A. Interconnections

12.The propagation of the crisis and subsequent tensions has underlined the case for surveillance to consider the impact of policies in one country on global stability. This includes: (i) assessing linkages and spillovers across sectors and across borders, as well as the policy implications; and (ii) drawing lessons from cross-country experiences taking into account the interplay of global, regional and country developments (see Box 2 for good examples).

Macro-economic and financial linkages and spillovers across countries

13.Surveillance should in all cases assess how a country is or might be affected by developments and policy actions in other countries (inward spillovers). Understanding inward spillovers is important both to assess their implications for the country’s own domestic and balance of payments stability, and more broadly to inform the Fund’s overall views on spillovers that may significantly impact global stability. Article IV consultations should cover inward spillovers from global developments (e.g., developments in major trading partners or commodity and asset markets) and advise recipient countries on how to mitigate the adverse impact of these spillovers on their economies. Whenever relevant, inward spillovers should also be part of discussions in countries with significant outward spillovers.

14.Outward spillovers, potential or actual, need to be discussed in two cases:

• When a member is not promoting its own domestic or balance of payments stability.

  Article IV consultations should discuss all outward spillovers that arise or may arise from (i) a member’s domestic policies where the member is not promoting its own domestic stability, or (ii) its exchange rate policies where the member is not promoting its own balance of payments stability. Relevant spillovers should be discussed irrespective of channels through which they transmit. Staff should recommend possible alternative policies that would ensure domestic or balance of payments stability, as the case may be, and reduce outward spillovers.

• When outward spillovers of a member country may have a “significant impact” on global stability. For members whose economic and financial policies are generating or may generate spillovers that may have a significant impact on global stability, Article IV consultations should also discuss the most significant potential or actual outward spillovers, even if the member is promoting its own domestic and balance of payments stability. These discussions should cover the policies that may generate or are generating these spillovers as well as the channels of transmission. In these cases, staff should suggest (but not require) country authorities to consider possible alternative policy options to minimize these spillovers, while continuing to promote the country’s own stability.

When a country is promoting its own domestic and balance of payments stability, its Article IV consultation does not need to discuss potential or actual outward spillovers, unless they may significantly impact global stability.

15.Outward spillovers are deemed “significant” if by themselves, or in combination with spillovers from other members’ policies, or through their regional impact, would enter the macrofinancial policy considerations of members representing a significant portion of the global economy. Examples of such spillovers potentially include policies implemented by countries that are systemically important,¹⁴ but also policies of countries that suffer from large vulnerabilities, which could trigger a systemic crisis in certain broader circumstances, either directly through trade and financial linkages with other countries or indirectly through market contagion. There are also many cases where policies of member countries may have a bearing on immediate neighbors or within and between tightly integrated regions, but where the broader spillovers are small, and do not warrant attention for policy settings in other parts of the world. There may be also policies of countries that suffer from large vulnerabilities that would not trigger a systemic crisis given the broader economic context. Such spillovers would not be considered significant, and would not require coverage in staff reports. The broad context should be an important factor in judging whether a spillover would be significant or not, and staff judgment should be applied in an evenhanded way.

16.Staff’s judgment on the significance of actual or potential spillovers should be guided from all available resources. Judgment could be based on:

• discussions with the authorities of major recipient countries of spillovers. Such discussions could be conducted in the context of the Article IV consultations with these countries, or through informal means of engagement.

• the results of multilateral surveillance exercises and products (e.g., global risk assessments, World Economic Outlook (WEO), Global Financial Stability Report (GFSR), Fiscal Monitor (FM), Pilot External Sector Report (ESR), Vulnerability Exercises, etc., as well as Spillover Reports and Financial Sector Assessment Programs (FSAP);

• information that signals the systemic importance of a country (e.g., G-20 countries, countries with mandatory financial stability assessments) or a spillover;

• available data sources and studies that estimate real and financial linkages across countries;¹⁵

• staff’s analyses of inward spillovers for recipient countries; and

• inputs from country teams of major recipient countries of relevant spillovers as well as from functional departments at an early stage.

Following country teams’ proposals, interdepartmental policy consultation meetings will decide whether the proposed potential or actual outward spillovers should be covered in a country’s Article IV consultation. If new information becomes available during a mission, interdepartmental consultations could take place to decide on the significance of the spillovers. The above guidance on the coverage of outward spillovers is a starting point: staff is encouraged to innovate in this area, and based on experience with the implementation of the ISD, this guidance note will be updated.

17. The following questions can help staff think through these issues in both source and recipient countries:

• How are inward spillovers influenced by the global environment? Risks identified in the GFSR, the WEO, and the FM, or by developments in other countries, may be helpful. Where appropriate, mission teams should also leverage the findings of the Pilot ESR, Spillover Reports, Regional Economic Outlooks (REOs), vulnerabilities exercises, and the EWE.¹⁶

• How might inward spillovers transmit themselves to the domestic economy and affect stability? Given the challenges in gathering reliable data and analyzing different channels, rigorous quantitative analysis may be difficult in some cases. Nevertheless, even qualitatively tracing out these linkages can be helpful (see C. Financial Stability).

• What are the policy implications of the analysis of inward spillovers? Is the policy framework flexible enough to address these spillovers? What are the specific policy options to reduce risks before they occur and to mitigate their impact if they materialize (see B. Risk Assessment)?

• For potential or actual outward spillovers, what are the transmission channels? An examination of the underlying drivers of critical balance of payment flows, as well as other factors (e.g., correlation with cross-border asset price movements or impact of source country growth changes on others) will help to identify the transmission channels.

• How significant are these outward spillovers? Given the direct and indirect channels of transmission, a quantitative assessment of outward spillovers is challenging. Nevertheless, outward spillovers can be judged to be significant if they could lead members representing a significant portion of the global economy to consider adjusting their macrofinancial policy stance to mitigate negative consequences on their economies. Examples of policies with significant outward spillovers include monetary easing or lax financial regulation in a systemically-important country, lose fiscal policy in a currency union, debt default in a country with strong cross-border linkages.

• What are the economic and financial policies that may generate these outward spillovers? For instance, is the monetary policy stance generating large capital outflows while preserving domestic credit growth at a sustainable level? Is lax financial regulation triggering asset price movements? Are capital flow management measures triggering outflows to other countries or retaliatory measures by other countries? Are structural issues depressing domestic demand (e.g., weak social safety net)?

• What are the policy implications of the analysis of outward spillovers? Are the policies that are generating outward spillovers affecting the country’s own stability? What alternative policies could mitigate these spillovers without undermining the country’s own stability?

Discussions on spillovers with members

18. For the purposes of the Fund’s multilateral surveillance, members are encouraged to implement exchange rate and domestic economic and financial policies, that, in themselves or in combination with the policies of other members, are conducive to the effective operation of the international monetary system. When the actual or potential spillovers from a member’s policies may significantly impact global stability, staff should suggest to the authorities possible alternative policy options to better promote global stability by minimizing these spillovers, while continuing to promote the country’s own stability. However, the Fund cannot require a member to change its policies in the interest of global stability as long as its policies are promoting its own stability.

Distilling lessons from cross-country experience

19.Surveillance should focus on highlighting lessons from similar experiences in other countries, in support of clear and concrete policy conclusions. While this can include comparison with peers, quantitative analysis, and qualitative case studies, the TSR suggests that authorities place a particularly high value on the discussion of relevant policy experiences in other countries when assessing or making recommendations about their own economy. In addition, country teams should make maximum use of FM, GFSR, REOs, WEO, Pilot ESR, vulnerabilities exercises and the EWE’s cross-country analyses in discussions with the authorities and, where useful, reference publicly available reports in the staff report. Functional departments should support this effort, including through collaborative cross-country policy work, the FAD repository of cross-country experience on fiscal operations, and tools (such as on cyclical adjustment of fiscal balances and on multipliers), and through the review process.

B. Risk Assessment

20.The assessment of risks is important to provide members with early warning and to promote policy responses, for purposes of both prevention and contingency planning.¹⁷ While teams are best placed to think through idiosyncratic risks, the assessment should leverage the analysis of risks conducted at the multilateral or regional levels (WEO/GFSR/FM/REOs), and be guided by the global risk assessment matrix (G-RAM). Staff are also encouraged to seek input from the functional departments at an early stage (well ahead of the policy consultation meeting). Staff’s dialogue with the authorities should include an explicit and thorough discussion which should also be reflected in the staff report. As part of this assessment, staff should consider:

• Risks to the baseline. Staff reports should discuss risks around the baseline scenario and policy implications. The report should set out the macroeconomic and financial sector risks and transmission channels, an assessment of their likelihood (e.g. high, medium, low), their potential impact—and staff recommendations for possible policy responses. Staff should consider policies both to reduce the probability that risks materialize or attenuate their effects (insurance) and to deal with the consequences should the risks materialize (contingency planning).

• Tail risks. Staff are also encouraged to explore tail risks—low-probability events with serious negative implications—even if their probability is unquantifiable. Although the authorities may be sensitive on these points, exploring tail risks with them is important, so as to draw their attention to the possible macroeconomic impact and discuss how to insure against them through adjustments in policies. In general, staff should ask themselves “what if” questions, while exercising judgment over which risks to highlight.

21.Risk analysis should build on the following inputs where relevant:

• Vulnerability assessments, the EWE and other multilateral surveillance. A variety of quantitative and qualitative information inputs could be drawn upon including from the vulnerability exercises for advanced economies (VEA), emerging markets (VEE) and low-income countries (VE-LIC) and the broader EWE, as well as the downside scenarios used in the WEO and the GFSR, and fiscal vulnerability indicators in the FM. Staff are encouraged to present alternative scenarios (including using stress tests) and to use the balance sheet approach.

• Debt sustainability analysis (DSA). Article IV reports should undertake debt sustainability analysis (DSA) in line with relevant guidance for market-access (MAC) and low-income (LIC) countries and could draw upon the Medium-Term Debt Strategy where available. The framework for public debt sustainability analysis for MACs has been modernized and revised guidance to staff on implementing the new risk-based framework is forthcoming. While a reasonable level of standardization will be maintained, teams will be expected to customize their analysis including alternative scenarios. Teams will also be expected to use templates developed for these purposes. A good practice for the interim period would be to bring in relevant elements of the new framework into the DSA particularly for countries facing public debt vulnerabilities.¹⁸ More in-depth discussion of risks to debt structures (i.e. maturity, currency, interest rate composition, and investor base) may be warranted for particular high debt cases. The framework for LIC debt sustainability framework has also been reviewed.

• Medium-Term Debt Strategy (MTDS). For countries with an up-to-date MTDS, staff should explore the recommendations in the strategy and use them to explore the extent to which interest rate, maturity and exchange rate mismatches would increase debt and fiscal vulnerabilities.

• Global Risk Assessment Matrix. The G-RAM lists key global and regional risks, and associates a broad probability of realization to each (low-medium-high). The G-RAM is an internal staff document, which is discussed among departments and approved by Management, updated at least quarterly or as needed to provide an up-to-date consistent set of risks around the staff’s baseline forecasts.

• Risk Assessment Matrix (RAM). Although not required, staff are encouraged to use a RAM similar to those already included in FSSAs as a focus point for the discussion of risks. The RAM provides a structured framework for analyzing risks and their possible impact and is now a standard feature of staff reports for Article IV consultations and Financial System Stability Assessment (FSSA).¹⁹ For Article IV reports, RAMs would cover global, regional, or country-specific macroeconomic and financial sector risks. RAMs reflect staff’s views on the source of risks and overall level of concerns as of the time of discussions with the authorities, and attempt to ask and answer “what if” questions and help: (i) identify key risks that could materially alter the baseline path discussed in staff reports (which is the scenario most likely to materialize in the view of IMF staff); (ii) assess the relative likelihood of realization of each (low-medium-high) risk listed—the staff’s subjective assessment of the risks surrounding this baseline; and (iii) assess the economic impact should these risks materialize (low-medium-high). The design of the RAM is flexible and staff are encouraged to innovate (see Box 3 which includes good examples from 2012 Reports). Nevertheless, to ensure consistency of global risks across Fund products, these should always be drawn from the G-RAM.

C. Financial Stability

22. Financial sector surveillance is a key component of Article IV surveillance. The focus should be on financial stability, the cross-border transmission of risks and two-way linkages between the financial sector and the real economy. Article IV consultations should systematically incorporate such analysis as they are the Fund’s primary instrument for surveillance of the financial sector in individual countries and an important tool for assessing global stability (see Box 4 for good examples). The IMF’s Financial Surveillance Strategy can be used to guide topic priorities (pages 9 to 12). Furthermore, the Strategy emphasizes the need for an integrated view of financial sector risks (including by drawing on salient analysis from multilateral surveillance products and the vulnerabilities exercises).

23. The Financial Sector Assessment Program (FSAP) should underpin the more continuous surveillance of the financial sector in Article IV consultations.²⁰ The FSAP provides comprehensive and in depth, but lower-frequency assessments. For 25 countries with systemically-important financial sectors, financial stability assessments have become mandatory and are formally part of Article IV surveillance. When available, staff should draw on the FSAPs’ analysis, in particular as reflected in the RAM, and integrate the findings into the Article IV staff report. Staff should also systematically follow up on the implementation of relevant FSAP findings and recommendations in Article IV staff reports in the years following an FSAP. To promote better integration and heightened prominence to financial surveillance issues and financial-real linkages, Article IV Executive Board meetings (and associated PINs) could include a dedicated discussion of FSSA issues, particularly for the systemically-important financial jurisdictions. When staff are of the view that a member’s participation in the FSAP should be of high priority, staff should say so in the Article IV report, irrespective of the authorities’ intentions.²¹

24.Country teams should seek up-to-date information on the financial sector. This includes: (i) the size, structure, soundness/performance, and cross-border exposures of banks and non-bank financial institutions and financial markets, and characteristics of the investor base when relevant and (ii) institutional, regulatory, and policy frameworks both for crisis prevention and management (e.g., systemic liquidity arrangements, cross-border arrangements, and macro-prudential framework).²²

25.Staff reports should present a clear analysis of financial stability and identify policy measures to address any related concern. The assessment of financial stability in Article IV consultations should focus on: (i) the stability of the system as a whole, not of individual institutions, unless they have systemic implications;²³ and (ii) on potential or actual spillovers that may significantly impact global stability. It should pay particular attention to cross-border issues, including, where relevant and to the extent data are available, off-shore and off-balance-sheet (e.g. shadow banking) transactions.

26.The analysis should be based on an assessment of financial sector risks and vulnerabilities and their potential impact on stability, subject to data availability. Staff should distinguish between potential risks to the financial system—events or developments that might trigger a crisis—and the underlying vulnerabilities that expose the system to such risks, and determine their likely two-way impact on and from the real economy (e.g., taking into consideration the possible implications of economic agents’ balance sheets for financial stability, the inter-linkages between financial and sovereign balance sheets, and how restoring financial stability could impact growth and policy responsiveness). Staff should also analyze the implications of the risks and vulnerabilities of a country’s financial sector on global stability, where relevant (see paragraph 15). This analysis should be informed by the extent to which a country is integrated either through its cross-border financial or real sector linkages or to the extent investors judge them to be of the same risk category.

27.Staff reports should also identify if there are key data limitations that may impede financial stability analysis. Article IV reports should report these data limitations and evaluate the extent to which they hamper proper financial stability analysis with the help of relevant functional departments.

28.The following questions (and the Financial Sector Surveillance Guidance Note) can be useful to help identify and prioritize financial stability concerns. For more detailed discussion of possible approaches, analytical tools, data sources, and ’best practice’ examples, please refer to the Financial Sector Surveillance Guidance Note (FSSGN) and the FSSGN website. See also Financial Sector and Bilateral Surveillance—Toward Further Integration. See also the Financial Surveillance Group’s (FSG) cross-departmental website for material on discussion on topical issues and of mission relevance.²⁴

• What are the main sources of risk? Emanating both from the financial system itself (including from the regulatory framework) and from the real economy, at home or abroad.

• What is the likelihood that the identified risks materialize? This judgment can be informed, for example, by estimates of probability of default or distress; the extent of asset price misalignments; concentrated exposures; and early warning models for assessing the likelihood of specific crisis events underlying the Fund’s vulnerability exercises.

• What are the main vulnerabilities of the financial system and how would the system and the broader economy be affected by a particular risk event? The analysis could be guided by stress-test results, including scenario analyses.

• What are the cross-border implications of the vulnerabilities of the financial system? The analysis could be informed by the cross-border linkages of the financial system as well as other indirect linkages (e.g., real sector channels, market pricing and contagion).

• What policies are needed to address both domestic and cross-border concerns? Article IV reports should indicate, when relevant, staff’s views on supervisory and regulatory policies, macroprudential policy, and priority areas for standards assessments (including views from Financial Stability Board (FSB) peer reviews).

• Do the authorities have adequate safety net and crisis management capacity? Given the vulnerabilities arising from an interconnected world, particular attention could be paid to cross-border arrangements and resolution frameworks, taking into account the implications on global financial stability.

29.The analysis of real-financial linkages should focus on whether the financial sector is a potential source or amplifier of instability. The following questions can help staff think through these issues:

• What are the critical channels of interaction between the macro-economy and financial markets and financial institutions (cross-border and across domestic sectors)? Data permitting, staff should seek to integrate balance-sheet effects and stress testing in macroeconomic scenarios to help assess the impact of the scenarios on financial solvency and viability and in turn the potential impact of financial balance sheets on sovereign balance sheets.

• How do changes in financial conditions affect economic activity across domestic sectors? Discuss whether prudential, supervisory and regulatory “fault lines” have significant macroeconomic implications, (e.g. ramifications of subprime mortgage lending on consumers channeled through shadow entities linked to banks).

• How does the financial sector affect the conduct of macroeconomic policies? For example, the role of the financial sector in the monetary transmission mechanism and policies, the composition of the investor base and its implications for the public debt and its management, the risks of contingent liabilities and implications for fiscal and macro-prudential policies, and cushions in monetary and fiscal policies to offset the adverse impact when financial sector risks materialize.

• How might problems in the financial sector potentially cause or amplify balance of payments instability? (For example, by triggering a reversal in capital flows and a balance of payments crisis).

• For countries with important financial sector links to other countries, what are the potential spillovers from financial sector developments and policies? For example, data permitting, an understanding of financial interconnections and cross-border exposures, including through global systemically-important financial institutions (GSIFIs) would be useful.^{25, 26}

Financial sector development

30.Financial sector development issues should be covered in Article IV consultations when relevant for stability. Fostering financial development, while managing attendant risks, can help instrengthening an economy’s resilience and capacity to cope with shocks and can help support inclusive growth. Financial development matters for stability for example by strengthening the transmission channels of macroeconomic policy tools and by widening the range of policy options. Additionally, financial development can affect growth by increasing access to credit for productive sectors of the economy by reducing the cost of capital. Financial sector development is more likely to be relevant in low-income countries.²⁷

D. Balance of Payments Stability

31. Balance of Payments stability is at the core of Article IV consultations. To ensure comprehensive coverage of the relevant issues, Article IV staff reports are expected to provide a clear assessment of: (i) the current account (CA) and the exchange rate level/competitiveness; (ii) developments arising from the capital and financial account that could lead to balance of payments instability for the member or its trading partners, including from the composition of inflows and balance sheet mismatches and intervention policies where relevant; and (iii) the cross-border spillovers from any of the above developments/policies that may significantly impact global stability (see Figure 1 and Box 5 for good examples). An assessment of balance of payments stability is broader than an assessment of the exchange rate, and of exchange rate policies. Nonetheless, exchange rate issues are a crucial part of surveillance, as the Articles give the Fund a unique responsibility in this area (see Annex I).

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Structure of Balance of Payments Stability Assessment

Citation: Policy Papers 2012, 088; 10.5089/9781498339773.007.A001

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32. Assessments of balance of payments stability in staff reports and policy notes are expected to contain the following:²⁸

• Clear bottom line and recommendations. Policy notes should include the staff’s preliminary assessment, and staff reports should include a clear analysis and bottom line view (while mindful of the inherent analytical uncertainties and, where relevant, data limitations), of whether the current account and the exchange rate are broadly consistent with medium-term fundamentals and desirable policies. The assessment should be fully integrated into the broader assessment of stability and the overall policy mix, and support clear policy recommendations. When there are no prima facie concerns, the discussion can be brief.

• Exchange rate estimates. Numerical estimates should be included in staff reports (drawing from the Pilot ESR, the External Balance Assessment (EBA) where available, and Consultative Group on Exchange Rates (CGER) and/or CGER-type estimates), except for countries with serious data limitations, where the assessment may be largely qualitative. For countries in the EBA exercise, staff should form their assessment of the current account and exchange rate using all the available methodologies— EBA/CGER, their own estimates and judgment. For transparency purposes, staff are encouraged to report both estimates and the reasons for differences. For economies included in the Pilot ESR, staff should ensure that the assessments of balance of payments stability are consistent between the Article IV and Pilot ESR with each reflecting updates that have occurred over the time period since the previous assessment. Staff are encouraged to use the Article IV to elaborate on the balance of payments stability assessment provided in the Pilot ESR.

• Consistency and country-specific circumstances. Teams are encouraged to check for consistency in assessment over time by checking past assessments, while taking account of changing circumstances.

• Transparency. Information on key assumptions should be transparently provided. This would include: (i) the results of exchange rate assessments; (ii) what, if any, adjustments have been made to standard assessment methods (e.g., high remittance countries, aid recipients, oil exporter); and (iii) why, if relevant, the bottom line assessment diverges from what would be expected from the exchange rate estimates. Staff should also indicate uncertainties that may arise in the assessment.

Elements of a balance of payments stability assessment

The balance of payments stability assessment should include an analysis of exchange rates, the current account and capital and financial account including balance sheet mismatches, reserve and intervention policies. Based on this analysis, the assessment should also indicate whether instability in any of these elements could potentially lead to global instability, particularly for countries that are systemically-important, or have significant trade and financial linkages to other countries.

Current account and exchange rate

33. Staff should assess whether the current account and equivalently, the real effective exchange rate are broadly consistent with medium-term fundamentals and desirable policies.

The current level of the real effective exchange rate (REER) should be compared to the level that would be consistent with the “underlying” CA being in line with the medium-term fundamentals and desirable policies. The “underlying” CA is the current account stripped of temporary factors, and assessed on the basis of the current REER and established non-exchange rate policies (those in place, as well as policies announced that are, to the best judgment of the team, likely to be implemented). The CA in line with medium-term fundamentals and desirable policies is one that leads the net external asset position to evolve in a manner consistent with the economy’s structure and fundamentals and appropriate non-exchange rate policies relative to other countries, and subject to a multilateral consistency constraint. Note that even if the current account can be explained by fundamentals and existing policies, if the country has inappropriate macroeconomic policies, the current account could be found to be out of equilibrium (e.g., if fiscal policy is too loose, then the current account may be weaker than fundamentals and desirable policies suggest).

34.If an under- or overvaluation is considered to be temporary, this should be made clear.

This could happen, in particular, in the following cases: (i) if the current level of the REER is affected by temporary factors such as tight monetary policy; (ii) if the economy is considered to be in transition to a new long-run net external asset position, so that the current account is expected to be temporarily out of line with fundamentals; and (iii) if the authorities’ established exchange rate policies would remove the under- or overvaluation over the medium term.

35.Recognizing the inherent uncertainties in the analysis of equilibrium exchange rates, the assessments should draw on all pertinent information, including notably:

• The indicators in the ISD (see Annex I).

• Where relevant, assessments and other information provided by the EBA and the CGER. The ISD and both CGER and EBA use the same conceptual framework. Of the three methodologies for EBA/CGER, the current account approach (which compares the underlying CA with a measure of the CA consistent with medium-term fundamentals and desirable policies) can be most directly related to the framework of the ISD. The equilibrium real effective exchange rate (EREER) approach (which relates the REER directly to fundamentals) can provide helpful additional insights. The external sustainability approach additionally illustrates the balance of payments position consistent with stabilizing the net international investment position. Where available, EBA results are likely to provide useful input for assessing exchange rates under the ISD, including through the provision of multilaterally-consistent assessments. The EBA builds on CGER and additionally includes “policy gaps” which may help in explaining the policies that may need to be adjusted to reduce an imbalance.

• Other relevant information. This could include the evolution of the real effective exchange rate, purchasing power parity estimates, export and import trade shares, and structural competitiveness indicators, among others.²⁹

36.In countries with serious data limitations, the assessment may need to be largely qualitative. It may be based on a discussion of recent and prospective balance of payments developments, DSA, reserve adequacy, and other factors.

Capital and Financial Account

37.Staff should assess whether developments in the capital and financial account raise concerns about a member’s balance of payments instability. This may happen even when the current account and exchange rate levels do not raise concerns. First, temporary fluctuations in the capital account may cause liquidity problems, even if the current account is at a level consistent with medium-term fundamentals. Second, a country’s external financing structure may create vulnerabilities which could unwind abruptly. Frequent sources of such vulnerabilities are mismatches in the currency or maturity composition between asset and liability sides of external balance sheets, concentration risk, or reliance on short-term funding. In individual cases, concerns about instability emanating from the capital and financial account may well be much more important than any arising from an under- or overvalued exchange rate.

38.Staff should also assess whether potential or actual spillover effects from developments in the capital and financial account and from capital flow management policies may significantly impact global stability. This may happen for instance when capital flow management policies implemented by a country to control potentially destabilizing capital inflows trigger retaliatory measures by other countries, and a proliferation of such measures could have significant global implications. Another example is when a country manipulates its exchange rate to gain competitive advantage over other members.

39.The evaluation of developments in the capital and financial account should include an assessment of: the size and sustainability of capital flows, against the background of the member’s reserves; the size and composition of external assets (other than reserves) and external liabilities; and the access to international capital markets. Work is underway to develop a balanced and flexible approach to managing capital flows to help countries reap the benefits of capital mobility while limiting the risks, and a series of papers has already been presented to the Board. The results will help the design of an approach to policies affecting capital flows.³⁰

Reserves and Intervention Policies

40.The adequacy of reserves is often a critical element in the assessment of a member’s balance of payments stability and global stability. In analyzing the adequacy of reserves, staff should consider a range of approaches, while taking into account particular country characteristics and vulnerabilities. Going beyond the traditional reserve adequacy indicators such as ratios of reserves to imports, short-term external debt (remaining maturity), and broad money, staff are also encouraged to make use of the new metrics for emerging market and developing economies proposed in the IMF paper “Assessing Reserve Adequacy,” while taking into account country-specific considerations. Staff are also encouraged, where relevant and feasible, to explore other approaches and indicators (such as ratio of reserves to gross external liabilities) and use scenario analysis to gauge the level of reserves needed to cushion the impact of a sudden stop in capital flows and other extreme balance of payments shocks.³¹

41.Staff reports are expected to cover intervention activities to the extent they are important for a member’s balance of payments stability and/or global stability. Where relevant, coverage would normally entail a description of past intervention episodes stating their objectives and analyzing their effectiveness, including whether they were coupled with sterilization. Intervention includes outright purchases/sales of foreign exchange or foreign exchange derivatives by the central bank, the ministry of finance, or others working on behalf of these.³² Staff should assess in particular whether there are protracted large-scale interventions in one direction in the exchange market.

42.The analysis and policy advice on intervention policies should be tailored to country-specific circumstances and avoid an overly prescriptive approach. The assessment should be made against the background of the de facto exchange rate regime and the adequacy of the member’s reserves. Staff’s advice regarding the use of intervention to influence the exchange rate should be guided by the following: particularly that intervention should be used to counter disorderly conditions in the foreign exchange market, and should not be used to manipulate the exchange rate to gain an unfair competitive advantage, nor in such a way as to result in balance of payments instability (for instance, a significantly over- or undervalued exchange rate).

Free Floaters, Currency Unions, and Dollarized Economies

43.Staff should assess the real exchange rate level in all cases irrespective of the exchange rate regime. Thus such assessments should also be undertaken for members who have a freely floating exchange rate (and hence no exchange rate policies), and those who do not have their own national currencies.

44.Under a floating exchange rate regime, as in other regimes, the real exchange rate can be under- or overvalued. This may happen as a result of non-exchange rate policies, as a result of other countries’ policies affecting the exchange rate of the country at issue, or because of market imperfections such as a bubble (which may burst in a disorderly way). Thus, even fully market-determined exchange rates can result in disruptive adjustments.

45.Currency unions. In currency unions, the real exchange rate and current account should be assessed both at the level of individual members and at the level of the union, and there should be an assessment of any vulnerabilities in individual members that may affect the stability of the union as a whole.

• At the level of the member. Staff reports for individual members are expected to assess to what extent policies implemented at the level of the member are promoting the member’s domestic balance of payments stability and contributing to the stability of the union as a whole. Reports should present an analysis of the country’s real exchange rate and balance of payments. The discussion can be phrased in terms of external competitiveness or the real exchange rate, including whether the REER is over- or undervalued.

• Staff reports on individual members should not include statements suggesting that the nominal exchange rate is over- or undervalued (unless this is the case at the union level).

• If the real exchange rate of an individual member is found to be over- or undervalued, the staff report for that member should refer to whether the union exchange rate is considered to be over-or under-valued. This helps clarify why policy adjustment in the individual member is or is not recommended. If the misalignment at the member’s level mirrors one at the union level, policy adjustment would be recommended at the union level. Otherwise, policy adjustment would be recommended at the level of the individual member.³³

• Significant vulnerabilities apparent at the level of the member should be flagged in both the report of the individual member and in the report of the currency union.

• At the level of the union. Union-level staff reports are expected to provide a clear bottom line assessment of whether policy frameworks are adequate, the extent to which exchange rate policies and other policies implemented at the level of the union (e.g., monetary policy, fiscal policy frameworks and financial sector policies) are contributing to the union’s stability and should include a bottom line assessment of the real exchange rate level, and associated exchange rate policies.

46.Dollarized economies. For members that use the currency of another member as their sole legal tender (“dollarized economies”), staff reports should still include a real exchange rate assessment. The exchange rate discussion can be phrased in terms of external competitiveness or the real exchange rate, and it should include a bottom line assessment including whether the REER is over- or undervalued. Where this is the case, the report needs to discuss the recommended adjustment in policies.

47.Principles for the Guidance of Members’ Exchange Rate Policies - For all members that implement exchange rate policies, Article IV missions should assess whether the member is observing the principles for the guidance of members’ exchange rate policies set out in the ISD. These principles are described in Annex I.³⁴ However, staff reports for Article IV consultations are not expected to provide an explicit compliance assessment unless a member is found to be noncompliant.

Coverage of exchange rate regimes in Article IV reports

48.Staff reports should identify the de facto and de jure exchange rate regimes. The de facto exchange regime should be understood as a backward-looking description, as assessed by staff, of the approach followed de facto by the authorities in the conduct of exchange rate policies. The description should be as elaborate as necessary to enable the reader to understand how exchange rate policies have been conducted in practice, and should include a classification of the de facto regime using MCM’s definitions and categories, as used in the Annual Report on Exchange Arrangements and Exchange Restrictions (AREAER).³⁵ (This does not mean that the last classification published in the AREAER should necessarily be used, as staff will take a fresh look at the issue during the Article IV consultation process and explain any difference in classification). Staff reports should also specify the de jure regime—namely, the regime that the authorities have reported to the Fund and typically also the publicly announced regime—at least in the Appendix on Fund Relations. If the de facto and de jure regimes coincide, both can be referred to simply as “the exchange rate regime.” Where applicable, reports should discuss changes in the authorities’ forward-looking policy intentions.

49.Reports should also provide a view regarding the adequacy of the de facto regime for maintaining stability. Staff should examine the consistency of the exchange rate regime with the policy mix, which can be more important for balance of payments stability than the regime itself. This may include where relevant a discussion of the appropriateness of the fiscal stance, the monetary objectives, and the financial sector regulatory framework. Discussion of alternative regimes should reflect the authorities’ views, and advice to alter the regime should take into account readiness and adequacy of the implementation capacity.

E. Traction

50.The ability to influence policy making—or traction—is the cornerstone of effective surveillance.³⁶ Policy debate and changes are shaped by many factors, of which Fund surveillance is only one. Traction for the Fund can be understood to have two dimensions: the extent to which the authorities engage with the Fund on its analysis and recommendations and more broadly, the value Fund surveillance adds to the policy debate including all stakeholders that may also influence policy; and the extent to which Fund advice is reflected in policy action. To enhance traction, staff should ensure for all countries the candor and evenhandedness of reports, and should use outreach where appropriate to help reach a wide audience and influence the public debate.

• As part of this process, at an early stage in the cycle, staff are encouraged to exchange views with the authorities on analytical topics for discussion. This needs to be done without compromising staff’s capacity—and obligation—to raise relevant and at times difficult issues.

• Macro-social issues which pass the test of being critical to the assessment of macroeconomic stability should be discussed, drawing on the expertise of other institutions with relevant mandate (e.g., ILO, World Bank).

Reports should include an assessment of the authorities’ responses to staff’s advice on key issues raised in previous Article IV discussions.

A. Issues within the Mandate of Surveillance

51.Adequacy of data provision. Comprehensive, timely, and accurate data are critical for surveillance, and staff should be familiar with the Guidance Note on Data Provision to the Fund for Surveillance Purposes.³⁷ Staff reports and Policy Notes are required to identify the adequacy of data provision for surveillance purposes in a Statistical Issues Appendix. When data provision has serious shortcomings that significantly hamper surveillance—including data deficiencies that hamper an assessment of financial stability—staff reports should discuss:

• Deficiencies. The nature of the deficiencies (coverage, quality, periodicity, timeliness or other aspects of data quality).

• Implications. The implications of the data shortcomings for the analysis, in particular policy conclusions that are subject to significant uncertainties.

• Remedial measures. In those cases where staff have had to construct key data based on limited information (either because of lack of, or long lags in, official data), specific and prioritized remedial measures, possibly including increased resources to ensure durable progress and proper assimilation of technical assistance.

• The extent of discussion of these issues would depend upon the extent of the shortcomings.

52.Reports on the Observance of Standards and Codes (ROSCs).³⁸ The Fund and the World Bank have endorsed 11 international standards and codes of good economic and financial practice in 12 policy areas; including anti-money laundering and combating the financing of terrorism (see guidance on AML/CFT). Staff should seek information on the observance of those standards that are relevant to country circumstances. Resources permitting, ROSCs, including those carried out in the context of FSAPs, are the preferred means of obtaining this information. The ROSCs’ findings relevant for stability should inform surveillance and be discussed in Article IV documents. In addition, Article IV reports should indicate when relevant staff’s views on priority areas for standard assessments, independently of the authorities’ perceived willingness to volunteer for such ROSCs.

53.Trade issues. Coverage is only expected: (i) where serious trade distortions hamper prospects for stability; (ii) where balance of payments are vulnerable to trade developments; or (iii) in systemically-important countries when trade policies have substantial impact on others (see paragraph 13). The possible impact of trade restrictions in services (including financial services) should not be forgotten.

54.Governance issues. When relevant for stability, staff should discuss governance issues and reforms with the authorities (see The Role of the IMF in Governance Issues).

55.Political and social developments. Article IV reports should include information on political and social developments when they are relevant for analysis of economic policies.

B. Matters Related to Article VIII and XIV

56.Article VIII and XIV issues. The ISD provides that, in principle, Article IV consultations should include consultations under Articles VIII and XIV. For all Article IV consultations, staff reports should indicate when a member has in place exchange restrictions or multiple currency practices subject to Article VIII or that are maintained under the transitional arrangements of Article XIV, Section 2. If the member does maintain such restrictions or multiple currency practices that are subject to approval under Article VIII, Sections 2(a) and 3, the staff appraisal should include an explicit recommendation concerning Board approval of the restrictions.³⁹ Missions should inform members that their failure to seek the Fund’s approval or to notify the Fund for the imposition or the maintenance of exchange restrictions or multiple currency practices will result in a breach of their obligations. Staff should encourage members who have not yet done so to accept the obligations of Article VIII, Sections 2, 3, and 4, following the relevant guidance to provide such encouragement. In addition, the appendix on Fund Relations should note any exchange restrictions imposed for security reasons and required to be notified to the Fund under Decision No. 144-(52/51).

A. Article IV Consultation Cycles⁴⁴

61. Consultations for countries without an arrangement are normally expected annually.

Consultations in countries that do not have an arrangement (other than FCL or PLL) or a PSI with the Fund are normally expected to take place annually (with a three-month grace period).⁴⁵ The Executive Board may decide to place a member that is not under a Fund arrangement or a PSI on a longer cycle, not exceeding 24 months, unless the member: (i) is of systemic or regional importance; (ii) is perceived to be at risk, or is facing pressing policy issues of broad interest to the Fund membership; or (iii) has outstanding Fund credit exceeding 200 percent of quota. The Fund may only place a member on a longer cycle with its consent and after consulting with its Executive Director. To enhance the Fund’s policy dialogue with a broad range of economic stakeholders, Article IV consultation cycles should be tailored to national policy timetables, such as budget cycles, to the extent feasible. When a member’s Article IV consultation has been delayed by more than 12 months, following the end of any applicable grace period for the conclusion of its Article IV consultation, formal steps to address prolonged delays are initiated (see Decision No. 15106-(12-21) February 29, 2012).⁴⁶

62.Members that are granted a Fund arrangement or a PSI, with the exception of FCL or PLL arrangements, are automatically placed on a 24-month consultation cycle.⁴⁷ In cases where a program review under an arrangement is not completed by the date specified in the arrangement, the next Article IV consultation will be expected to be completed by the later of (i) 6 months after the date specified in the arrangement for completion of the review, and (ii) 12 months, plus the 3-month grace period, after the date of completion of the previous Article IV consultation, unless a review is completed before the later of these dates, in which case the consultation reverts to a 24-month cycle (i.e., will be expected to be completed within 24 months of the previous consultation).

63.Remaining on a 24-month cycle. Members that have completed a Fund arrangement (other than FCL or PLL arrangements) by drawing all amounts or a PSI by completing all reviews may remain on the 24-month cycle if they do not meet any of the criteria described in paragraph 62 above. At the time of the final review under the arrangement or PSI, staff should assess whether the consultation cycle should be shortened back to the standard 12-month cycle, based on the above criteria. When this is the case, the staff report for the final review should seek the Board’s approval of such shortening of the cycle through a recommendation in the staff appraisal (to be reflected in the summing up).⁴⁸ If an arrangement expires with undrawn amounts or is cancelled by the member, or if a PSI expires with uncompleted reviews, is terminated, or is cancelled by the member, the member will remain on the cycle it was on, unless the Board determines that a different cycle should apply (which could be done through an ad-hoc decision that the Board could consider on a lapse-of-time basis).⁴⁹

64.Members that are granted an FCL or a PLL arrangement are automatically placed on the standard 12-month consultation cycle. For members that, prior to the approval of an arrangement were on a cycle longer than the standard 12 months, the first Article IV consultation following the approval of the arrangement is expected to be completed by the later of (i) six months following the approval of the arrangement, or (ii) 12 months plus a grace period of three months, after the date of completion of the previous Article IV consultation. At the end of an FCL or a PLL arrangement that member will remain on the 12-month cycle, unless the Executive Board determined that a different cycle should apply (which could be done through an ad-hoc decision that the Board could consider on a lapse-of-time basis).

B.Consultations with Members of Currency Unions⁵⁰

65.Consultations for members of currency unions should comprise the following: ⁵¹

• Individual members. The frequency of Article IV consultations for individual members is determined by individual country circumstances (e.g., whether or not they currently have a program or PSI in place).

• Discussions with regional institutions. Yearly staff discussions should be held with regional institutions responsible for common policies in the currency unions. The discussions are held separately from the discussions with the individual member countries of the currency unions, but are considered an integral part of the Article IV process for each member. These discussions focus on policies under the aegis of the regional institutions and, as relevant, other policies of regional importance.

• Reports and summing ups at the union level. An annual staff report on the discussions with the regional institutions is prepared followed by a Board discussion, which are both considered an integral part of the Article IV consultations with individual member countries. Each union level summing up should include language to the effect that the views expressed by Directors in that union level summing up will form part of their discussions in the context of the Article IV consultations for individual currency union members that take place before the next annual Board discussion for the currency union.

• Informal reports at the union level. A second round of staff discussion with the regional institutions and an informal report to the Board may be needed to provide adequate context for bilateral consultations with the currency union member countries that do not coincide broadly with the annual Board discussion on the currency union’s policies.

C.Process and Documentation

66.The documentation requirements and review process for Article IV consultations are set out below. For more details on the latter, see “Combined Guidelines for the Review Process” on the review process website. Also see the working with eReview website for country review work.

• Policy Note. This note (3-4 pages, plus charts and tables) should be prepared ahead of the consultation to lay out the key diagnostics and proposed focus of the consultation and policy advice. It should include background; macroeconomic outlook; policy line on key issues, including surveillance priorities; supportive charts and tables; and note any divergences of views among departments that arose from the policy consultation meeting (see below).

• Policy Consultation Meeting. This meeting between the area departments and reviewing departments should be held 2 to 3 weeks before the mission to discuss and agree on the content of the Policy Note, before it is sent to management for clearance.

• Board discussion. Article IV staff reports are expected to be discussed by the Executive Board within 65 days of the end of the discussions for countries other than PRGT-eligible members, and within three months for PRGT-eligible countries. These should be understood as outer limits as staff are expected to finalize staff reports as quickly as possible after the end of discussions with the authorities.

Staff report requirements. The requirements for staff reports are listed in Annex II.

• Background documentation. Background documentation for Article IV staff reports may be produced, in the form of papers covering selected issues and statistical annexes, i.e. comprehensive sets of historical data tables. The choice of selected issues papers (SIPs) should be guided by their centrality to the discussion and each SIP should begin with a description of how the papers fit in the consultation discussions. There is scope to cut back from delving into issues that are not clearly at the core of the Fund’s mandate and those solely on individual country issues (rather than with a cross-country perspective). Staff has great discretion on whether or not to produce comprehensive statistical annexes and is expected to make this decision in consultation with country authorities. Statistical annexes need not be produced when data are freely available from other sources, which is increasingly the case.

• Summing Up. With the exception of when Article IV reports are considered on a lapse-of-time basis (see below), the Executive Board’s conclusion of an Article IV consultation will be reflected in a Chairman’s Summing Up of the discussion, which will be communicated to the member concerned.

• Lapse-of-time procedure. The lapse-of-time (LOT) procedure will be proposed for Article IV consultations where the following conditions apply: (i) there are no acute or significant risks, or general policy issues requiring Board discussion; (ii) policies or circumstances are unlikely to have significant regional or global impact in the near term (i.e. within one year); (iii) in the event a parallel program review is being completed, it is also being completed on a LOT basis; and (iv) the use of Fund resources is not under discussion or anticipated. The LOT procedure should not be used when: (i) the last Article IV consultation was concluded on a LOT basis; (ii) more than 24 months have elapsed since Board discussion of an Article IV consultation; or (iii) the country is on a 24-month consultation cycle and has not been considered by the Executive Board under a program review in the preceding twelve months. On the basis of these eligibility criteria, the Managing Director, with the approval of the Executive Director for the member concerned, would propose completion of an Article IV consultation on a LOT basis at the time the staff paper is circulated to the Executive Board. The Executive Director for the member concerned may also propose the completion of an Article IV consultation by LOT no more than two business days after the staff paper is circulated to the Executive Board, and preferably as soon as possible after the staff paper is circulated.⁵²

• Combining reports. There is usually scope for combining Article IV and UFR papers (requests and reviews), though some may prefer to follow a “two-papers” approach. Under either approach, it is critical that the Article IV coverage remain comprehensive and deal with all relevant issues.

• Clustering. While recognizing there is often scheduling constraints, teams are encouraged to coordinate Article IV consultations to facilitate Board discussion of clusters of interconnected countries (e.g., countries tied together through financial, trade or other links or exposed to a common set of issues).

67.Staff visits allow Fund staff to hold discussions with member countries on their economic developments and policies in between Article IV consultations. Interdepartmental review procedures for briefings ahead of staff visits apply if there is a change in policy line or economic circumstances. When these changes are substantial, a full review involving a policy note, any needed background materials, and a policy consultation meeting is required. For less substantial changes, the interdepartmental review could be conducted in a more streamlined way, for instance through informal meetings or by exchange of e-mails or of redlined suggestions, and potentially with a narrower set of reviewing departments. If country teams and SPR reviewers agree there is no change, a one-page brief is adequate and to be circulated for information only.

68.Informal country matters sessions offer opportunities to inform the Board about significant developments between Article IV consultations. Where warranted, the Board may also be kept apprised of economic developments in a member and of staff’s assessment of these developments through issuance of a report in between Article IV consultations (e.g., following a staff visit). Regular provision to creditors or donors of staff assessments of a member’s policies can be done through assessment letters, which are issued upon request. Assessment letters should only be provided when an up-to-date PIN or Chairman’s statement is not available.⁵³