IMF surveillance role: fundamentally misaligned?

5 October 2007

Shortly after IMF members agreed to a new bilateral surveillance framework on exchange rates in June it was undermined by the US and criticised by civil society. Now the US wants the Fund to start regulating sovereign wealth funds.

After the reform of the surveillance framework (see Update 56) the Chinese central bank issued angry statements decrying Fund interference in Chinese economic policy. But the first blows actually fell on the US, as the Fund’s annual economic report on the US economy released in August declared the dollar overvalued. The report mimicked language in the surveillance decision which said that “fundamental exchange rate misalignment” would prompt thorough review by the IMF.

The next day, a US Treasury official in testimony before US Congress publicly rejected the idea of determining the proper exchange rate for a currency. The official, Mark Sobel, was arguing against proposed US legislation that would punish China for its ‘undervalued’ currency: “While exchange rate models yield valuable insights, there is no reliable or precise method for estimating the proper value of an economy’s foreign exchange rate or measuring accurately a currency’s undervaluation.” Similar reservations about the concept of fundamental exchange rate misalignment have long been expressed by developing countries, most recently in IMF board discussion on how to implement the the recommendations of the Independent Evaluation Offiice report on the IMF’s exchange rate surveillance.

US Treasury has cut the legs from under the IMF

Michael Mussa, chief economist at the Fund from 1991 to 2001 and now a fellow at Washington-based think tank The Peterson Institute thought it unwise of the US to cast doubt on currency valuations: “The US Treasury has cut the legs from under the IMF before it even started the race. This was foolish and unnecessary when they could have just said nothing.” Adam Lerrick, a professor at Carnegie Mellon University and fellow at the neoliberal think tank American Enterprise Institute, said: “The US criticism will certainly weaken the authority of the Fund to comment on China’s currency. The Chinese are likely to argue that the Fund is wrong about their currency, too, and point out that even the U.S. doesn’t trust the Fund’s views.”

Some civil society critics of the Fund might be heartened that the Fund’s new surveillance framework is being undermined. Aldo Caliari of Washington-based NGO Center of Concern felt that the new framework would impinge on developing country policy space because it “reduces the policy space needed for developing countries to successfully grow using a trade and export-led model”. He continues: “It should be underscored that the growth of export revenue leads to current account surpluses, which will put pressure on the exchange rate to appreciate. Thus, the type of ‘sustained’ and ‘stable’ exchange rate required for the success of the export-based development strategy is going to require a degree of government exchange rate and monetary policy intervention.”

Jan Kregel, a professor of finance at the Levy Economics Institute of Bard College, faulted the new decision for being too in line with the interests of private sector financiers in the industrialised countries: “Since 1973 the IMF changed its role from being a sole lender of last resort to one of providing good housekeeping seals of approval for country policies to convince private investors to remain or increase lending to a country. By definition the policies then were conditioned by the requirements of the private lenders rather than the countries. The new surveillance measures are just another step on the path to which the IMF will no longer be a lending institution but one that ensures countries apply policies that satisfy the requirements of international private lenders rather than national interests.”

What to do about sovereign wealth funds?

Still, the US is proposing yet another expansion of mission for the IMF: regulating sovereign wealth funds. These funds are investment vehicles established by countries with large foreign currency reserves, such as oil exporters and most recently China. With an increasing number of countries building up large precautionary reserves because they do not want to rely on the IMF in times of financial crisis, sovereign wealth funds are becoming a popular way to for these countries to earn higher returns than they would get from the standard method of holding reserves, buying US Treasury bonds.

The funds invest in public and private companies, including those in other countries.The US and European countries are worried that such funds could be acquiring strategically important assets in industrialised countries, such as ports or utility companies, and might act on geopolitical motives rather than economic ones.

US Treasury official Clay Lowry proposed in a speech in June, “I believe that the IMF and World Bank could take a very useful step by developing best practices for sovereign wealth funds, perhaps through a joint task force.” Lowry highlighted the risks sovereign wealth funds posed to financial market stability and emphasised that the solution is greater transparency and clearer management guidelines. He also invoked the risks that sovereign wealth fund activity in industrialised countries might provoke reactions of financial protectionism.

While recognising the risks to stability stemming from a lack of transparency, and comparing these risks to those posed by hedge funds, in September the IMF’s chief economist Simon Johnson rejected the need for quick action by the Fund. “What should the IMF do about this situation? There’s certainly no need for dramatic action. For one thing, the situation involves sensitive issues of national sovereignty. For another, at their current level of $3 trillion, sovereign funds aren’t a pressing issue.”