Biennial Review of the Fund's Surveillance—Overview; Modalities of Surveillance; Content of Surveillance; and Public Information Notice on the Executive Board Discussion

Biennial Review of the Implementation of the Fund's Surveillance and of the 1977 Surveillance Decision - Overview, Modalities of Surveillance, and Content of Surveillance


Biennial Review of the Implementation of the Fund's Surveillance and of the 1977 Surveillance Decision - Overview, Modalities of Surveillance, and Content of Surveillance

I. Introduction

1. This biennial review examines the implementation of the Fund’s surveillance over members’ exchange rate policies and considers the principles and procedures set out in the 1977 Surveillance Decision.1 This review comes in the wake of several Board discussions of surveillance, discussions of reports with a surveillance dimension such as those of the Independent Evaluation Office (IEO), and close attention to the conduct of Fund surveillance by the International Monetary and Financial Committee (IMFC) over the past two years.2

2. This paper summarizes two companion papers, one on the content of surveillance and the other on its modalities, and proposes issues for discussion by Executive Directors.3 Specifically, it consists of the following elements: (i) a brief overview of the purposes and organization of Fund surveillance; (ii) a description of the methodology and objectives of this review; (iii) a presentation of the conclusions of the companion papers grouped around four dimensions of surveillance, namely staff analysis, policy dialogue with country authorities, communication of the Fund’s views, and assessments of the overall effectiveness of surveillance; (iv) a discussion of resource implications; and (v) issues for Board discussion, focusing on definition of priorities for surveillance activities for the next two years.

II. Purposes and Organization of Surveillance

3. As required under the Articles, the Fund conducts surveillance to oversee members’ compliance with the obligations specified under Article IV, Section 1. Regarding those obligations that relate directly to exchange rate policies, the Board adopted general principles in 1977 that continue to provide guidance to members on the performance of these obligations. With respect to those obligations relating to the performance of domestic economic and financial policies, which are very general in nature, Fund surveillance has evolved over the years, reflecting changes in the international financial system. Members are required to provide the Fund with such information that the Fund considers necessary to enable it to conduct its surveillance activities (M,5).4

4. The Fund exercises its surveillance mandate through Article IV consultations, which in principle take place annually, Board discussions of global developments, and maintenance of close contacts with members. The Fund may also make use of special consultations and supplemental consultations. In practice, these procedures have rarely been used. Article IV consultations, which culminate in Board discussions, involve multiple steps and outputs, including compilation of economic and financial data, production of analytical studies, dialogue with country authorities, communications with non-officials, and written reports (M,6).5

5. In the context of its regular Article IV consultations, discussions may often include matters that do not directly relate to the performance of members’ obligations under Article IV, Section 1. These discussions, however, are voluntary in two senses. First, the Fund is not required to discuss these matters. Second, the Fund cannot require the member to provide information respecting these issues for the purposes of surveillance (M,7).

6. The exercise of the Fund’s surveillance mandate in Article IV consultations and formal Board discussions of global developments is informed and supported by many complementary activities. These activities, which rely on members’ voluntary cooperation, include: staff visits; participation in the joint Fund-Bank Financial Sector Assessment Program (FSAP), which result in Financial System Stability Assessment reports (FSSA); participation in the standards and codes initiative, which result in Reports on Observance of Standards and Codes (ROSC); informal Board meetings on country matters; World Economic and Market Developments sessions; the quarterly vulnerability assessment exercise; publication of Article IV consultation documents, and outreach activities, such as conferences and seminars (M,8).

7. The Executive Board has regularly reviewed the implementation of the Fund’s surveillance and the 1977 Surveillance Decision.6 In addition to amendments to this decision, the reviews resulted in Board conclusions on the conduct of surveillance, which were laid out in summings up and transposed in successive operational guidance notes to staff. Notably, in the 2002 review of surveillance, Executive Directors came to the following conclusions on the coverage and focus of surveillance: (i) coverage of surveillance had expanded over the years from a relatively narrow focus on fiscal, monetary, and exchange rate policies to a broader purview encompassing external vulnerability assessments, external debt sustainability analyses, financial sector vulnerabilities, and structural and institutional policies that have an impact on macroeconomic conditions; (ii) the broader coverage of surveillance constituted a necessary and positive adaptation of surveillance to a changing global environment; (iii) individual Article IV consultations should continue to focus on key issues, and the twin objectives of breadth and focus could only be achieved by ensuring selectivity of coverage according to country-specific circumstances; and (iv) coverage of individual consultations should be guided by selection of topics based on macroeconomic relevance and, within these topics, matters at the apex of the Fund’s hierarchy of concerns—i.e., external sustainability, vulnerability to balance of payments or currency crises, sustainable growth and the policies to achieve it, and, for systemically important countries, conditions and policies affecting the global or regional economic outlook (C,3).

III. Objectives and Methodology of the Review

8. This review revolves around one central question: how can surveillance be made more effective across the whole membership? Considering the chain of activities that composes Fund surveillance and the complex relationship between the surveillance process and its ultimate economic objectives (i.e., financial stability and sustained sound economic growth), this question is approached by analyzing four different facets of Fund surveillance and related activities: the focus and depth of the Fund’s economic analysis and policy advice; the nature of the policy dialogue with country authorities; communication of the Fund’s policy messages, including signaling to creditors and donors in the context of surveillance; and assessments of the overall effectiveness of surveillance. Through this approach, the review seeks to answer the IMFC’s call for proposals to enhance the focus, quality, persuasiveness, impact, and overall effectiveness of surveillance (M,2-3).7

9. The review does not seek to assess whether Fund advice was right or wrong, or whether Fund surveillance was effective or ineffective, in individual cases. Neither does the review for the most part attempt to assess whether analysis of, or policy recommendations on, a particular issue—say, short-term macroeconomic projections or medium-term fiscal targets—were generally right across the membership. Answering these questions—for a few countries or a few issues—would have necessitated in-depth country- case studies, similar to those done in the wake of financial crises, or exhaustive cross-country studies, such as those undertaken in reviews of the implementation of the 1994 Madrid Declaration.8 These were beyond the scope of this review (M,17).

10. The review consists of an in-house assessment complemented with additional perspectives. The in-house assessment is based on a detailed survey of Article IV consultation documents covering all consultations concluded by the Executive Board between January 2003 and early March 2004, a review of multilateral surveillance documents, analysis of information on other surveillance activities (e.g., staff visits), a survey of mission chiefs, and collection and analysis of data on resource costs. The focus of all these activities was largely determined by the conclusions of the 2002 biennial review of surveillance, which identified several areas for improvement. In addition, staff explored different concepts of quality, attempted to define better the stages underlying the surveillance process, conducted a number of outreach activities to gather views external to the staff, and attempted to define monitorable objectives. Outreach activities included interviews, surveys, and workshops with country authorities (including Executive Directors), market participants, think tanks and other non-governmental entities, and the media (C,6; M,13-16).

IV. Focus and Quality of Analysis

11. Well-focused surveillance exercises and well-substantiated analyses are essential for effective surveillance. This section presents results on the scope of Fund surveillance and aspects of the quality of its analyses in the past two years, and puts forth recommendations for further improvement.

A. Focus

12. Under the expanded reach of surveillance, the challenge has been to keep individual Article IV consultations focused on key issues. As indicated above, the Executive Board agreed that this is to be achieved by ensuring that coverage is adapted to country-specific circumstances, with selection of topics based on macroeconomic relevance and, more pointedly, on matters at the apex of the Fund’s hierarchy of concerns (C,3).

13. This review confirms that Fund surveillance has generally succeeded in embracing the wider coverage without losing focus, a conclusion initially reached in the 2002 biennial review of surveillance. The focus of surveyed Article IV consultation reports varies substantially across countries, according to country-specific circumstances. In the view of assessors, the scope of coverage was broadly adequate—i.e., it was neither too broad nor too narrow, the focus of the consultation was clearly set out and well justified, and covered issues met the criterion of macroeconomic relevance—in more than three quarters of these reports (C,8-9).

14. Nevertheless, there remains scope for greater selectivity in coverage of individual Article IV consultations. Specifically, one could seek:

  • Narrower but, when necessary, deeper coverage of macroeconomically relevant issues outside the Fund’s traditional areas of expertise. On occasions, the treatment of one or another of these issues in the Article IV consultation report was not substantive, which raised doubts about the quality of exchanges between staff and the member on this issue and, overall, the benefit from its inclusion in the coverage of the consultation (C,33,37,102,103,122; M,20). This could be remedied by (i) greater selectivity of coverage of these issues in individual consultations; (ii) greater use of information from outside experts, such as the World Bank or the OECD, on covered issues; and (iii) where information or expertise is unavailable to cover with appropriate depth an issue, acknowledgment of this situation and recommendations to remedy it (e.g., inclusion in country team’s work program, recommendation to undertake a ROSC).

  • More selective coverage of trade issues. The coverage of trade issues has improved in the last two years, particularly for systemically important members. Nevertheless, it remains unfocused or insufficiently selective for a significant portion of the membership. In some cases, important elements, such as significant changes in regional trade agreements or sizable foreign impediments to export performance, were not highlighted. In some other cases, coverage was considered too lengthy given country specific circumstances—e.g., a largely open trade regime, no significant concern about market access, and no systemic impact of trade policies. Trade issues should be covered if they have an important influence on growth prospects or promotion of stability (C,29-30,37). Where covered, treatment of trade policies should be closely linked to discussions of other economic developments and policies.

  • Streamlined formal requirements on coverage of Article IV consultations. Country authorities perceive that attempts to cover a large number of secondary issues in Article IV consultations are distracting. The tendency to use the Article IV consultation process as a “catch-all” vehicle to address a variety of Fund-wide issues of interest should be discouraged. A number of guidance notes on coverage of issues beyond the macroeconomic and financial areas could be cancelled or modified to reflect better the need for selectivity in coverage of individual Article IV consultations (M,28-30).

  • Provision of information to the Board through different channels than Article IV consultations. Some information currently included in Article IV staff reports might be more efficiently provided to the Board in a different way—for example, on a designated space on the intranet, where information would be updated as appropriate and referenced in staff reports, or through omnibus reports (M,31).

15. In addition, the focus of individual surveillance exercises could be subject to greater debate, announcement, and accountability.

  • Debate. As regards bilateral surveillance, some country authorities have expressed the desire to have exchanges of view with Fund staff on priorities for analytical work. Indeed, such dialogue has long been part of good practice. Such informal exchanges might be promoted. In addition, interdepartmental pre-brief meetings, which have become more frequent, have proven useful in surfacing different perspectives on key policy issues at an early stage. They could be used to discuss the strategic focus of consultations more systematically (M,27). As concerns multilateral surveillance, Executive Directors have used discussions on WEO reports and GFSRs to suggest topics that could usefully be covered in future WEO reports and GFSRs. Staff welcomes this practice, which is useful input in the staff’s choices.

  • Announcement. Country work programs, which would be articulated around limited sets of priorities and include a multi-year perspective, could be disseminated to the Board at the time of Article IV consultations (M,27).

  • Accountability. The selection of particular topics is ultimately the responsibility of the staff, who should be held accountable for the choices made. In each staff report, inclusion of a few sentences indicating the topics selected as the main focus is therefore critical. Discussions of individual Article IV consultations, WEO reports, and GFSRs would be vehicles to consider whether these choices were appropriate, given the Fund’s surveillance mandate and the priorities for surveillance activities set by the Executive Board (see paragraphs 7 and 78). At an aggregate level, subsequent reviews of surveillance would be another.

B. Quality

16. The review focused on two of aspects of the quality of analysis, namely depth of coverage by topic and freshness of perspective.

Depth of coverage

17. At the conclusion of the 2002 biennial surveillance review and in subsequent policy discussions, the Executive Board identified several issues whose coverage in Fund surveillance could be strengthened. These were spillovers effects of policies in systemically important members, exchange rate issues, financial sector issues, external vulnerability assessments—including balance sheet analysis and debt sustainability—, and sources of growth. In addition, the Executive Board decided to return to coverage of social issues in Fund surveillance and consideration of IEO suggestions on social program protection, and to review the Fund’s experience with governance issues in the context of this biennial review. This section outlines the conclusions of the review of coverage of these issues in Fund surveillance over the past two years and offers recommendations for further improvement.

18. Two main messages emanate from this review of coverage of specific issues in bilateral surveillance. First, coverage of a few areas, which have a direct bearing on matters at the apex of the Fund’s hierarchy of concerns and are within the Fund’s areas of expertise, should be strengthened further. These areas include the systemic impact of the policies of the largest economies and the transmission of shocks at a global or regional level; financial sector stability; exchange rate issues; and vulnerability assessments. Some Article IV consultations already meet requirements in these areas. For others, the challenge lies in moving toward best practice. As discussed in Section VII, progress may be constrained by availability of staff resources. Second, as highlighted above (paragraph 14), coverage of macroeconomically relevant issues outside the Fund’s traditional areas of expertise has been, but could still be more, selective.

Global and regional spillovers

19. The review considered the extent to which Article IV consultations focused on developments and risks in the global economy or in the region; and the extent to which surveillance of the G-3, which has a large impact on the world economy and a decisive influence on global financial conditions, focused on the systemic impact of these countries’ policies.9

20. The Fund’s bilateral and multilateral surveillance has become more integrated over time. Nevertheless, there remains substantial room to strengthen the analysis of regional and global spillovers (C, 40-54).

  • Quantitative macroeconomic analysis is well integrated, with country teams using WEO data as inputs for quantitative work and the WEO database drawing on results of bilateral surveillance. However, most Article IV staff reports contain little explicit discussion of the impact of global economic conditions and risks. The near absence of references to global capital markets in Article IV reports is particularly striking.

  • The WEO reports have provided detailed analysis of the impact of economic conditions and policies in G-3 countries on the rest of the world; and the GFSR has analyzed developments and risks in global capital markets, including transmission of (positive or negative) shocks from mature to emerging markets. These analyses have generally found limited echo in Article IV consultation reports for G-3 countries, apart from treatment of the systemic impact of their trade policies.

  • Many Article IV reports refer to economic conditions in large regional trading partners, and area departments have made considerable efforts to strengthen regional surveillance. However, these activities generally get little explicit reflection in Article IV staff reports, and reports with substantial coverage of regional spillovers are relatively rare.

21. In staff’s views, efforts to better integrate bilateral, regional, and multilateral surveillance would need to focus on (C,57):

  • in bilateral surveillance of the G-3, discussing the global consequences of their policies more fully, which would provide opportunities for a richer policy dialogue on these issues between the Fund and national (or regional) authorities;

  • in bilateral surveillance of all members, linking past and prospective economic performance to global economic and financial conditions more explicitly; highlighting which global risks identified in the latest WEO, GFSR, or IMFC communiqué have particular relevance for the member concerned, and discussing how the member would cope if these risks materialized; and providing a more consistent analysis of regional spillovers by making fuller use of existing regional surveillance initiatives.

22. To assist these efforts, specific mechanisms could be promoted such as (i) strengthened procedures to facilitate exchanges of view among departments on key risks identified in the latest WEO report, GFSR, and IMFC communiqué and their implications for the focus of bilateral surveillance consultations; (ii) discussion by the Board of regional developments—which could include presentation of standardized indicators for all countries in the region and cover exchange rate issues and regional transmission of shocks—led by area departments, possibly annually; and (iii) enhancements to the elements pertaining to global capital market conditions, including in the WEO’s analytical apparatus, in cooperation with ICM. In addition, greater use of alternative scenario(s), highlighting the global risk(s) of most significance to the member concerned, should be actively promoted in each Article IV consultation. To facilitate discussions of regional economic interactions, coordinating the timing of Article IV consultation discussions of neighboring countries could also be envisaged, if national calendars and staff resources make this feasible (C,58).

Exchange rate analysis

23. The Executive Board has often stressed that a thorough discussion of exchange rate issues is essential for Fund surveillance. At the conclusion of the 2002 biennial review of surveillance, Directors called for candid treatment of exchange rate issues throughout the membership (C,66-67).

24. Discussions of exchange rate regimes typically focus on consistency of the regime with macroeconomic policies, institutional conditions, and the external environment— this is in line with guidance from the Executive Board. They sometimes address management of the exchange rate regime, particularly for countries whose regime is a managed float. The de facto regime is rarely identified to be different from the de jure regime. The sustainability of the exchange rate regime is only ever questioned for pegged regimes. When advice on the nature or management of the regime is offered, it generally leans towards greater exchange rate flexibility regardless of the level of economic development. Important exceptions pertain to countries that maintain a hard peg or seek membership in a currency union (i.e., EU accession countries) (C,70-73).

25. When staff advises a change in exchange rate regime (i.e., adoption of a more flexible regime) or in the exchange rate (i.e., a depreciation), country authorities tend to disagree and Executive Directors usually hold diverging views. Authorities generally stress the benefits of the current regime for macroeconomic stability and the potential negative impact of exchange rate volatility. In these cases, a number of Directors typically share the authorities’ views that the current exchange rate policy remains appropriate (C,76- 77).

26. Assessments of external competitiveness are often limited to an analysis of the evolution of a real effective exchange rate indicator; and exchange rate levels are often found to be “about right” or in line with fundamentals. When a misalignment is identified, reports typically conclude that the exchange rate is overvalued. Cases where the exchange rate is assessed to be undervalued are rare and, in these few cases, the degree of undervaluation is typically considered slight (C,74-75).

27. Overall, the review indicates that pointed discussions of exchange rate issues are both rare and controversial. It thus suggests that candid treatment of exchange rate issues remains a significant challenge. Given the sensitivity of these issues, this challenge is not likely to be fully overcome. Nevertheless, to achieve a measure of progress, a few practical steps are worth pursuing: (i) identifying clearly the de facto regime; (ii) making more systematic use of a broad range of indicators and other analytical tools to assess external competitiveness; (iii) treating exchange rate issues (e.g., the choice of regime, the consistency between the exchange rate regime and other policies and institutional conditions) in particular depth, and presenting the policy dialogue between staff and the authorities on these issues in a comprehensive and balanced manner, when views differ between the authorities and staff (C,78-79).

28. The review also suggests that it would be worth exploring further (i) whether the lessons of the past decade on the dangers of fixed exchange rates are applied too broadly—in particular circumstances, as suggested by research findings, a fair degree of fixity in the exchange rate regimes may be worth considering for developing countries with limited exposure to private capital markets; (ii) whether there may be some bias towards finding exchange rates overvalued; and (iii) what are the most promising paths to achieve a successful move towards greater flexibility, as economies mature (C,80).

Financial sector analysis

29. At the conclusion of the 2002 biennial review of surveillance, the Executive Board emphasized that the coverage of financial sector issues needed to be brought up to par with coverage of other main areas of surveillance. Directors were concerned that, in the absence of an FSAP, the quality of financial sector surveillance had been uneven across countries (C,3).

30. The coverage of financial sector issues has improved since 2002, but is not yet at par with coverage in other main areas. Coverage varies substantially across countries: it is generally quite broad for emerging market countries, with the discussion providing substantial insights into macro-financial linkages; it is more selective for industrial countries; it is uneven for developing countries. This variance can be partly, but not fully, explained by the intensity of concerns about financial sector weaknesses. It also reflects allocation of financial sector expertise, as visible from the additional quality of coverage in consultations with substantial MFD or ICM participation, either in the form of an FSAP (jointly done with the World Bank) or of participation in the Article IV consultation. In many Article IV consultation reports, an assessment of the soundness of the financial system is presented; this assessment is not always explicitly supported by substantial data or analysis, and staff conducting this review questions how such an assessment can be made (C,26-27).

31. Efforts need to be pursued to keep improving treatment of financial sector issues in Fund surveillance. As indicated by Executive Directors at the conclusion of the last FSAP review, these efforts cannot be expected to rely solely on full FSAP assessments, given resource constraints and the voluntary nature of this program.10 Other options—e.g., focused FSAP updates, MFD and ICM participation in Article IV missions, separate MFD or ICM missions, monitoring of financial sector developments from Fund headquarters, training of area department staff by MFD—need to be used as well to bring necessary expertise to bear on analysis of financial sector issues.11 This review offers initial indications that use of these alternatives options can substantially enhance coverage of financial sector issues (C,37).

Vulnerability assessments

32. Vulnerability to balance of payments or currency crises and external sustainability are two matters at the apex of the Fund’s hierarchy of concerns. At the conclusion of the 2002 biennial review of surveillance, Executive Directors welcomed efforts to strengthen vulnerability assessments and pointed to two issues that deserved greater attention: the private sector’s balance sheet exposure to interest or exchange rate shocks, and debt sustainability (C,3).

33. In recent years, to reinforce its capacity to identify vulnerabilities in member countries, the Fund has undertaken substantial work that is bearing fruit. More than two-thirds of the reports covered in this review provided views on domestic sources of vulnerability to balance of payments, currency, or financial crisis. In most cases, these discussions were supported by relevant analyses of debt sustainability, financial and corporate sector vulnerabilities, domestic policy developments, and occasionally domestic political economy factors. Treatment of vulnerabilities was most substantive for emerging market countries. As discussed above, there was, however, less coverage of vulnerabilities identified from multilateral assessments (C,34-35).

34. Vulnerability assessments are benefiting from initiatives to enhance coverage of balance sheet issues, including implementation of the strengthened framework for debt sustainability assessments. Balance sheet issues have received substantial attention in surveillance of both advanced and emerging market economies. In advanced economies, the focus has been on private balance sheet vulnerabilities, particularly in connection with risks stemming from rising real estate prices and mortgage lending. In emerging market countries, staff reports have focused on the potential transmission of shocks across domestic sectors under crisis conditions, key factors contributing to resilience under such conditions, and ensuing policy advice. Nevertheless, limited data availability remains an obstacle to detailed balance sheet analysis in many instances (C,82-86).

35. Only a limited number of reports provide an integrated assessment of crisis vulnerabilities and a clear view on the severity of these vulnerabilities. In most cases, the discussion of vulnerabilities is distributed throughout the report and different elements of analysis are not tied together. In addition, it is not always easy to discern the intensity of staff’s concerns about existing vulnerabilities (C,36).

36. Overall, the review indicates that (i) the existing strategy to strengthen vulnerability assessments and balance sheet analysis is having a positive impact and should continue to be implemented diligently, recognizing constraints stemming from data weaknesses; and (ii) there is a need to integrate various components of vulnerability assessments better. This work takes particular importance in the current global environment where, as stressed by the IMFC, vulnerabilities to prospective exchange rate and interest rate movements are a priority concern (C,37,91).

Growth in low-income countries

37. Article IV consultation reports for low-income countries typically contain a broad treatment of growth objectives, their relation to poverty reduction, and potential means to achieve these objectives. This coverage, which is part of the analysis of the medium-term outlook, can be seen to reflect recognition that, with progress on macroeconomic stability, the dominant challenge in many low-income countries is to sustain high rates of growth and to reduce poverty. For PRGF countries, PRSPs are mentioned but rarely play a central role in discussion of the medium-term outlook. A few reports reflected briefly on the country’s prospects for meeting the Millennium Development Goals (MDGs) (C,21-24).

38. It is worth considering how to reflect more fully the PRSP process and the international community’s efforts to achieve the MDGs in Fund surveillance. To facilitate consideration of progress toward reaching the MDGs, an MDG table will be included in selected Article IV reports. Article IV consultations for PRGF countries could also be used to analyze alternative macroeconomic frameworks aimed at meeting the MDGs, which could shed light on sustainable macroeconomic scenarios under different aid flow assumptions. For PRGF countries, coordination and sequencing of the PRSP process, program discussions, Article IV consultations, and ex post assessments pose a significant challenge; this issue merits further analysis (C,37).

39. In addition, in surveillance of low-income countries, greater attention could be paid to external shocks than can derail growth and actions to improve resilience to such shocks. Most Article IV consultation reports for low-income countries point to risks that can damage growth prospects, including external shocks, and jeopardize achievement of poverty reduction goals. Nevertheless, these reports rarely contain an explicit discussion of the possible quantitative impact of external shocks on the domestic economy and of reforms to minimize vulnerability to these shocks—an observation consistent with the above conclusions on the coverage of global spillovers in bilateral surveillance (C,22).

Institutions and investment climate

40. Improving the investment climate and strengthening institutions are two overlapping elements often highlighted in growth-oriented reform agendas for low- income countries. Other often stressed components in these agendas are structural fiscal reforms and improvements to physical infrastructure.

41. Investment climate issues and institutional reforms also receive substantial attention in surveillance of middle-income countries. Most Article IV consultation reports for middle and low-income countries address institutional issues, and a large share of them cover factors that affect the climate for private investment. Coverage of institutional issues is most substantial on fiscal-related aspects (e.g., fiscal transparency, efficiency of public enterprises), financial supervision and regulation, and legal and judicial reforms. Trade and customs regimes also receive substantial attention (C,96-104,116-119).

42. The review points to two questions that deserve attention: generally weak coverage of issues outside the Fund’s traditional areas of expertise, and limited follow- up on past recommendations. Weak coverage of issues outside the Fund’s areas of expertise may be explained by paucity of available information (e.g., still limited availability of ROSCs on corporate governance and insolvency and creditor rights) or limited use of outside information (e.g., reports of the World Bank and other multilateral development banks on the investment climate in individual countries). Limited follow-up on implementation of past recommendations raises the concern that the policy dialogue is not focused on sustained implementation of key reforms (C,105-109,120-122).

43. In light of these conclusions, in addition to the above conclusion on the selectivity of coverage of issues outside the Fund’s traditional areas of expertise, it is recommended to strengthen attention to past policy recommendations, their continued validity, and implementation. Given that, in many circumstances, institutional reforms and actions to improve the investment climate are likely to be successful only if they are pursued over a number of years, continuity in the policy dialogue between the Fund and members is crucial. In addition, to facilitate use of outside information, efforts are underway to channel information available from the World Bank, UNCTAD, and other providers to Fund country teams on a more systematic basis (C,123,140,143-144).

Social issues

44. In recent years, the Fund has paid much attention to social issues. For many members, coverage of social sector issues may be explained by the emphasis placed on poverty reduction and achievement of social objectives in PRSPs and, generally, in the international community’s efforts to meet Millennium Development Goals. For some members, the relevance of social issues may stem from the role of social safety nets as shock absorbers to mitigate the impact of necessary policy adjustments on various sections of society and thus facilitate their implementation.12 The IEO has recommended that, during Article IV consultations, staff invite country authorities to suggest what are the existing critical social programs and social services they would like to see protected in the event of adverse shocks (C,31).13

45. More than half of Article IV consultation reports include some discussion of the macroeconomic impact of social policies. A majority of these reports concern low-income countries, where coverage addresses incidence of poverty and human development indicators. For other members, coverage is justified by concerns about entrenched unemployment, or the macroeconomic impact of income inequality. Coverage of social issues is particularly substantive in post-conflict countries and members with endemic political and social instability. For some other countries, coverage is limited to a few passing references (C,32-33).

46. The review suggest that, as for other issues outside the Fund’s traditional areas of expertise, coverage of the macroeconomic dimension of social issues has generally been selective, but that, at the margin, further selectivity of coverage is desirable. This would allow for greater depth of treatment where needed.14 As regards the IEO recommendation mentioned above, in members where shocks could have a sizeable and sudden impact on social conditions, Article IV consultation missions—and other contacts between staff and member countries—may offer an opportunity to solicit members’ views on protection of social safety nets or of other priority expenditures in times of economic stress. Such discussions would be conducted on a voluntary basis (C,37).


47. The guidance note on governance adopted by the Executive Board in 1997, and reviewed in 2001, promotes greater attention to governance issues in the Fund’s policy advice and technical assistance.15 The two main aspects of this work are: improving the management of public resources; and supporting the development of a transparent and stable economic and regulatory environment (C,124).

48. Governance issues continue to be raised in a significant share of surveillance reports, with coverage focused on the development of policies, institutions, and administrative systems that embody good governance. For the membership as a whole, the primary area of coverage is the fiscal domain, with transparency of the budget and operations of public enterprises as prominent topics. The second most common area of coverage is judicial reforms and broad-based anti-corruption measures. In developed countries, corporate governance was the issue most likely to be raised. In these countries, coverage of the “supply side” of corruption was also frequent, with references to implementation of the OECD convention against bribery of foreign official mentioned in four-fifths of members that have ratified the convention (C,129-133).

49. Nevertheless, the review highlights two questions that deserve consideration: limited use and, on occasion, availability of relevant information; and relatively weak treatment of past and current policy recommendations. This view logically echoes the above conclusions on coverage of institutional reforms. Apart from cases where surveillance and use of Fund resources are combined, staff appears to draw relatively little on World Bank expertise or on other outside information. Lack of information (e.g., non-availability of ROSCs) may, in some instances, hinder coverage of some governance issues. References to governance tend to be limited to descriptions of facts and of the authorities’ past or current actions; they tend to stop short of assessing adequacy of these steps or needs for further action (C,134-137).

50. Overall, implementation of the 1997 guidance note on governance in surveillance activities has been broadly satisfactory. Further efforts could be concentrated on (i) greater use of outside information and, where needed, development of new information—i.e. encouragement to have ROSCs on fiscal transparency or on monetary and financial transparency undertaken; and (ii) greater attention to policy recommendations. As noted above for institutional reforms, greater use of additional sources of information and greater focus on past and current policy recommendations would be expected to enrich the policy dialogue between the Fund and its members on governance issues (C,138-142).

Freshness of perspective

51. In April and July 2002, the Executive Board adopted several steps to ensure that Article IV consultations in members with Fund-supported programs provide a periodic reassessment of economic conditions and policies, stepping back from the program framework. Directors endorsed guidance clarifying the role and nature of surveillance in program countries. The guidance stressed the need for the following four elements: a comprehensive assessment of recent economic developments, a candid analysis of the short- and medium-term outlook, a stocktaking of the policy strategy to date, and a candid account of the dialogue between staff and the authorities on key policy issues. Directors also took a decision allowing for greater flexibility in consultation cycles in program countries so that these consultations could be scheduled when a comprehensive assessment of economic developments, prospects, and policies was most useful. As a result, about two-thirds of Article IV consultations in program countries were conducted on a stand-alone basis or at the time of the adoption of a new arrangement. In addition, a few Article IV consultations combined with discussions of use of Fund resources were carried out differently than usual, with addition of a senior staff member to lead the Article IV consultation discussions (C,13,15).

52. In March 2003, the Executive Board adopted a complementary measure for countries with a longer-term program engagement, namely conduct of ex post assessments (EPAs) and strategic forward planning in the context of Article IV surveillance.16 EPAs are expected to be prepared by an interdepartmental team prior to the Article IV consultation mission; reflect input from the World Bank; and cover an analysis of the problem facing the member, a critical and frank review of progress during the period of Fund-supported programs, and a forward-looking assessment that takes into account lessons learned and presents a strategy for future Fund engagement (C,14).

53. This review shows that the quality of coverage of surveillance in program countries highlighted in the 2002 guidance has risen, with the most striking improvement relating to taking stock of the economic policy strategy to date.17 Discussions of this issue addressed, at a minimum and in broad terms, past policy implementation and the success or failure of previous programs. Most reports went into substantial detail, laying out policy objectives under past programs, identifying areas of weak implementation, discussing factors that contributed to the success or failure of the program, and shedding light on the remaining policy agenda (C,17-18).

54. Progress was more muted regarding candid presentation of the short and medium-term outlook and candid account of the policy dialogue in Article IV consultations, particularly when undertaken at the time of a request for, or review of, use of Fund resources (UFR). Several reports pointed to efforts to improve discussions of risks to the outlook, supported by debt sustainability analyses, presentation of alternative scenarios, or discussion of sensitivity to shocks. For a significant number of other reports, the discussion of the short-term outlook remained minimal. Regarding the policy dialogue, areas of dissension or the path to consensus often remained unclear (C,19-20).

55. Given these generally encouraging results and the still recent launch of EPAs, it is proposed to review further progress in surveillance in program countries, once substantial experience with EPAs has been gained. It may be noted that the above- mentioned steps to strengthen integration of bilateral and multilateral surveillance—particularly, greater use of alternative scenario(s) focused on one (or a few) key global risks—should help strengthen discussion of the economic outlook in program countries as in other countries, building on progress made through implementation of the strengthened debt sustainability framework (C,37). It may also be noted that efforts to strengthen the policy dialogue should balance the needs for a fresh perspective in surveillance and the benefits of continuity in relations between the Fund and its members (paragraphs 56-58).

V. Policy Dialogue

A. Dialogue in Bilateral Surveillance

56. A close and frank policy dialogue is an essential ingredient of effective surveillance. Most officials interviewed and most mission chiefs surveyed rated the quality of the policy dialogue between the Fund and members positively, but also pointed to scope to enhance it further. In interviews with officials, three issues came to the forefront: the need for greater efforts to ensure that surveillance is conducted and perceived as a collaborative and mutually beneficial exercise, and not just an audit; the recommendation that contacts between Fund staff and the authorities be better timed, paced, and targeted; and the strongly held views that high turnover of staff on country teams undermined the establishment of a rapport based on trust. In relation to the first of these three issues, authorities also expressed a strong interest in provision by staff of cross-country or regional analysis (M,33).

57. The review of Article IV consultation reports points to similar conclusions. Assessors considered the presentation of the policy dialogue to be candid in most reports for non-program countries, though with some variance across policy areas. Where the presentation of the policy dialogue was not seen as candid, the coverage of the authorities’ views was limited; in those cases, the report’s section on policy discussions read more like a monologue than a genuine policy dialogue (M,34;C,11-12).

58. Certain steps could be taken to raise the quality of the policy dialogue with the authorities (M,36,38):

  • More cross-country comparative studies could be prepared by staff and fed into discussions with authorities. By adding value to the discussions, this would help strengthen the sense of collaboration between the Fund and country authorities.

  • Regular contacts outside the Article IV consultation, which are already frequent, could be intensified. They could take the form of short staff visits, exchanges of informal policy notes, and organization or participation in conferences and seminars, including regional conferences. Resident representatives are also seen as having a very useful role.

  • To strengthen engagement in Article IV consultations, a policy statement prepared by the member and provided to staff ahead of the Article IV consultation mission could be helpful. It could cover the member’s main macroeconomic, financial, structural, and institutional policies, including reactions to previous consultations.18

  • At the end of Article IV consultation missions, a one-page note targeted at senior policymakers could be prepared, as a complement to the Article IV mission’s concluding statements.

  • Mechanisms for staff rotation and mobility across countries could be reviewed to reach greater continuity in the policy dialogue, enhance mutual trust, and build up country-specific knowledge. These objectives would have to be balanced against the benefits of bringing fresh perspectives to country work.

B. Modalities of Surveillance in Currency Unions

59. For members of currency unions, the conduct of surveillance requires that discussions be held with representatives of relevant regional institutions, since these institutions have responsibilities over monetary and exchange rate policies—an area at the heart of Fund surveillance (M,74).

60. Formal procedures for surveillance of the euro area were adopted in 1998. They made discussions with regional institutions an integral part of the Article IV consultations with euro area members. Other elements of these procedures include: twice- yearly staff discussions; an annual Board discussion based on a staff report and resulting in a summing up; and, to the extent feasible, clustering of individual Article IV consultations. These modalities have worked reasonably well in practice (M,75-78).

61. Modalities of surveillance of the three other currency unions—the West African Economic and Monetary Union, the Central African Economic and Monetary Community, and the Eastern Caribbean Currency Union—have moved towards greater formalization. In recent years, annual staff reports on regional discussions have been prepared and discussed by the Board for all three currency unions. Public information notices (PINs) and, in some cases, staff reports were published. The coverage of regional discussions with these currency unions was broadly comparable to that of the euro area (M,79-81).

62. The absence of a formal regional consultation process in these three currency unions weakens the ability of the Fund to exercise surveillance. Further formalization of surveillance activities would be desirable. The establishment of a clear framework for policy discussions with regional institutions and the explicit recognition that these discussions form part of the Article IV consultation with concerned members would strengthen surveillance over monetary and exchange rate polices, trade policies, and financial sector regulation and supervision. The modalities for more formalized consultations would need to be determined in consultation with the relevant national and regional authorities, and approved by the Executive Board (M,82-84).

VI. Communication and Signaling

A. Communication

63. Communication by the Fund has been seen as a means to enhance the overall effectiveness of surveillance. It is designed to contribute to informing economic discussions in member countries and decisions by market participants. Officials and non-officials interviewed in the context of this review linked two aspects of communication, namely general dissemination of surveillance output to the public—including direct contacts with non-government representatives—and publication of country documents, to the effectiveness of Fund surveillance (M,39).

64. As previously stressed by Executive Directors, communication, including publication of staff reports, should not come at the expense of reduced candor in the Fund’s dialogue with members and in reporting to the Board. The majority of interviewed officials indicated that publication should remain subsidiary to the Fund’s role as a provider of frank, high-quality policy advice. Some officials observed that publication is now widespread; and that fears of adverse market impact had not been realized. Some other officials said that the risks associated with publication should not be discounted. Many market participants believed that political pressures already excessively influenced published staff assessments (M,46-47).

65. The Fund’s efforts to intensify communication to the public have raised the profile of surveillance in recent years. Yet public understanding of the role of surveillance and public knowledge of the Fund’s policy messages remain limited. Those interviewed gave credit to transparency policies, more frequent outreach activities, and other innovations in mission modalities, which were tailored to each member’s specific circumstances. At the same time, interviewed officials stressed that, in most cases, the nature of Fund surveillance was understood by only a narrow group of officials and its policy messages reached few people (M,40-41).

66. To strengthen communication, various steps could be considered (M,45,48):

  • A general reflection on interaction with the various audiences of surveillance. It could assess what are the most useful forms of outreach according to members’ circumstances, and who can best conduct outreach activities. It could also revisit the role and format of Board summings up. These themes could be taken up in the forthcoming review of the Fund’s external communications strategy.

  • A more active outreach program, including within governments, designed to explain the purposes and modalities of surveillance and disseminate the key findings of individual surveillance exercises.

  • Enhanced contacts with local think tanks and participation in conferences in members countries. For instance, a local research institute could offer a platform for hearing local views, presenting the conclusions of work related to the consultation, and discussing desirable avenues for future research.

  • Active dissemination of best practices (e.g., on presentation of staff reports) and information on innovations in consultations (e.g., press conferences) within the Fund. Further experimentation with the formats and styles of staff reports could also be encouraged.

  • Encouragement to members to make greater use of the “right of reply” provided for in transparency policies, to increase comfort with publication while preserving candor.

B. Monitoring and Signaling

67. The Fund has been faced with a recurring demand for two outputs: policy monitoring at high frequency; and delivery of a clear signal on the strength of a member’s macroeconomic policies. This demand has arisen from a variety of reasons, including the need to address high crisis vulnerabilities, a desire to stress commitment to sound policies, or a need to provide assurances to donors or creditors (M,66-67).

68. Members have expressed a demand for such services in circumstances where they could not be met with a Fund arrangement. The Fund does provide high-frequency monitoring and a clear signal in the context of a program relationship, in addition to financing (contingent on the existence of financing needs). However, members may not wish, or be able, to follow that route (because they have limited actual or potential financing needs, or because they cannot or do not wish to commit to the conditionality of a formal program) (M,67).

69. While flexibility in the procedures for surveillance and surveillance-related activities has allowed the Fund to respond to demands for high-frequency monitoring, efforts to establish a signaling mechanism outside a program context have met with limited success. Several procedures were established but rarely used. Signaling SMPs were discontinued by the Board due to risks of misuse of the instrument. Recently, new proposals for signaling mechanisms did not find sufficient support in the Board (M,68).

70. The design of a robust signaling mechanism must address a number of delicate issues. These include incentive compatibility (to address the fact that the signal is given upfront prior to policy implementation), definition of a standard against which to assess country performance, signal clarity, assurance of country ownership, and, where relevant, acceptability to the donor community (M,70).

71. Greater transparency has raised the potential for signaling in the context of surveillance; and there is scope to use more extensively the flexibility in existing surveillance procedures to provide more frequent and clearer signals than done so far. With the possibility to disseminate PINs, staff reports, and assessment letters to the public, a number of avenues for signaling have been opened. Article IV consultations could be conducted at a higher than annual frequency to permit more frequent issuance of a Fund view (as opposed to staff’s views) on a member’s policies. A member could present a home-grown quantitative economic framework, possibly complemented by a detailed and monitorable policy agenda, for use as a benchmark against which to assess performance in a surveillance context, when the policy framework itself would be evaluated. This quantified framework and policy agenda could form the core of a policy statement that would be provided to staff in the early stages of the Article IV consultation (see paragraph 58) (M,69,71).

72. Further work is needed to determine the most promising avenues to respond to members’ demands for signals. Executive Directors will have the opportunity to come back to this issue in a number of forthcoming meetings, including discussions of precautionary arrangements and of the Fund’s signaling role in low-income countries (M,72).

VII. Assessing Effectiveness

73. Assessing the overall effectiveness of surveillance is an essential but daunting task. The Fund has a mandate to exercise surveillance over members’ economic and financial policies and surveillance over members’ exchange rate policies, and devotes substantial resources to this activity. It must be accountable to its members for the discharge of this mandate and the use of the resources spent on it. However, the relationship between the surveillance process, members’ policy decisions, and the final objectives of surveillance (i.e., sustained sound economic growth with price stability, financial stability) is complex. In addition, with the broadening of the purview of surveillance and its transformation into a more public process, the chain of reactions to Fund policy advice has become even more intricate and difficult to trace (M,9-12).

74. Interviews with officials and non-officials confirmed that assessing the effectiveness of surveillance is challenging. Most of those interviewed considered that, overall, Fund surveillance contributes positively to decision making. However, they pointed out that its impact is far from uniform across countries, and that it occurs at different places in the results chain (i.e., the chain from policy advice (and other factors) through policy decisions to economic outcomes). Most officials found that surveillance helped stimulate the policy debate within the government; official and others thought that, in some cases, Fund advice also helped stimulate the broader domestic policy debate; and market participants tended to value most the dissemination of high-quality and standardized data (M,49).

75. To make further progress in assessing the overall effectiveness of surveillance, the following steps could be considered (M,52-56):

  • Making sure that, at the end of each review of surveillance, the strategic objectives for the period ahead are set out and are thus monitorable.

  • Maintaining the requirement that Article IV consultation reports include a brief assessment of the authorities’ response to the key policy challenges identified in previous consultations. While experience with this requirement has been mixed, it is worthwhile giving staff more time to gain experience implementing it. Over time, such assessments should help identify main obstacles to effective surveillance, and increase the Fund’s accountability for its surveillance activities.

  • Encouraging Executive Directors to present more detailed views on the overall effectiveness of surveillance in Board discussions of Article IV consultations, including in their written statements. Such a practice, including comments on the staff’s choice of key topics and on the authorities’ response to previous Fund policy recommendations, would help generate more systematic information and views on factors that boost (or limit) effectiveness of surveillance in different circumstances.

  • Promoting identification of the priorities of individual Article IV consultations and related modalities during their preparation. Pre-brief meetings offer one mechanism for inter-departmental exchanges of view on these questions.

  • Pursuing methodological work on assessments of effectiveness of surveillance, including in the context of the work on performance indicators.

VIII. Use of Staff Resources

A. Recent Trends

76. Key characteristics of recent trends in use of staff resources in surveillance and related activities are as follows (M,92-97):

  • the amount of resources dedicated to surveillance grew markedly in FY2001-03, reaching 510 staff years, from an average of 410 staff years in FY1998-2000;

  • this increase was concentrated in two areas, namely FSAP and ROSCs and multilateral surveillance;

  • during this period, resources dedicated to traditional bilateral surveillance activities have slightly declined to around 320 staff years or 1.8 staff years per member in FY2003;

  • in addition to FSAP and ROSCs, a number of initiatives have increased demands on staff time and competed with traditional surveillance activities—for instance, ex post assessments, which have cost around 0.2 to 0.3 staff year per assessment; and

  • Fund-wide averages mask significant differences across country groups, with bilateral surveillance of the G-7 economies being the most resource intensive given their complexity and systemic importance and bilateral surveillance of low-income countries the least resource intensive.

B. Resource Implications of the Review’s Proposals

77. The resource implications of the review’s recommendations can be summarized as follows (M,98-106):

  • Implementing the recommendations of this review would entail significant costs, which staff broadly estimates at 27 to 32 staff years and, including related travel costs, US$10 to 11 million—about 5 to 6 percent of total resources now devoted to surveillance.19 The largest element would relate to improved coverage of financial sector issues.

  • The review identified a few potential sources of saving. Streamlining formal requirements and more selective coverage of issues outside the Fund’s traditional areas of expertise could save some resources. There may be other sources of offset, but they are difficult to quantify and unlikely to be large enough to meet estimated needs.

  • Thus, the total net costs of the review’s recommendations are large and there seems to be little scope for implementing them fully without devoting additional resources to surveillance. It is notable that the staff resources devoted to bilateral surveillance (essentially in the area departments) have slightly declined in the past five years. At the same time, there is recognition that the surveillance process has become more complex. Area departments now feel that they have little, if any, scope to add tasks without affecting quality.

  • Faced with this situation, the staff recommends (i) giving immediate Fund-wide priorities to three of the review’s recommendations, namely sharpening the focus of consultations, enhancing financial sector surveillance, and deepening the coverage of regional and global spillovers in bilateral surveillance (both for countries where shocks originate and countries where they are felt); and (ii), as for other recommendations, priorities would have to be defined on the basis of members’ circumstances.

  • The Board could discuss a potential increase in resources allocated to surveillance in the context of the next budget discussions. Should it wish to pursue this avenue, refined cost estimates could be presented to the Board at that time. These estimates would lay the ground for proposals on reallocation of resources across surveillance activities as well as between surveillance and other areas.

IX. Issues for Discussion

78. Executive Directors may wish to address the following conclusions and recommendations:

  1. On focus of surveillance. The conclusions of the 2002 review of surveillance on the coverage and focus of surveillance, which emphasize that selection of issues should be based on the criterion of macroeconomic relevance and, within these topics, matters at the apex of the Fund’s hierarchy of concerns, remain valid (paragraph 7). The Fund has generally succeeded in embracing the wider coverage of surveillance without losing focus. There is scope for greater selectivity in coverage of individual consultations, with narrower (but when necessary deeper) coverage of issues outside the Fund’s traditional areas of expertise, more selective coverage of trade issues, streamlined formal requirements, and provision of information through different channels than Article IV consultations (paragraph 14). The choice of focus of individual surveillance exercises should be subject to greater debate, announcement, and accountability (paragraph 15).

  2. On content of surveillance in macroeconomic and financial areas. There remains substantial room to strengthen the analysis of global and regional spillovers (paragraphs 21- 22, 39). Candid treatment of exchange rate issues remains a significant challenge (paragraphs 27-28). The coverage of financial sector issues has improved but efforts need to be pursued to keep strengthening treatment of these issues in Fund surveillance (paragraph 31). The current strategy to strengthen vulnerability assessments and balance sheet analysis is having a positive impact, but there is a need to integrate various components of vulnerability assessments better (paragraph 36). There may be scope for fuller reflection of the PRSP process and international community’s efforts to achieve the MDGs in Fund surveillance (paragraph 38).

  3. On content of surveillance in areas outside the Fund’s traditional areas of expertise. Investment climate issues, institutional reforms, and social issues receive substantial attention in Fund surveillance. In addition to greater selectivity of coverage and wider use of outside expertise, coverage of the first two of these issues would benefit from greater attention to past and current implementation of policy recommendations (paragraphs 43 and 46). Implementation of the 1997 guidance note on governance has been broadly satisfactory (paragraph 50).

  4. On freshness of perspective. The quality of surveillance in program countries has risen since 2002, with progress being most pronounced on taking stock of the economic policy strategy to date. Promotion of the use of alternative scenarios in Article IV consultation would help make further advances in discussions of the economic outlook (paragraph 22). Further progress can also be expected from EPAs; a further review of surveillance in program countries should wait until substantial experience has been gained with EPAs (paragraph 55).

  5. On policy dialogue. Various steps could be taken to raise the quality of the policy dialogue between the Fund and member authorities, including preparation of more cross- country studies, more frequent contacts, and provision of policy statements by member countries (paragraph 58).

  6. On surveillance in currency unions. The review recommends to seek formalization of surveillance activities with currency unions (other than the euro area) in consultation with relevant national and regional authorities (paragraph 62).

  7. On communication. Various steps could be considered to strengthen communication of the Fund’s policy messages, including a general reflection on interaction with various audiences, enhanced contact with local think tanks, and encouragement to members to make greater use of the “right of reply” provided for in transparency policies (paragraph 66).

  8. On signaling. The Fund has been faced with a recurrent demand for delivery of a clear signal of the strength of a member’s macroeconomic policies. The design of an acceptable signaling mechanism involves many delicate issues. There is scope for providing clearer and sharper signals in the context of surveillance than has been done so far (paragraph 71). Executive Directors will have the opportunity to discuss signaling issues in a number of forthcoming meetings (paragraph 72).

  9. On assessing overall effectiveness of surveillance. The review points to the importance and the complexity of assessing the effectiveness of surveillance. To make further progress on this front, several steps could be considered, including setting monitorable strategic objectives in reviews of surveillance, promoting identification of priorities and enhancing discussions of effectiveness in individual Article IV consultations (paragraph 75).

  10. On use of staff resources. The review presents information on use of staff resources on surveillance and tentative estimates of the costs of the review’s recommendations. It argues that these costs cannot be met without additional resources devoted to surveillance activities (paragraph 77).

  11. On overall priorities. This review is centered on one ultimate objective, namely making surveillance more effective across the whole membership. Given the limits on resources, there is a need to define priorities among objectives and thus implementation of specific recommendations, reflecting as well that effectiveness of Fund surveillance depends on evenhanded implementation. The Fund’s total surveillance effort should be evaluated against these priorities at the time of the next review of surveillance. As a balanced approach across the membership, staff recommends, inter alia, to give immediate Fund-wide priorities to sharpening the focus of consultations, enhancing financial sector surveillance, and deepening the coverage of regional and global spillovers in bilateral surveillance. These would be monitorable objectives for the next review of surveillance. In addition, given the IMFC’s call for further progress on improving debt sustainability and reducing balance sheet vulnerabilities as well as further work on surveillance in low-income countries, the next review of surveillance could be an opportunity to take stock of the situation in these areas (paragraph 77).

  12. On the review of the 1977 Surveillance Decision. This review suggests that the 1977 Surveillance Decision, as amended, continues to provide an appropriate legal framework under which to seek further improvements in implementation of Fund surveillance.


The 1977 Surveillance Decision, as Amended

1. The Executive Board has discussed the implementation of Article IV of the proposed Second Amendment of the Articles of Agreement and has approved the attached document entitled “Surveillance Over Exchange Rate Policies”. The Fund shall act in accordance with this document when the Second Amendment becomes effective. In the period before that date the Fund shall continue to conduct consultations in accordance with present procedures and decisions.

2. The Executive Board shall review the document entitled “Surveillance Over Exchange Rate Policies” at intervals of two years and at such other times as consideration of it is placed on the agenda of the Executive Board.

Decision No. 5392-(77/63)

April 29, 1977, as amended by

Decision No. 8564-(87/59), April 1, 1987,

Decision No. 8856-(88/64), April 22, 1988,

and Decision No. 10950-(95/37), April 10, 1995

Surveillance over Exchange Rate Policies

General Principles

Article IV, Section 3(a) provides that “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.” Article IV, Section 3(b) provides that in order to fulfill its functions under 3(a), “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.” Article IV, Section 3(b) also provides that “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 purpose 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.” In addition, Article IV, Section 3(b) requires that “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 and procedures set out below, which apply to all members whatever their exchange arrangements and whatever their balance of payments position, are adopted by the Fund in order to perform its functions under Section 3(b). They are not necessarily comprehensive and are subject to reconsideration in the light of experience. They do not deal directly with the Fund’s responsibilities referred to in Section 3(a), although it is recognized that there is a close relationship between domestic and international economic policies. This relationship is emphasized in article IV which includes the following provision:

“Recognizing…that a principal objective [of the international monetary system] 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.”

Principles of 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.

  1. protracted large-scale intervention in one direction in the exchange market;

  2. an unsustainable level of official or quasi-official borrowing, or excessive and prolonged short-term or quasi-official lending, for balance of payments purposes.

  3. (a) the introduction, substantial intensification, or prolonged maintenance, for balance of payments purposes, or restrictions on, or incentives for, current transactions or payments, or

    (b) the introduction or substantial modification for balance of payments purposes or restrictions on, or incentives for, the inflow or outflow of capital;

  4. the pursuit, for balance of payments purposes, of monetary and other domestic financial policies that provide abnormal encouragement or discouragement to capital flows;

  5. behavior of exchange rate that appears to be unrelated to underlying economic and financial policies that provide abnormal encouragement or discouragement to capital flows; and

  6. unsustainable flows of private capital.20

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, including the size and sustainability of capital flows, 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.

Procedures for Surveillance

I. Each member shall notify the Fund in appropriate detail within thirty days after Second Amendment becomes effective of the exchange arrangements it intends to apply in fulfillment of its obligations under Article IV, Section I. Each member shall also notify the Fund promptly of any changes in its exchange arrangements.

II. Members shall consult with the Fund regularly under Article IV. In principle, the consultations under Article IV shall comprehend the regular consultations under Articles VIII and XIV, and shall take place annually. They shall include consideration of the observance by members of the principles set forth above as well as of a member’s obligations under Article IV, Section 1. Not later than three months after the termination of discussions between the member and the staff, the Executive Board shall reach conclusions and thereby complete the consultation under Article IV.21

III. Board developments in exchange rates will be reviewed periodically by the Executive Board, inter alia in discussions of the international adjustment process within the framework of the World Economic Outlook. The Fund will continue to conduct special consultations in preparing for these discussions.

IV. The Managing Director shall maintain close contact with members in connection with their exchange arrangements and exchange policies, and will be prepared to discuss on the initiative of a member important changes that it contemplates in its exchange arrangements or its exchange rate policies.

V. If, in the interval between Article IV consultations, the Managing Director, taking into account any views that may have been expressed by other members, considers that a member’s exchange rate policies may not be in accord with the exchange rate principles, he shall raise the matter informally and confidentially with the member, and shall conclude promptly whether there is a question of observance of the principles. If he concludes that there is such a question, he shall initiate and conduct on a confidential basis a discussion with the member under Article IV, Section 3(b). As soon a possible after the completion of such a discussion, and in any event not later than four months after its initiation, the Managing Director shall report to the Executive Board on the results of the discussion. If, however, the Managing Director is satisfied that the principles are being observed, he shall informally advise all Executive Directors, and the staff shall report on the discussion in the context of the next Article IV consultation; but the Managing Director shall not place the matter on the agenda of the Executive Board unless the member requests that this procedure be followed.

VI. The Executive Board shall review the general implementation of the Fund’s surveillance over members’ exchange rate policies at intervals of two years and at such other times as consideration of it is placed on the agenda of the Executive Board.22


Surveillance over Exchange Rate Policies, DEC No. 5392-(77/63), 4/29/1977, as amended (see Appendix), available at


Enhancing the Effectiveness of Surveillance—Operational Responses, the Agenda Ahead, and Next Steps (4/10/2003; Public Information Notice No. 03/50, 4/10/2003); Strengthening Surveillance (9/10/2003; Public Information Notice No. 03/116, 9/10/2003); Review of Data Provision to the Fund for Surveillance Purposes (4/12//2004); Evaluation of the Role of the Fund in Recent Capital Account Crises—Report by the Independent Evaluation Office (7/28/2003); Independent Evaluation Office—Evaluation of Fiscal Adjustment in IMF- Supported Programs (9/9/2003); Evaluation of Prolonged Use of Fund Resources (9/25/2002); Communiqués of the International Monetary and Financial Committee of the Board of Governors of the International Monetary Fund (Press Release No. 03/50, 4/12/2003; Press Release No. 03/159, 9/21/2003; Press Release No. 04/84, 4/24/2004); all above available at


Biennial Review of the Implementation of the Fund’s Surveillance and of the 1977 Surveillance Decision—Content of Surveillance, available at; Biennial Review of the Implementation of the Fund’s Surveillance and of the 1977 Surveillance Decision—Modalities of Surveillance, available at


References in parentheses are to paragraphs of the paper on the modalities of surveillance, labeled “M”, and on the paper on the content of surveillance, labeled “C”.


Article IV consultations also serve other purposes than surveillance. Article IV consultations encompass regular consultations under Articles VIII and XIV. On occasions, they are used as a vehicle for a dialogue with members on international economic issues, which is conducted on a voluntary basis consistently with the Fund’s purposes (Article I(i)).


Reviews have been conducted biennially since 1988. They were undertaken annually between 1978 and 1988.


Communiqué of the International Monetary and Financial Committee of the Board of Governors of the International Monetary Fund (Press Release No. 04/84, 4/24/2004), available at


Mexico—Report on Fund Surveillance, 1993-94 (3/23/1995); Review of Members’ Policies in the Context of Surveillance—Lessons from Surveillance from the Asian Crisis (3/9/1998); Lessons from the Crisis in Argentina (3/24/2004), available at; Communiqué of the Interim Committee (Press Release No. 94/69, 10/2/1994), available at; Review of Members’ Policies in the Context of Surveillance (8/8/1996).


The G-3 is defined as the United States, the European Union/euro area, and Japan.


IMF Reviews Experience with the Financial Sector Assessment Program and Reaches Conclusions on Issues Going Forward (Public Information Notice No. 03/46, 4/4/2003), available at


A forthcoming guidance note on financial sector surveillance in Article IV consultations should help further strengthen cooperation between area and functional departments in this area.


For further discussion, see Evaluation of the Role of the Fund in Recent Capital Account Crises—Report by the Independent Evaluation Office (7/8/2003), available at


Independent Evaluation Office—Evaluation of Fiscal Adjustment in IMF-Supported Programs (9/9/2003), available at


It must be noted that, under Article IV, Section 3(b), it is open to the Fund to discuss such policies as background for an assessment of a member’s exchange rate policies and to discuss the implications of social policies for the member’s exchange rate policies, but not to assess the policies themselves.


The Role of the Fund in Governance Issues—Guidance Note (7/2/1997).


IMF Concludes Discussion on Prolonged Use of Fund Resources (Public Information Notice No. 03/49, 4/9/2003).


Article IV consultations for program countries discussed by the Board between January 2003 and early March 2004 were reviewed to assess the impact of the steps adopted in 2002. Implementation of EPAs is too recent to allow for a review at this time.


Provision of a policy statement would not determine the scope of the Article IV consultation. As indicated in paragraph 14, staff is responsible, and accountable, for the selection of topics in individual surveillance exercises.


These estimates are provided only as tentative indications of resource costs. These have been developed, in consultation with OBP, on the basis of Fund-wide averages and broad assumptions. The only exception is financial sector surveillance, where the number was derived from preliminary, country-by-country estimates provided by area departments. All estimates are of “net” resource requirements, that is, over and above resources currently devoted to these tasks. Full implementation of the review’s recommendations, and the concomitant incurrence of related gross costs, would not imply that “best practice” would be achieved in all areas discussed in the review. For instance, as regards financial sector surveillance, the resource costs are those necessary to meet the minimum requirements; as regards balance sheet analysis, the review only contemplates, and costs, continued implementation of the current experimental approach; and, as concerns surveillance in low- income countries, the review points to the need for further policy work, whose eventual recommendations would have to be costed.


This paragraph, as well the following paragraph, were amended on April 10, 1995 by Decision No. 10950-(95/37), available at


This paragraph was amended on April 1, 1987 by Decision No. 8564-(87/59), available at


This paragraph was amended on April 22, 1988 by Decision No. 8856-(88/64), available at