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Burial of a Controversy: The IMF, the US and the Renminbi

The United States has tried hard in recent years to make China revalue its currency. It dragged the International Monetary Fund into this campaign and attempted to make the Washington-based institution carry out "surveillance" of the exchange rate of member-countries. The campaign was formally buried recently, due in no small measure to the US need to bring China into efforts to end the global slump.


Burial of a Controversy: The The decision is that the IMF will no longer label member currencies as “funda-
IMF, the US and the Renminbi mentally misaligned”. By this, as rgemonitor (24 July 2009) puts it, “A semantic but
significant standoff was resolved….” How
was it resolved? The attempt in this piece
K Subramanian is to cover the efforts made by the US to

The United States has tried hard in recent years to make China revalue its currency. It dragged the International Monetary Fund into this campaign and attempted to make the Washington-based institution carry out “surveillance” of the exchange rate of member-countries. The campaign was formally buried recently, due in no small measure to the US need to bring China into efforts to end the global slump.

K Subramanian ( retired from the Ministry of Finance and writes frequently on global economic affairs.

Economic & Political Weekly

september 5, 2009

long-standing controversy has been buried, sadly, with no bugles or trumpets. It is clear that A merica has decided to end its currency war with China and the International Monetary Fund (IMF) is toeing its line.

On 8 July 2009, the Executive Board of the IMF concluded its review of Article IV consultations with the People’s Republic of China (PRC). A fortnight later, its views were given out in a Public Information N otice (PIN No 09/87 dated 22 July 2009). The most significant part of the review concerns the exchange rate for renminbi (rmb). Since 2006, the IMF could not conclude any Article IV review for PRC due to the festering differences over exchange rate.

The review says, “The Directors welcomed the important progress made in the past few years in increasing the market’s role in determining the exchange rate, as well as the consequent substantial real a ppreciation that has been achieved since the exchange rate reform in 2005.” They note the gradual appreciation of the value of rmb since 2006 and how it is managed. The board proceeds to offer advice on “the need for further strengthening of renminbi as a part of a comprehensive strategy to rebalance the economy”.

Perhaps for the first time, the PIN is more transparent inasmuch as it reflects the divergence of opinion among members. It continues, “Some Directors nevertheless supported the view that the renminbi remains substantially undervalued” (emphasis added). It counterbalances this view with that of some others pointing to “methodical difficulties of making e xchange rate assessments”. “These Directors generally considered that exchange rate appreciation would only play a supplementary role in supporting reforms to reorient the Chinese economy and should be pursued in a gradual manner, as and when conditions permit.” These are the voices of emerging economies now heard in the boardrooms of the IMF.

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use (abuse?) the IMF as a weapon in its a rmoury to fight China. America’s war on rmb commenced in 2001. It started as a b ilateral issue in the wake of growing trade deficits with China. Indeed, the US was facing difficult circumstances what with twin deficits, growing unemployment and loss of manufacturing due to outsourcing.

For all the ills, the US public, especially the senators, began to blame China as a “currency manipulator”. The charge was that rmb was undervalued giving its exporters an undue advantage. US senators tabled more than 200 bills seeking to impose p unitive tariffs on imports from China.

In the early stages, the issue remained bilateral. High level delegations visited C hina and impressed upon it the advantages of a market orientation to financial reforms. It became the staple diet for the Strategic Economic Dialogue (SED) with China.

China remained stubborn. Soon, the US brought pressure through the G-7 and this was also to no avail. China maintained that while it was committed to moving t owards a “flexible, market-based foreign exchange rate”, it would do so at a time of its choice and not under duress.

In fairness, China elaborated the i ntractable problems faced by its banking and financial sectors and how it could not r eform the exchange rate alone upfront. China also argued how any sudden change would destabilise Asian econmies as it had become the fulcrum in Asian trade flows.

Lining Up Economists

Though the US arranged the expertise of several economists (mostly former IMF hands) to establish that rmb was undervalued, anywhere from 10% to 40%, C hina, in its turn, could marshal many economists, including Nobel laureates, in defence of its approach. Indeed, there was a reasonable counter view that any precipitate change in the value of the rmb


would destabilise the Chinese economy and disrupt its social stability.

In a surprise move, on 21 July 2005, the People’s Bank of China (PBOC) delinked the rmb’s dollar peg and set its value against a basket of currencies. It was r evalued by 2.1% with an assurance that it would be adjusted in future as a “managed float” with changes “when necessary, a ccording to market development as well as economic and financial situation”. It was a deft stroke which blunted much of the criticism. The US Treasury was happy and informed Congress that China was on the mend. The punitive bills in Congress were withdrawn.

It was not a victory but an uneasy truce. Sadly, the US Treasury was caught between the continuing demands of domestic lobbies and the glacial pace of China’s currency reform. With the publication of successive rounds of data revealing mounting trade deficits and China’s surpluses, tension would mount and lead to strident demands on China.

By 2005, the IMF feared marginalisation of its role with the premature exit of its former debtor clients. It led to an embarrassing situation where it would not be able to meet its own budgetary costs. Rodrigo de Rato, then managing director, took up what was called the “Strategic Review” of the IMF’s activities. It was an ambitious plan which sought to rediscover the IMF’s surveillance capabilities and load it with new responsibilities to redress global fi nancial imbalances.

New US Initiatives

The US Treasury seized the opportunity and hitched the currency war to the w agon. Tim Adams of the US Treasury d emanded that the IMF should be “far more ambitious in its surveillance of exchange rates” and its most fundamental responsibility was exchange rate surveillance, that is, policing China. Rato disagreed openly and refuted the US charge that China was violating IMF rules against currency mani pulation. He referred to the Treasury’s own currency r eports to Congress and alleged that it was changing its position for political r easons. In this round, the IMF seemed to have the advantage.

Much against its resistance, the US Treasury would continue to exert pressure on the IMF to join the war. This was d iscernible in the new surveillance system unveiled by Rato in the spring meetings of the IMF in April 2006. It envisaged a proactive role to address global imbalances and to conduct “specific consultations with specific governments, not in a bilateral process but in a multilateral one”. It will zero in on “relationships, linkages, spillovers” between one country’s policies and the rest of the global financial system. Though China was not named, it was clear how the system would work.

Under Rato’s leadership, the IMF had ambitious plans to commence discussions with world’s leading powers. It started discussions on global imbalances with China, Saudi Arabia along with the US, Eurozone and Japan. It was called a “grand bargain” and months of globetrotting by senior IMF staff led nowhere. The intention was to needle China over the currency issue. Several critics like Morris Goldstein had a ssessed that it was no more than “window dressing and inaction” that would not “ advance the grand bargain” (Financial Times, 21 April 2006). Some others interpreted it “as the IMF yielding to US demands that the Fund bring China to heel over the country’s refusal to let the Yuan appreciate against the dollar”. US frustration was clear when it wanted the IMF to be “far more ambitious in its surveillance of exchange rates” and not be seen “asleep at the wheels on its most fundamental r esponsibility”.


Rato was hapless as he lacked the ability and the powers to undertake surveillance. The IMF’s writ ran over indebted countries and not the richer ones. China did not need the IMF’s assistance. What was required was a new mandate which would empower the Fund to undertake surveillance of all member countries i ndebted or not.

Revised Framework

On 18 June 2007, the IMF managing director announced the new framework for surveillance under the rubric of “IMF R eforms”. The background leading to this decision is shrouded in mystery. There are no documents. Though it can be dismissed as “conspiracy” theory, one can see the “behind-the-stage” influence of the US Treasury on the IMF.

When Rato announced the new decision, he sounded victorious. Secretary Hank Paulson was quick to say, “The revised decision sends a strong message that the IMF will put exchange rate surveillance back at the core of its duties.” Little did they realise that it was an unwise and hasty decision which was not sustainable. They attempted to amend and destabilise a messy framework which had been in force since 1977 and which had neither been fully understood by the IMF staff nor enforced at any time since its inception.

By the 1970s, the regime of par values had collapsed and countries moved to a

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september 5, 2009 vol xliv no 36

Economic & Political Weekly


system of flexible exchange rate arrangements. After prolonged and contentious negotiations, the Articles of Agreement were formally amended. They gave the members freedom to adopt any exchange rate of their choice. Thus, exchange rate became a variable within the domain of their economic policies as sovereigns. The role of the IMF was changed from an umpire to an observer.

One of the Fund documents (“Article IV of the Fund’s Articles of Agreement: An Overview of the Legal Framework, Legal Department, 28 June 2006”) explains,

…The substance of Article IV was effectively negotiated by a small group of members outside the Executive Board and presented a delicate compromise. When the text was presented to the Board by the group, it was generally understood the scope for substantive change was limited, notwithstanding the fact that a number of Executive Directors

– and staff – expressed concern regarding the vagueness and ambiguity of its terms. As another backgrounder (“IMF: Review

of 1977 Decision over Exchange Rate Policies: Background, 30 June 2006”) e xplained,

It remains the official bedrock and foremost display window of the Fund’s mandate, yet surveillance practitioners, both on the side of the Fund staff and on the side of the country authorities, are unacquainted with it – a fate that, in some respect, has been shared by Article IV itself.

It was on to this detritus that the IMF, at the behest of the US, decided to latch its new powers. The 1977 mandate had three principles: freedom to adjust rates which it was needed in response to underlying conditions; freedom to pursue domestic policies and exchange rate necessary for financial stability; and, last, duty to pursue responsible exchange rate policies and avoid policies to interfere with the adjustment process or gain undue advantage over others. The earlier approach that countries shall “avoid manipulating e xchange rates” is replaced by a new one which characterises actions as “securing fundamental exchange rate misaligned in the form of an undervalued exchange rate” in order to “increase net exports”. The intention behind this revision was clear: it gave the IMF a handle to attack China. Sadly, it was wishful thinking!

When it was discussed in the IMF executive board, China dissented and warned

Economic & Political Weekly

september 5, 2009

the IMF not to back the US pressure for faster appreciation of the Yuan. It requested the IMF to carry out its duties on mutual understanding and respect. Many analysts drew attention to the fact that the mandate would disrupt the future IMF-China relations.

No Discussion of China

The issue had become so controversial that the IMF’s executive board could not discuss China’s economy since 2006, in spite of rules that it should regularly assess member economies. At the IMF’s annual meetings in October 2008 Raghuram R ajan, the IMF’s former chief economist, now at the University of Chicago, said the focus of exchange rates from 2007 was an “unmitigated disaster” (Financial Times, 26 January 2009).

Even as the US was trying to set the IMF on China, it had a taste of its own medicine. The IMF came out with its finding in its A ugust 2007 report that the US dollar was “over valued”. The US Treasury o bjected to the finding and Paulson told Congress that it is impossible to measure a currency’s fair value. As Bloomberg commented (23 August 2007), the US Treasury took two years to persuade the IMF to police global currency market and just two months to trash the initiative once the IMF adopted it.

The eruption of the financial crisis in the US in 2007 made a sea change to the issues. Dollar value itself became a threatening issue to emerging economies, e specially China and Gulf countries h olding dollar assets. IMF was able to edge its way through the crisis and find a new avatar. Sadly, it has to depend on China and other emerging economies for its own funding. China’s stimulus became important as much for China as for other economies. The rules of the game have to change to reflect changing economic and political realities.

A background paper brought out by the Independent Evaluation Office of the IMF (“IMF Surveillance: A Case Study on IMF Governance” by Biagio Bossone, BP/08/10) alerted that while the current model of the IMF governance helped to build consensus on adapting surveillance policy to changes in the world economy, “it has also weakened the role of the IMF in delivering effective surveillance and has failed to

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generate right incentives to member countries to engage effectively”. It concedes that success in surveillance is ultimately a function of political and institutional decisions of the leading countries about how to run global governance. It admits indirectly surveillance is a matter of ownership and governance of the IMF. It admits a shift in the IMF’s power balance without saying it openly.

Change in Circumstances

By March 2009, the change in the mood was visible. IMF officials began to woo China especially after the idea of floating a $250 billion bond. China had agreed to chip in but was holding back. Washington Post (31 March 2009) reported how the IMF wanted to avoid singling out China and decided to invite other countries. IMF Chief Economist Olivier Blanchard argued, “But it is better to avoid labelling” countries for misbehaviour as “That’s proven incredibly counterproductive”. In later months, there were reports of the IMF s oftening currency rules and avoiding use of the specific phrase “fundamentally misaligned” in its assessment of exchange rates that it sought to introduce through its amendment in June 2007.

Without much publicity or fanfare, the IMF issued revised operational guideline on 22 June 2009. It admits,

...the attempt to apply exchange rate related ‘labels’ – for instance, the use of specific t erminology such as ‘fundamental misalignment’ as called for by the Interim Guidance for 2007 Decision – has proved an impediment to effective implementation of the D ecision.

It goes on to elaborate how it has weakened the “candour of some assessment” and was “the main reason why Article IV consultations with a few members have fallen far behind schedule”. It concedes that it had undermined IMF surveillance and runs counter to the objective of the 2007 Decision and damaging the institution’s credibility.

Though many words have been used, those who follow the IMF’s activities will agree that it is a huge fig leaf to cover its shame. The sum and substance of the new decision is that the hasty decision crafted in June 2007 lies buried. It is an admission that the US is buying peace with China over the currency war.

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