G7 Strengthens Currency Statement As China Bristles At IMF Changes
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As the G7 group of industrialized countries toughened its stance last week on the value of the yuan, the International Monetary Fund (IMF) moved toward issuing a report on China’s currency under new IMF guidelines criticized by the Chinese.
In an Oct. 19 statement, G7 finance ministers “reaffirm[ed]” that exchange rates should reflect “economic fundamentals,” and expressed the undesirability of “[e]xcess volatility and disorderly movements” in exchange rates for economic growth.
“We continue to monitor exchange markets closely, and cooperate as appropriate,” U.S. Treasury Secretary Henry Paulson and his G7 counterparts stated. “We welcome China’s decision to increase the flexibility of its currency, but in view of its rising current account surplus and domestic inflation, we stress its need to allow an accelerated appreciation of its effective exchange rate.”
Morris Goldstein, a senior associate at the Peterson Institute for International Economics, said on Oct. 26 that the members of the European Union have realized that if the Euro increases in value against the dollar and the yuan, and the U.S. doesn’t take policy actions to control the dollar, “it’s China” that must act.
Goldstein said that the new G7 statement can be attributed at least in part to increased pressure from members from the European Union as the Euro continues to gain strength against both the U.S. dollar and the Chinese renminbi (RMB).
IIE Senior Fellow Nicholas Lardy predicted such an EU reaction in an Oct. 12 interview with Inside US-China Trade. As China and other Asian countries maintain artificially weak currencies, the U.S. current account deficit continues to grow, Lardy noted. In turn, he said, the dollar loses value against non-Asian currencies. “If you believe that our exchange rate is driven by this underlying dynamic, when not revising versus the yen and RMB, you will get an over-reaction against the EU, Canadian, and other currencies,” he said (Inside US-China Trade, Oct. 17).
As the U.S. and EU appeared to move closer to agreeing that action must be taken against China’s currency, China sharply criticized the language adopted by the IMF last June for use in its currency monitoring system.
“We regret that the Fund adopted in June the Decision on Bilateral Surveillance over Members’ Policies (the 2007 Decision) in the absence of consensus among its members,” China’s Vice Finance Minister Li Yong said earlier this month at the annual IMF meetings in Washington Oct. 20-22. “The Fund should adhere to its consensus-based approach in the adoption of major resolutions. We note that the application of the 2007 Decision over the past months has given rise to some controversy due to certain less clearly defined core concepts.”
Li added that the new system “has had an adverse impact on the effective implementation of surveillance.” The IMF “should focus on whether a member country’s exchange rate regime is consistent with its medium term macroeconomic policies, rather than on the level of the exchange rate,” Li said.
Instead, the IMF should move forward based on a “clear consensus” on the best methods of establishing a “prudent, fair and effective” system of monitoring and “enhance its surveillance of countries issuing major reserve currencies.”
One source familiar with the new IMF process noted that Li’s speech included no farewell to outgoing managing director Rodrigo De Rato, who leaves his post on Oct. 31. An IMF official said that De Rato’s replacement, Dominique Strausse-Kahn, would “play a role” in the drafting of the final report “as it moves through the building.”
Goldstein noted that the use of the new bilateral surveillance mechanism and the new managing director of the IMF will face a crucial test as China’s review moves through the system. If Strauss-Kahn does not take stronger action against China, he risks “losing credibility,” Goldstein said.
Goldstein noted, however, that there is reason to be hopeful that Strauss-Kahn would be persuaded to act since his background is in economics, as opposed to the political background of De Rato.
One IMF official told Inside US-China Trade on Oct. 26 that before the IMF issues its report, the IMF China team is expected to return to China for further consultation on the new language in coming weeks, or possibly in the beginning of 2008, followed by an IMF board meeting to discuss the report.
On June 18, the IMF “legal framework for bilateral surveillance” was changed to include a standard that countries should avoid exchange rate policies that generate “external instability.”
The IMF principles regarding exchange rate policies had previously stated that countries should not manipulate exchange rates to gain unfair competitive advantage; should intervene in the short term to control “disorderly” markets; and if they do intervene, should take into account the interests of other countries.
Filed by Amadeus Domaradzki under Exchange Rate Management and Monetary Policy, Macroeconomic Policy, Multilateral Trade