far been largely ineffective on major industrial countries, resulting in asymmetry in the international adjustment process, the burden of which has fallen disproportionately on developing countries.” To achieve its objectives, “Fund surveillance should effectively influence the policies of industrial countries in a manner that would be supportive of growth, particularly of developing countries.”
With regard to the major industrial countries, the Group proposed that:
Multilateral surveillance and bilateral (Article IV) consultations should form two stages of the surveillance process, rather than two parallel operations. The first stage would involve multilateral discussions or negotiations to be conducted on a regular basis within the framework of the IMF about a mutually consistent set of objectives, and a set of policies to collectively achieve these objectives…. The second stage would involve comparison between the actual outcomes and the recommended targets or indicators, or a discussion of what measures would be appropriate when the two differ. This stage might most appropriately be conducted as part of Article IV consultations….
Once an agreement is reached on the policy changes, deviations in implementing the suggested policy changes should give rise to information notices. The country concerned could raise the matter in the Fund’s Executive Board for a full discussion as to how or why the suggested policies could not be put into effect. If the Board is not convinced of a country’s explanations, it could request the Managing Director of the Fund to discuss the matter with the country concerned and report back to the Board the outcome of the discussions for further appropriate action.
For developing countries:
Policy recommendations should be made with a view to promoting adjustment as a part of economic development. The underlying needs of finance for such adjustment should be assessed and methods for providing such finance should be indicated….
Prescriptions for change in these countries’ exchange rate policies should recognize that:
Changes in resource allocations are time-consuming and would need adequate financing…. In many developing countries, controls to limit capital outflows may become necessary for the stability of exchange and interest rates. Flexibility in regard to use of multiple currency practices is also necessary in certain cases.
The report urges that:
In view of the underlying confidentiality of the exchange of information and discussion between the members and the Fund, no publicity should be given to the conclusions of the consultations in any form.
The catalytic role of the Fund [in facilitating the flow of resources from banks and other creditors to a member country] should, in principle, be exercised without ‘enhanced surveillance.’ In cases where it proves necessary ‘enhanced surveillance’ should be considered exceptional and undertaken only at the request of a member country.
Some proposals call for the more frequent use of supplemental consultations, provision for which already exists in the surveillance principles. Such consultations could be triggered either by particular developments, such as large changes in exchange rates, or by a decision by the Executive Board, at the time of an Article IV consultation, that shortcomings in a member’s policies indicated a need for further review before the next regular consultation. The aim would be to have a more continuous dialogue with the member in situations of concern.
Greater continuity of dialogue is also an aim of proposals that the Fund follow up Article IV consultations more systematically, extending a recent innovation whereby developments and policies are discussed against the background of the conclusion of the previous consultation. A related proposal is that members be asked to reply formally to the views of the Fund.
Proposals for extended follow-up often are linked to proposals for calling the attention of authorities at the highest level to the Fund’s views. One such proposal calls for the Fund’s Managing Director, in selected cases, to be in contact with the finance minister of the member concerned regarding the outcome of the consultation.
Some of the most controversial proposals relate to publicizing the views of the Fund. As already mentioned, the Fund has actively expanded its role in multilateral forums and has taken on a more public role. But Article IV consultations have thus far been treated as confidential. The new proposals envisage the public release of staff reports, or parts of them, or, in selected cases, a public statement by the Fund’s Managing Director at the conclusion of the consultation. Such approaches have strong potential for focusing attention on key policy issues, but they raise the question of the extent to which international organizations should become involved, however indirectly, in domestic political processes. The traditional confidentiality of the Fund’s relations with member countries has been an integral part of the consultation process and the consequences of departing from that confidentiality would need to be considered carefully.
These ideas and others are currently being discussed both inside the Fund and in a variety of forums outside (see box on G-10 and G-24 views). Some of them may eventually be adopted, and will no doubt contribute to a strengthening of surveillance. In the last analysis, however, procedural innovations cannot ensure that surveillance is effective. The sovereign nations that make up the Fund’s membership are responsible for formulating their own policies, and only insofar as such policies are formulated within the broad framework of the international interest can surveillance be said to be truly effective.
New from the IMF: WORLD ECONOMIC OUTLOOK, OCTOBER 1985
Revised Projections by the Staff of the International Monetary Fund
These revised projections to the World Economic Outlook published in April 1985 review the increasing signs of hesitancy in the pace of world economic expansion in the first half of 1985, marked by a slowing of growth in the industrial countries and a significant fall in commodity prices. They show that although growth prospects for the industrial countries in the period 1985–90 remain generally on course, growth in the developing countries is expected to be somewhat lower than projected earlier.
The projections cover the current evolution of and prospects for output, employment, prices, international payments and debt, and the policy stances for both industrial and developing countries. A final section summarizes the policy conclusions that arise out of the new analysis, and a Statistical Appendix completes the volume.
* * *
WORLD ECONOMIC OUTLOOK, October 1985. Revised Projections by the Staff of the International Monetary Fund, US$10.00. (US$6.00 to university libraries, faculty members, and students)
WORLD ECONOMIC OUTLOOK, April 1985. Airmail—US$15.00 (US11.00 to university libraries, faculty members, and students); surface mail—US$12.00. (US$8.00 to university libraries, faculty members, and students).
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