IMF surveillance: nature and significance

By Aftab Ahmad Khan

The International Monetary Fund (IMF) administers the international monetary system and operates as a central bank to central banks. The institution was established on December 27, 1945 when 20 countries signed the Articles of Bretton-Woods Agreement (charter). Financial operations of the Bank began on March 1947.

The celebrated economist Lord Keynes and the American diplomat H.D White played a leading role in the creation of the Fund.

The purposes of the Fund are to encourage international monetary cooperation, facilitate the expansion and balanced growth of international trade and thereby contribute to the promotion and maintenance of high levels of employment and real income and to the development of productive resources of its members and help member countries in correcting balance of payments deficit, promote exchange stability and assist in the establishment of a multilateral system of payments in respect of current transactions between members and the elimination of foreign exchange restrictions which hamper growth of world trade.

Central to the purposes and operations of the Fund is its mandate under the Articles of Agreement to “exercise firm surveillance over exchange rate policies of members” and to “adopt special principles for the guidance of all members with respect to their policies.”

The IMF carries out this mandate by examining international monetary issues and by examining all aspects of member countries macro-economic and related structural policies, since these policies taken together have important implications for the exchange rate system.

The IMF surveillance is designed to encourage members to adopt appropriate policies and to help them in identifying issues and problems in a timely manner so the members can adopt corrective measures more quickly.

In recent years fundamental shifts in the global economy such as rapid growth of private capital markets, increased regional monetary integration, the implementation of current account convertibility and market oriented reforms in a large number of countries have greatly increased the importance of effective and timely surveillance.

Prior to the collapse of the par value system in 1971, the implicit surveillance under the Bretton Woods system focused only on the obligations a member had to maintain the par value of the currency. After 1971, international financial arrangements became more complex as countries were free to adopt any type of exchange arrangements, ranging from “continuing to peg their current rates to the U S dollar, to allowing the rates to be freely determined by private exchange markets without official intervention.” The concept of explicit surveillance introduced in the 1978 amendment to the IMF’s Articles of Agreement was based on the idea that good international behaviour depended not on whether a country maintained a fixed rate or a flow or a peg to another currency but rather on the policies that the country actually followed.

The principles and procedures that guide Fund surveillance over exchange rate were established by the amendments to Article IV and by a 1977 decision of the IMF Executive Board. These guidelines specify that the IMF shall monitor whether members are abiding by a “code of conduct” in their external monetary relations or pursuing unwarranted monetary or fiscal policies for balance of payments purposes. The guidelines also specify that the IMF shall monitor whether changes in a country’s exchange rate system seem to be warranted by underlying economic and financial conditions. Such appraisals are to be made against the backdrop of the general economic circumstances facing the country. Surveillance has thus come to require a broad and detailed economic review of member countries.

A crucial instrument of IMF surveillance is Article IV consultation, which focuses on a systematic review of economic developments and policies in the member country and how these policies have affected the exchange rates and balance of payments of other countries.

Relevant structural policies are also examined if these are germane to macro-economic developments and policies. In recent years, surveillance has also taken into account such topics as poverty, industrial, market and environmental issues. As financial markets across the world have become more integrated, IMF surveillance has become more focused on capital account, and financial and banking issues.

Aside from country surveillance, IMF also conducts surveillance at the global and regional levels. So far as global surveillance is concerned, the IMF’s World Economic Outlook prepared twice year and International Capital Markets Report provide opportunities to assess global implications of members’ policies and give an analytical account of key developments in the international monetary system and its prospects.

While conducting regional surveillance, the IMF examines the policies pursued at regional levels. The IMF has also increased its participation in member countries regional initiatives.

Experience indicates that delayed adjustment forced by markets can be more costly and disruptive than measures promptly taken. There is, therefore, a greater need for continuous policy review by all countries and for the Fund to participate more fully in the process.

In the interest of stabilising the international economic situation, the IMF should strengthen its surveillance over industrial countries. Financial policies of the major industrial countries determine to a large extent the stability of the international capital markets and a lack of balance in their macro-economic policies and insufficient policy coordination can result in sharp fluctuations in interest rates and exchange rates. Instability in interest rates and exchange rates among industrial countries impose costs on developing countries, owing to their limited opportunities to hedge against movements in these rates.

Recent events have also clearly demonstrated that effectiveness of Fund surveillance is predicated on the timely provision of data. In this behalf it is heartening to learn that the Fund has helped to develop and disseminate a set of standards regarding the coverage, frequency and timelines of data, their quality and integrity, and their availability to the public. Countries subscribing to this special ‘data dissemination’ standard agree to adhere to these sound practices and to provide information to the public via an electronic bulletin board on the Internet provided by the Fund.

The transparency provides market participants with information needed to form judgments on policies and performance of subscribing countries and thereby contributes to more informed investment decisions.

In recent years, the Fund has adopted several measures to make surveillance more effective with close policy dialogue with countries and increased focus on countries that were seen to be at risk and where financial tensions were likely to spill over to other countries.

It is generally recognised that the sound evolution of the world economy calls for greater attention to new issues and risks. At the same time, the traditional areas of surveillance should not be neglected. To make these competitive objectives compatible, the following principles have been agreed upon by the Fund:

(a) Article IV consultations will concentrate on core topics directly linked to the Fund’s statutory mandate to exercise “surveillance over exchange rate policies of members.”

(b) Greater attention will be paid to capital account developments.

(c) Countries where developments have potential spill-over effects on others will be more closely watched.

(d) Where important economic policies are formulated at supra-national level, with potential impact on several economics, the Fund will continue to strengthen its focus on regional surveillance.