Abstract

For the purposes of some treaties, it is necessary to measure changes in exchange rates. Under the original Articles of the IMF, for example, the IMF’s reaction to a proposed change in the par value of a member’s currency depended on whether the change, together with all previous changes, did not exceed 10 percent, a further 10 percent, or an amount beyond 20 percent, of the initial par value. The changes were cumulative, in the sense that all changes, whether upward or downward, went into the calculation as a gross and not a net amount.1 While the par value system was in operation, there was no difficulty in measuring individual devaluations or revaluations, or total changes, because there was a common denominator in terms of which these changes were calculated.

GATT

For the purposes of some treaties, it is necessary to measure changes in exchange rates. Under the original Articles of the IMF, for example, the IMF’s reaction to a proposed change in the par value of a member’s currency depended on whether the change, together with all previous changes, did not exceed 10 percent, a further 10 percent, or an amount beyond 20 percent, of the initial par value. The changes were cumulative, in the sense that all changes, whether upward or downward, went into the calculation as a gross and not a net amount.1 While the par value system was in operation, there was no difficulty in measuring individual devaluations or revaluations, or total changes, because there was a common denominator in terms of which these changes were calculated.

A member might not have established a par value or it might have allowed its currency to float upward or downward in violation of the member’s obligations under the Articles. Nevertheless, the measurement of depreciation or appreciation of the currency was not difficult. The common denominator of the par value system was gold or the United States dollar of the weight and fineness in effect on July 1, 1944, which was an indirect reference to gold through the medium of a dollar of fixed gold value. It has been seen that the United States was deemed to be maintaining the external value of the dollar in relation to gold because the United States had undertaken to buy and sell gold freely for dollars with the monetary authorities of other members. The IMF’s primary rule, therefore, for measuring changes in the exchange rate of a floating currency in terms of gold was to take the midpoint between the highest and the lowest rates, quoted in the main financial center of the country of the floating currency, for cable transfers for spot delivery of U.S. dollars.2

The changes referred to above were in par values or in the gold value of a floating currency during the period of the par value system. Par values, of course, were not exchange rates. Exchange rates were the rates at which currencies were traded in exchange transactions. The IMF and its members had to measure exchange rates in that sense also. For example, members had to take appropriate measures to confine exchange rates in exchange transactions taking place within their territories to a certain range. It was not difficult to determine whether exchange rates were or were not within the range, again because gold (or the U.S. dollar of fixed gold value) was the common denominator. For each of the currencies involved in an exchange transaction there was a par value defined in relation to gold. Therefore, there was a ratio between the two currencies, called the parity, and the legal limits (margins) that demarcated the permissible range were simply defined as a percentage above and below the parity. Similarly, in the EMS today there is no difficulty in recognizing whether the margins for exchange rates between EMS currencies are being respected or whether the divergence threshold has been crossed, because the ECU functions as a common denominator for the ERM.

There is now no common denominator for the purpose of regulating exchange rates in the discretionary system of exchange arrangements under the Articles of the IMF. A so-called change in an exchange rate of a currency must now be explained as a change against some particular standard. For example, a change against one currency may not be a change against another currency. Even a change against a composite of currencies, such as the SDR or the ECU is a change in the sum of the weighted changes against the currencies that comprise the composite but not necessarily a change of the same amount against other currencies unless they are currencies pegged to the composite. This statement does not mean that a standard of measurement cannot be found that would have broad or general application.

A standard of measurement can be either common or uniform. A common standard would be the same for all the currencies to which it was applied. The SDR would be an example of such a standard because it would permit no variations in its application to currencies. A uniform standard would be the same kind of standard but not the same standard, because there would be variations in its application among the currencies to which it was applied. An example of such a standard would be a basket of currencies determined by the pattern of trade, but necessarily the pattern would differ from currency to currency except in the highly unlikely event that the pattern for two currencies was the same. As a consequence, if it becomes necessary for the purposes of a treaty to measure changes, the standard against which to make the measurement must be specified.

The GATT is a major treaty under which a problem of measurement has arisen for the purpose of one provision. The negotiators of the GATT assumed the continued existence of the par value system, but an attempt to adapt the treaty to the new conditions that emerged after the par value system had disappeared was considered an arduous task, and even one that might not succeed if undertaken. The effect of Article XXX:1 of the GATT is that the provision under which the problem arose could be amended only if all contracting parties accepted a proposed amendment.

The problem of measurement was related to a fundamental objective of the treaty, and it was essential to find a solution. A central obligation under the GATT is the tariff concession. It is a commitment by a contracting party not to levy more than a stated tariff on a “bound” item. Tariffs fall into three classes: (i) an ad valorem duty, expressed as a percentage of the current value of an import; (ii) a specific duty, expressed as a fixed amount for a physical unit of an import, such as two pesos per bottle; and (iii) a compound duty, composed of both ad valorem and specific elements.

The specific duty is the least popular category, but it gave rise to the problem of measurement. An increase for an importing country in the domestic currency value of an import, whether resulting from an increase in the foreign price or a depreciation of the domestic currency, does not affect the level of protection afforded by an ad valorem duty. In the case of a specific duty, however, the level of effective protection, or, in other words, the ad valorem rate of protection, increases with upward movements in the value of an import in terms of the currency of the importing country. As the rate of protection afforded by an importing country’s specific duties is whittled away by depreciation of the country’s currency, the negotiators of the GATT realized that a contracting party would be willing to bind specific duties in tariff negotiations only if the duties could be adjusted. A formula for adjustment is set forth in Article II:6(a) of the GATT, which in pertinent part still reads as follows:

The specific duties and charges included in the Schedules relating to contracting parties members of the International Monetary Fund, and margins of preference in specific duties and charges maintained by such contracting parties, are expressed in the appropriate currency at the par value accepted or provisionally recognized by the Fund at the date of this Agreement. Accordingly, in case this par value is reduced consistently with the Articles of Agreement of the International Monetary Fund by more than twenty per centum, such specific duties and charges and margins of preference may be adjusted to take account of such reduction …

The problem this provision was meant to resolve did not vanish with abrogation of the par value system. A substitute standard had to be found once it became impractical to apply the common denominator of the par value system, in order to preserve the effect of the provision. In theory, the U.S. dollar, another currency, the SDR, or another composite of currencies could serve as the substitute. The alternative to a common standard could be a standard for each currency. If, for example, the currency of Patria was pegged to another currency or to a basket of currencies, a change in the exchange rate of Patria’s currency could be measured in relation to the currency of the peg or in relation to the basket.

Any single currency to serve as the common standard would have certain disadvantages, even if agreement could be reached on the currency. For example, it would follow necessarily that no changes would be deemed to occur in the exchange rate of the chosen currency. Therefore, the contracting party that issued the currency would not have the benefit of Article II:6(a) of the GATT if the protective effect of the country’s specific duties had been eroded, even though the contracting party probably would be a major trading country. A standard of measurement cannot itself be presumed to be subject to measurable change. Furthermore, the country of the denominator currency would be at a disadvantage in comparison with countries that made substantial imports from it, because this solution implicitly but necessarily postulated the stability of the denominator currency.

The economic policies and conditions of the country of the currency in which the standard was denominated could have a major influence on the exchange rates of the currencies of other countries. De facto instability in the policies and conditions of the chosen country might produce frequent and disequilibrating changes in the exchange rates of other currencies according to such a technique of measurement, notwithstanding the de jure (that is to say, postulated) stability of the denominator currency. The occasions on which other countries invoked Article II:6(a) might be embarrassingly numerous.

A further objection to a single currency as the standard was that it would be an unsatisfactory indicator of the effects of changes in exchange rates on the protection offered by specific duties in countries that did not import on a large scale from the country of the denominator currency. Another currency might be stable against the denominator currency but depreciate against the currencies of countries from which there were substantial imports.

In view of the disadvantages of a currency as the common standard of measurement, it might be assumed that the SDR would be the most likely choice as a basket of currencies. Nevertheless, for various reasons, the SDR has not been chosen as the solution: (1) A number of currencies are pegged to the SDR. No change would appear in the exchange rate of such a currency against the SDR, except when the peg itself for that currency was modified. (2) A change in the relationship of a currency to the SDR is equivalent to the weighted sum of the changes in relation to all the currencies in the basket. However, a change in the exchange rate in relation to the SDR of a currency in the SDR basket, say, the French franc, would be equivalent to the weighted sum of the changes in relation to the currencies in the basket except for the French franc. A currency has no exchange rate in relation to itself. The effect of the exception is that the SDR would not be a true common standard for measuring changes in the exchange rate of each currency in the SDR basket. (3) It would be highly unlikely that the weights of the currencies in the SDR basket would be an exact reflection of the pattern of a country’s imports.

A composite of currencies other than the SDR as a common standard is imaginable, but it would be subject to the same disadvantages as the SDR and to some others as well. It would not be easy to negotiate international agreement on the currencies to be included in the composite and on the weights to be assigned to them.

The solution for the GATT has not been simple. It is an individual standard for each currency. The solution applies a uniform (but not a common) standard in the sense that a single formula determines the way in which the individual standards are calculated. An index is constructed for a country’s (Patria’s) currency that takes account of the currencies of the countries from which Patria imports, with weights proportionate to the share of each country in Patria’s total imports.

This solution has its own disadvantages. It measures changes in terms of the domestic currency in the unit price of all imports and not solely changes in the unit price of those imports on which specific duties are to be adjusted. The duties may not apply to all imports or to imports from all countries. An imperfect solution is preferable to no solution or to a solution perfect in principle but too complex to administer conveniently in practice. As Alan Greenspan has said, “better is better than not better.”3

The GATT Council of Representatives, on January 29, 1980, approved Guidelines for Decisions Under Article II.6(a) of the GATT. Paragraph (a) of the Guidelines provides that if a contracting party requests an adjustment in bound specific duties to take account of the depreciation in its currency, the Contracting Parties must ask the IMF to calculate the size of the depreciation. The IMF must be asked also to determine the consistency of the depreciation with the Articles, but what is meant by consistency is unclear in view of the permissiveness of the discretionary system of exchange arrangements. Perhaps a decision by the IMF that a member’s exchange rate represented manipulation of exchange rates or the international monetary system in violation of Article IV, Section 1 of the IMF’s Articles would be the clearest and most obvious case of inconsistency, but the IMF has not adopted such a decision so far.

Paragraph (b) of the Guidelines refers to a concept of the “import-weighted average exchange rate” of the applicant’s currency. A change under this concept is calculated by comparing the average value of this exchange rate over the six months preceding a request with the average value over the six months preceding a specified reference date (the date when the specific duties were last bound or adjusted consistently with the GATT). To ensure that the depreciation is not temporary in the world of fluctuating exchange rates, at least a year must elapse after the reference date before a request is made. To ensure accuracy, the calculation normally should be based on the currencies of the trading partners from which the applicant imports at least 80 percent of its total imports. Special provisions are adopted for cases in which (i) the applicant expresses its specific duties in terms of other currencies or an international unit of account instead of the applicant’s currency, or (ii) the applicants participate in a customs union, such as the EC, and define their common specific duties in terms of a unit of account composed of the currencies of the participants in the customs union.

Under paragraph (c) of the Guidelines, if the IMF notifies the Contracting Parties that a depreciation exceeds 20 percent and is consistent with the IMF’s Articles, the Contracting Parties are deemed to have authorized the adjustment requested by the applicant. The depreciation must be more than 20 percent to justify an adjustment, in order to discourage requests inspired by minor depreciations. (It is not uncommon in international arrangements to include a provision that changes in exchange rates less than a defined amount are to be ignored for the purpose of the arrangement.) A safeguard is provided if a contracting party complains that adjustment under Article II:6(a) in accordance with the Guidelines would impair the value of the concession.

Paragraph (d) of the Guidelines provides a further safeguard if, during the period of six months beginning six months from the date of the IMF’s notification under paragraph (c), a contracting party claims that the value of a concession adjusted in accordance with the Guidelines has been impaired by a partial or full reversal of the depreciation on which the adjustment was based. The Contracting Parties may then decide to modify or withdraw their authorization of the adjustment.

IMF

Under Article IV, Section 1 of the IMF’s Articles, 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,” and each member is obliged to

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.

Devaluation or depreciation of a member’s currency usually improves the member’s competitive position. The difficulty is to determine whether changes in exchange rates are inconsistent with the general undertaking to collaborate or with the particular obligation to avoid manipulating exchange rates.4 A similar difficulty existed under the IMF’s original Articles, which were understood to prohibit a devaluation that went beyond what was necessary to correct a fundamental disequilibrium and was unfairly competitive.5 Although the difficulty precedes the establishment of the discretionary system of exchange arrangements, the problem exists now in radically different circumstances and in principle could arise more frequently than under the par value system. The devaluation of the currency of an industrialized member country in October 1982 against the basket to which the currency was pegged caused some concern in the IMF that the devaluation might have been more than was appropriate under Article IV and that it might provoke retaliatory changes in exchange rates by other members. Progress toward a stable system of exchange rates might have been imperiled. It should be noted that the standard for measuring the change that gave rise to concern was an individual one adopted by the member itself.

The incident drew attention to the fact that the IMF had not institutionalized a quantitative indicator of changes in exchange rates. The formulation of such an indicator had been resisted because it might have pointed more often to members that pegged the exchange rates of their currencies than to other members. The members subject to this disproportionate effect were more likely to be smaller developing countries. It might have seemed to them that the primary purpose of such an indicator would be to focus on changes in the peg and therefore to discriminate against these countries. Industrialized countries, however, might have had an equal objection because of the suspicion that the true objective of an indicator would be to monitor changes in the floating exchange rates of their currencies because of the importance of these currencies in international trade and payments. Furthermore, it might have been suspected by members, whether industrialized or developing, that the establishment of norms related to changes in exchange rates was the real motive of the proposal, so as to extend the regulatory authority of the IMF and diminish the freedom of members assured to them by the discretionary system.

The IMF is directed by the Articles to exercise firm surveillance over the exchange rate policies of members. The basic decision of the IMF on surveillance describes developments that might indicate the need for special discussions by the organization with a member.6 One development is “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.”7 It was agreed that an objective indicator of behavior of the exchange rate would be useful for informing the IMF’s Executive Board of changes that might deserve its attention because of this language. A formal procedure based on an indicator would relieve the Managing Director of the burden of making possibly unpopular judgments about the changes he should place on the agenda of the Executive Board. A general and nondiscretionary practice on the changes to be notified to the Executive Board would not be open to an objection of discrimination by any member or by any class of members.

Agreement was reached in March 19838 and has led to the development of criteria adapted to the circumstances of each member. The doctrine of the uniform treatment of members, which is much relied on in the affairs of the IMF, and sometimes excessively, does not, as a matter of law, impede recognition of realistic differences among members or classes of members when differences are inherent in the character of the relevant provision and recognition of them promotes the purposes of the IMF.9 In this respect, although not in others, the practice resembles the solution of the uniform standard found for Article II:6(a) of the GATT.

The IMF’s practice is to give the Executive Board notices of “real effective exchange rates,” which are defined for all members by the IMF staff as “nominal effective exchange rates adjusted for relative movements in local currency cost or price levels between the home country and the rest of the world.” The nominal effective exchange rate of a member’s currency is calculated as a weighted average of the exchange rates for the currency against the currencies of the member’s trading partners. The nominal effective exchange rate is adjusted for the purpose of arriving at the real effective exchange rate by taking account of the member’s comprehensive cost and price competitiveness. Notices of real effective exchange rates are provided to the Executive Board quarterly, as well as special notices for individual members whenever specified changes occur in these exchange rates for member’s currencies. The special notice is given whether a change is upward or downward, whether the change takes place in a single step or is the cumulative effect of various steps, and whatever the member’s exchange arrangement may be.

A special notice is given if the amount of a change or changes in the real effective exchange rate for a member’s currency is 10 percent or more from such exchange rate on the latest occasion on which the Executive Board has discussed the member’s exchange rate policy. Usually, this discussion will be the final stage of the most recent of the IMF’s periodic consultations with members under its procedures for surveillance over the exchange rate policies of members. As in the solution adopted for the purpose of Article II:6(a) of the GATT, lesser changes are exempted from the procedure.

A notice does not necessarily imply that a change is inconsistent with a member’s obligations under the Articles or is in any other way disturbing. The Executive Board may have criticized the member’s exchange rate policy as harmful to the member’s competitiveness, and change may have been brought about as a response to that criticism and encouragement of a change. Another reason why a notice in itself does not imply that the exchange rate has become, or is becoming, inappropriate or contrary to the member’s obligations is that a country’s comprehensive cost and price competitiveness is not the only influence on its balance of payments position. The evolution of a real effective exchange rate may have to be evaluated by taking account of other economic developments.

Conversely, the absence of a notice under the procedure is not irresistible evidence that the exchange rate continues to be desirable. The real effective exchange rate is an indicator related to the current account of the balance of payments and purchasing power parity, and not an indicator of the impact of capital flows on exchange rates. The many technical problems connected with the determination and implications of the real effective exchange rate and changes in it are one reason why the IMF continues to adapt its procedure.

The procedure of individual notices is a safeguard, in some ways comparable to the safeguards under the decision on the Guidelines for Decisions under Article II:6(a) of the GATT. A purpose of the procedure under the GATT is to protect a contracting party if the exchange rate for its currency undergoes certain changes, while the IMF’s procedure is designed to protect other members if certain changes take place in the exchange rate of a member’s currency. The procedure, however, can protect the member itself if the exchange rate for its currency may have become disadvantageous to the member.

As a result of the procedure, Executive Directors of the IMF and members are kept aware of developments in exchange rates. Under the IMF’s Rules and Regulations the agenda of the Executive Board may include any item requested by an Executive Director.10 The Articles11 and the By-Laws of the Board of Governors12 provide that each member not entitled to appoint an Executive Director may send a representative to attend any meeting of the Executive Board when a request made by, or a matter particularly affecting, the member is under consideration by the Executive Board. These procedural safeguards protect the interests of all members, whether a member has a grievance or has been the target of a complaint.

For the purpose of calculating real effective exchange rates, members are divided into three classes. The indicator is applied to each class in such a way that an increase in the level of the indicator implies an appreciation of the exchange rate or a loss in comprehensive cost and price competitiveness. For the first class, consisting of industrialized countries, the weighting scheme is based on production and trade in manufactures. The second class consists of smaller industrialized countries and most developing countries, and for these members the weighting scheme takes both manufactures and primary products into account. The third class consists of a small number of countries for which there are statistical difficulties. Ad hoc calculations have to be made for these members.

The IMF’s practice involves a uniform standard of measurement in the sense described earlier, because the practice establishes an individual standard for each member by which to measure change in the real effective exchange rate of its currency. In this respect, the practice resembles the GATT Guidelines, but differs from them in the technique for determining the individual standards. Under the Guidelines, the formula for this purpose is the same for all contracting parties. Under the IMF’s practice, different formulas are applied to the first and second classes of members, while for the third class a different formula could be applied to each member of that class.

The allocation of a member to a class and the details of the index of competitiveness to be applied are discussed with the member, and its agreement is sought. This procedure should make it impossible for a member to argue that the standard applied to it is unfair. A notice to the Executive Board usually includes a detailed explanation of the change in the real effective exchange rate and an appraisal by the IMF’s staff of the member’s balance of payments prospects. The staff may conclude that a depreciation is appropriate or that an appreciation has not resulted in a worrisome loss of competitiveness.

This discussion of the IMF’s practice is concluded here with three comments. First, it will be apparent that such concepts as the nominal effective exchange rate, real effective exchange rate, and import-weighted effective exchange rate have special legal or operational importance for particular purposes in the discretionary system of exchange arrangements.13 Each concept permits a variety of weighting schemes, among which the choice depends on the particular analytical purpose that is to be served. The purposes lead not only to different calculations but also to different results. Second, the results shown by real effective exchange rates are no more than indicative at best. To reach reasonably safe economic judgments, other indicators must be taken into consideration. Third, the IMF’s practice measures changes in exchange rates, and therefore the notices to the Executive Board do not apply to cases in which exchange rates have been immobile. This behavior of the exchange rate may cause justifiable concern, but any such anxiety will have to be expressed in the IMF’s periodic consultations with members or in negotiations with members for use of the IMF’s resources.

1

Article IV, Section 5(c) (original Articles).

2

Joseph Gold, Maintenance of the Cold Value of the Fund’s Assets, IMF Pamphlet Series, No. 6 (Washington: International Monetary Fund, 2nd ed., 1971), pp. 18–24, 51–53.

3

New York Times (New York), June 5, 1983, p. 12 F.

4

It is not implied by this formulation that the immobility of an exchange rate cannot be inconsistent with these obligations.

5

Article IV, Sections 4 and 5(a) (original Articles).

6

Selected Decisions, Fifteenth Issue, pp. 9–18.

7

Ibid., p. 12.

8

International Monetary Fund, Annual Report, 1983 (Washington, 1983), pp. 144–45,

9

Joseph Gold, Legal and Institutional Aspects of the International Monetary System: Selected Essays [Volume 1] (Washington: International Monetary Fund, 1979), pp. 57–70, 469519; ibid., Volume II (1984), pp. 255–307.

10

Rules and Regulations, Rule C-6.

11

Article XII, Section 3(j).

12

By-Laws, Section 19.

13

The U.S. Internal Revenue Service applies the concept of a “weighted average exchange rate” for certain tax purposes (Temp. Treas. Reg. 1.989(b)-IT). The concept is defined as “the simple average of the daily exchange rates (determined by reference to a qualified source of exchange rates within the meaning of §1.964–1(d)(5)), excluding weekends, holidays and other nonbusiness days for the taxable year.” “A qualified source of exchange rates shall be any source which is demonstrated to the satisfaction of the district director to reflect actual transactions conducted in a free market and involving representative amounts. In the absence of such a demonstration, the exchange rates taken into account in the computation of the earnings and profits of the foreign corporation shall be determined by reference to the free market rate set forth in the pertinent monthly issue of ‘International Financial Statistics’ or a successor publication of the International Monetary Fund, or such other source of exchange rates reflecting actual transactions conducted in a free market and involving representative amounts as the Commissioner may designate as appropriate for this purpose.” Weighting for the purpose of the Internal Revenue’s concept takes account of the volume of transactions to which an exchange rate applies when the exchange rate enters into the calculation of an average.