Electronic copy available at: http://ssrn.com/abstract=1300542

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Currency Manipulation and the Paralysis of the Law

By Claus D. Zimmermann, LL.M. (Yale), Doctoral Candidate (University of Oxford)1

Final draft as of 31 August 2010, full copyright retained by the author

Abstract This paper examines why existing international law is unable to effectively resolve sophisticated scenarios of currency manipulation, like notably the maintenance of an undervalued real exchange rate. This paralysis of the law arises from a number of factors. First, IMF Article IV:1(iii) prohibits currency manipulation essentially only to the extent that it is undertaken with the intent to gain an unfair competitive advantage over other IMF members. This standard makes it practically impossible for the IMF to find a member in breach of this provision; the political cost of doing so would be too high. The IMF’s 2007 Surveillance Decision appears to have increased the efficiency of bilateral surveillance merely for good faith scenarios of exchange rate misalignment. Second, a potential WTO claim arguing that currency manipulation amounts to a prohibited export subsidy can be expected to break down. The two main reasons for this are the legal uncertainty arising from the requirement to consult the IMF under GATT Article XV:2 and the exception under GATT Article XV:9(a) preventing a finding of breach under the GATT for any exchange measures that are IMF-consistent, thus effectively introducing the IMF’s inoperable “intent” requirement into WTO dispute settlement. Third, the use of unilateral trade remedies against currency manipulation is unlikely to survive a challenge at the WTO for the same reason. This paper argues that anything but a formal amendment of the Fund’s Articles, removing the stigmatizing, bad faith element in the prohibition of currency manipulation, will not resolve the current dilemma. The new focus of a revised IMF Article IV:1 might be put on ensuring that IMF members conduct their fiscal, monetary, and exchange rate policies in a way that avoids excessive global imbalances. The stakes are high and go well beyond the harmful effects of currency manipulation itself, since persisting paralysis within a legal framework might ultimately affect the credibility and legitimacy of the institutions in charge of it. 1 An earlier version of this paper has been written, to a large extent, during an internship in the Legal Department of the IMF in Washington, DC. However, it expresses the personal opinion of the author and does not necessarily represent the views of the institution or those of the IMF’s staff members. Various IMF staff members have provided highly insightful comments on earlier versions of this paper, above all Debbie Siegel whom I am particularly indebted to for her invaluable advice. I also owe great thanks to Kyung Kwak, Ross Leckow and General Counsel Sean Hagan. All remaining errors are obviously my own. Earlier versions of this paper were presented at the International Monetary Fund, the Institute for International Economic Law at Georgetown University, Washington, DC, and the University of Oxford. I gratefully acknowledge generous financial support by the ERP-scholarship programme of the German Ministry of Economics and the German National Academic Foundation.

Electronic copy available at: http://ssrn.com/abstract=1300542

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Table of Contents Introduction 2 1. The key scenarios of exchange rate misalignment and their economic impact 6 2. An assessment of the IMF’s revised approach to exchange rate misalignment 11

2.1 The code of monetary conduct under IMF Article IV:1 11

2.2 The changes introduced with the 2007 Surveillance Decision 13

2.3 Conceptual differences between the IMF and WTO legal frameworks

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3. Tackling currency manipulation under trade law? The key issues 27

3.1 Identification of the relevant governmental measures 28 3.2 The enigmas of GATT Article XV

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3.2.1 The ambiguities surrounding the consultation requirement in

GATT Article XV:2 29

3.2.2 The exception under GATT Article XV:9(a) 38

3.2.3 GATT Article XV:4 as an independent basis for a claim? 41

3.3 Currency manipulation as a prohibited export subsidy? 43

3.4 Unilateral trade remedies against currency manipulation? 51

Conclusion

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Introduction

1 Economic history is replete with examples where states have interfered with foreign

exchange markets in order to influence exchange rates. The commercial conflicts between the

two world wars, for instance, were fought not only via the imposition of tariffs, but relied also

heavily upon competitive devaluations. Sine then, straightforward competitive devaluations have

become a very rare phenomenon; contemporary scenarios, in which exchange rate policies are

Electronic copy available at: http://ssrn.com/abstract=1300542

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criticized for their potential competitive impact, tend to be much more sophisticated. The

ongoing controversy over the alleged undervaluation of the Chinese currency, the renminbi

(“RMB”),2 is an outstanding example of the extent to which alleged attempts to provide a

monetary stimulus for export led growth fuel debate around the world.3

2 For almost a decade now, China’s exchange rate policy has been subject to fierce

criticism, in particular by United States (“US”) politicians. Between 1995 and July 2005, China

operated an outright currency peg with the US Dollar (“USD”) at a rate of RMB 8.28 per USD.

Over the course of the following three years, the Chinese authorities let the RMB appreciate by

around twenty-one per cent against the USD under a managed float. From July 2008 until June

19, 2010, the RMB was again effectively pegged to the USD, this time at around RMB 6.83 per

USD. On June 19, 2010, one week before the G-20 Toronto Summit, China’s central bank

announced that it would increase the exchange rate flexibility of the RMB, but emphasized that it

did not see the economic basis for a large-scale appreciation of the RMB under its new managed

float. Two months later, the RMB had indeed appreciated merely by less then one percent

against the USD.4

3 The present debate on alleged currency manipulation is certainly not new. In the late

1960s and early 1970s, for example, Japan and West Germany, both then in the process of

rebuilding and industrializing their economies after World War Two, were criticized for

maintaining their respective currencies, the Deutsche Mark and the Yen, at artificially low levels

in order to promote exports.5 Also, the way in which US politicians from both sides of the aisle

2 The RMB is the official currency of the People’s Republic of China (“China”). It translates as “People’s currency.” Yuan, which is often used as a synonym for the RMB in the public debate, is strictly speaking the unit of account of the RMB (one yuan, two yuan, …). 3 For an overview of the key economic issues, see Wayne M. Morrison & Marc Labonte, China’s Currency: A Summary of the Economic Issues, CRS REPORT FOR CONGRESS (December 7, 2009, Order Code RS 21625). A succinct overview of the key questions that arise from the alleged undervaluation of the Chinese exchange rate under international law can be found at Charles Proctor, USA v China and the Revaluation of the Renminbi: Exchange Rate Pegs and International Law, (2006), 17 EBLR 1333 (2006) as well as at CHARLES PROCTOR, MANN ON THE LEGAL ASPECT OF MONEY 566-573 (6th ed., OUP 2005). 4 On the recent Chinese policy shift and current legislative action in the US on the issue, see Claus D. Zimmermann, Congress Continues to Attack Currency Manipulation as China Defuses G-20 Pressure For Now: the International Law Issues, 14(19) ASIL Insight, June 30, 2010. 5 For detail, see C. Fred Bergsten & John Williamson, Exchange Rates and Trade Policy, in TRADE POLICY IN THE 1980’S 99, 102 (William R. Cline ed., MIT Press 1984).

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have threatened in recent years to legislate on currency manipulation, attacking China’s

exchange rate policy more or less explicitly, very much recalls the saber-rattling that preceded

the Plaza Agreement of 1985.6

4 Exchange rate and trade policies have often been claimed to be the two sides of the same

coin. It is commonly accepted that exchange rate deviations from the economic equilibrium level

can have at least a short-term impact on the competitiveness of exporters. Whether or not

changes of the nominal exchange rate can have a long-term impact on trade flows depends

crucially on how flexible prices are. To the extent that exchange rate policies can produce shifts

not only in the nominal but also the real exchange rate, they are commonly accepted to have

analogous economic effects to both import tariffs and export subsidies. These latter policies are

arguably substitutable, even though they stem from different legal techniques.

5 Under the rules of the International Monetary Fund (“IMF”) (IMF Article IV:2(b)7),

members of the IMF are left with considerable freedom with respect to the exchange

arrangement of their choice, with the exception of any type of gold standard.8 Today, most

developed economies allow their currencies to float, i.e. these countries let their exchange rates

be determined by market forces. By contrast, developing countries usually pursue policies of

more or less fixed exchange rates, often through pegging their own currency to the currency of a

larger economy like the US, Japan, or the Euro area, or to a whole basket of currencies. The

central problem with exchange rate pegs is that the underlying economic fundamentals tend to

change without this being reflected in corresponding adjustments of the nominal value of the

6 The Plaza Agreement (also called Plaza Accord) was an agreement between France, Japan, the United Kingdom, the United States, and then West Germany, to intervene in currency markets to bring about an appreciation of the Japanese Yen and the Deutsche Mark in relation to the USD. It was signed on September 22, 1985, at the Plaza Hotel in New York City; hence its name. 7 For ease of reading, this paper makes consistent use of this shorthand for referring to provisions contained in the Articles of Agreement of the International Monetary Fund, the constituent treaty of the IMF. The detailed reference would have read: “Article IV, Section 2(b) of the Articles of Agreement of the International Monetary Fund.” 8 Overall, the IMF has identified eight different categories of exchange rate regimes: (i) exchange arrangements with no separate legal tender (i.e. where one state uses the currency of another), (ii) currency board arrangements, (iii) conventional fixed peg arrangements, (iv) pegged exchange rates with horizontal bands, (v) crawling pegs, (vi) exchange rates within crawling bands, (vii) managed floating with no predetermined path for the exchange rate, and (viii) independently floating. For a detailed description of each category, see IMF, De Facto Classification of Exchange rate Regimes and Monetary Policy Framework (July 31, 2006), http://www.imf.org/external/np/mfd/er/2006/eng/0706.htm.

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exchange rate with the result that the latter becomes either under- or overvalued. It is important

to point out from the outset that states wishing to maintain their exchange rate artificially at

either a significantly under- or overvalued level over a longer period of time will usually have to

do more than to intervene on foreign exchange markets as buyers or sellers of foreign currency,

but will also have recourse to mechanisms controlling and restricting the free flow of capital.

6 International law is not silent with respect to the use of exchange rates for protectionist

purposes. IMF Article IV:1(iii) states that each member “shall avoid manipulating exchange

rates or the international monetary system in order to prevent effective balance of payments

adjustment or to gain an unfair competitive advantage over other members.”9 However, unless

confronted with an abrupt, disproportionately large, and overtly competitive devaluation,10

having to determine whether or not a specific IMF member is manipulating its exchange rate in

order to gain an unfair trade advantage, is not only an economically highly complex, but also

politically extremely delicate undertaking. As a consequence, IMF Article IV:1(iii), which

should be regarded as one of the key provisions of the multilateral code of monetary conduct, is

rendered essentially inoperable as is once again being amply demonstrated, at least arguably, by

the current Chinese scenario.

7 This paper provides a detailed analysis of the main conceivable approaches under

international law to the issue of currency manipulation. The key objective of this paper is to

examine why existing international law appears unable to deal effectively with sophisticated

scenarios of currency manipulation, like notably the maintenance of an undervalued real

exchange rate. With international law being effectively sidelined with respect to one of the

currently most sensitive issues in international economic relations, it is highly likely that an

eventual solution to the longstanding debate on the alleged undervaluation of the RMB will

exclusively result from political power play. Working towards this conclusion, this paper

proceeds along the lines of the following three sets of questions:

9 Emphasis added. 10 As previously noted, there are not many concrete recent examples for such competitive devaluations, but the obligation just described appears to have been breached in a 1982 incident where Sweden devalued its currency by 16 per cent in order to improve the competitive circumstances for the Swedish industry. For a detailed description see ANDREAS F. LOWENFELD, INTERNATIONAL ECONOMIC LAW (OUP, Oxford 2003) 536-537.

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8 First, under which conditions does currency manipulation entail real trade effects? In

answering, this paper provides a succinct overview of the relevant economic mechanisms with

respect to exchange rate shifts. The findings of this section will be the basis for the subsequent

legal analysis.

9 Second, how does the IMF address exchange rate misalignment and to what extent, if at

all, has the 2007 review of the IMF’s bilateral surveillance mechanism put the Fund in a better

position with respect to ensuring observance of the multilateral code of monetary conduct as

enshrined in IMF Article IV:1? Part of the answer to this question will be to analyze the

conceptual particularities of the IMF’s approach to exchange rate misalignment that distinguish

the IMF’s approach from the WTO legal framework.

10 Third, what can be said about the viability of the main conceivable claims against

exchange rate manipulation under the WTO agreements as an alternative forum outside the IMF?

This section is focused on analyzing the many enigmas of GATT Article XV11 (the key provision

of the IMF-WTO relationship) and assesses whether currency manipulation could be

successfully tackled as a prohibited export subsidy at the WTO or by imposing unilateral trade

remedies.

1. The key scenarios of exchange rate misalignment and their economic impact

11 In the public debate on currency manipulation, scenarios of alleged exchange rate

undervaluation – stemming from either a competitive devaluation or an undervalued exchange

rate peg – are the dominant feature. This focus is due to the trade advantages that potentially

arise from exchange rate undervaluation and is reflected in the current state of international law:

the prohibition under IMF Article IV:1(iii) extends only to exchange rate manipulation that

serves “the purpose of securing fundamental exchange rate misalignment in the form of an

undervalued exchange rate in order to increase net exports.”12 However, many developing

11 For ease of reading, and in analogy to the approach adopted with respect to the IMF Agreement, I opted for this way of referring to what would read in detail “Article XV of the General Agreement on Tariffs and Trade 1994”. 12 IMF, Public Information Notice (“PIN”) No. 07/69, IMF Executive Board Adopts New Decision on Bilateral Surveillance Over Members’ Policies (June 21, 2007), http://www.imf.org/external/np/sec/pn/2007/pn0769.htm (emphasis added).

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countries do not maintain under-, but overvalued exchange rate pegs. Overvalued exchange rate

pegs tend to be an unsustainable phenomenon in the long run and often result in major

devaluations.13

12 There are many reasons why a currency develops a tendency to increase in value,

including trade surpluses, high interest rates and high rates of foreign investment. All these are

factors that create demand for a currency and push its value up via simple mechanisms of supply

and demand. The most common reason for overvaluation in developing countries, however, is

inflation, in particular in combination with an exchange rate peg. If inflation in one country

outpaces that in another country, the currency of the high-inflationary economy appreciates. If

the nominal exchange rate between the two currencies is prevented from moving since one is

pegged to the other, the overvaluation will become apparent only in relative prices.

13 Interest group dynamics are arguably the single-most important reason why a country

would maintain an overvalued exchange rate for too long. Industries that rely on cheap imports

will lobby extensively to preserve an overvalued exchange rate, while exporters will call for a

devaluation in order to increase the competitiveness of their products on foreign markets.

Whereas this is the pattern most commonly encountered, the exchange rate policy in favour of

which exporters and importers will lobby ultimately depends on the price elasticities of demand

and supply of their respective products.14

14 Over a longer period, the maintenance of an overvalued exchange rate is usually not

sustainable, since eventually the country concerned will run out of foreign exchange and will be

unable to pay off its foreign debts. Unable to maintain the once chosen exchange rate peg it will

13 For a detailed analysis of the unsustainability of exchange rate pegs, see Harris Dellas, P.A.V.B. Swamy & George S. Tavals, The Collapse of Exchange Rate Pegs, 579(1) THE ANNALS OF THE AMERICAN ACADEMY OF POLITICAL AND SOCIAL SCIENCE 53 (2002). 14 The price elasticity of demand is a measure of the sensitivity of demand to price changes. It is measured as elasticity, i.e. it measures the relationship as the ratio of percentage changes between the quantity demanded of a good and changes in its price. Water is a good example of a good that has inelastic characteristics in that people will pay almost anything for. The demand for coffee on the other hand is very elastic because as the price of coffee increases, there are many substitutions that consumers may switch to. This elasticity is much enhanced by international trade, since consumers might not only switch from coffee to black or green tea, but from domestic coffee to coffee imported from other countries. As a consequence, producers of a product with a very elastic price elasticity of demand can be expected to lobby in favour of a devaluation, whereas others producing more inelastic goods (for example diamonds) will want to see a maximum of overvaluation.

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have to devalue. Devaluations that are merely aimed at adjusting the exchange rate to underlying

economic fundamentals following an unsustainable overvaluation are obviously quite distinct

from a manipulation of the exchange rate aimed at achieving an undervaluation of the real

exchange rate in order unfairly to promote exports.

15 For the analysis provided in this paper it is crucial to understand how an undervaluation

of the real exchange rate can be achieved and maintained. When faced with increased demand

for its currency, a country that once opted for a system of fixed exchange rates, for example a

former British colony that once pegged its currency to the pound sterling, has only the choice

between abandoning its currency peg in order for the nominal exchange rate to reflect the

changing economic fundamentals and intervening on the foreign exchange markets in order to

relieve existing excess demand for its currency through selling it.15 If such interventions are

undertaken on a large scale, over a longer period of time and in a one-sided direction16 in order

to prevent the currency from appreciating, the country concerned will have to pile up huge

amounts of foreign exchange.17 When buying foreign exchange, countries usually buy foreign

government bonds, which, if undertaken on a large scale, can have a significant impact on

keeping down the yields of such government bonds (and, more generally, interests rates in the

country whose currency is subject to these massive purchases).18

16 However, in order to secure real trade effects, and therewith an allegedly unfair

competitive advantage, it is clearly not enough to maintain a specific nominal exchange rate. It is

the real exchange rate, i.e. the relationship between the nominal exchange rate multiplied by the

15 In perfect analogy, when confronted with an excess supply of its currency, and if unwilling to devalue its exchange rate accordingly, the country would logically intervene in foreign exchange markets through buying its currency in order to soak up any excess supply. As considered above, such efforts to maintain an overvalued exchange rate usually come to an abrupt end as soon as the country runs out of foreign exchange meaning that it can no longer intervene in foreign exchange markets as needed in order to maintain its overvalued exchange rate peg. 16 It should be noted in this context, that “protracted large-scale intervention in one direction in the exchange market” is the first of seven indicators considered by the IMF in the context of its bilateral surveillance mechanism (see IMF, supra note 12 and section 2.2 of this paper). 17 For example, reports from earlier this year suggest that the Chinese USD reserves had grown to about USD 2.45 trillion by June 2010, http://www.chinability.com/Reserves.htm. 18 The argument that the Chinese exchange rate policy helps the US to sustain its massive balance of payments deficit and acts as an incentive for Americans (through maintaining US interest rates low) to continue spending instead of starting saving is inscribed in precisely this logic.

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respective purchasing power factor, that determines whether or a nominal undervaluation might

have any real impact on trade flows. Taking measures in order to hold inflation down, in other

words to prevent prices from adjusting to economic fundamentals by appreciating, is therefore

absolutely necessary in order to avoid that any potential real impact of a nominal undervaluation

is zeroed by a corresponding increase in prices.

17 In the public debate it is often taken for granted that a devaluation or an undervalued

exchange rate peg have real effects on trade equivalent to both increased import tariffs and

export subsidies. Since both of these measures distort trade, so the common argument, countries

facing a deterioration of their trade balance with a country that manipulates its exchange rate

should either consider taking unilateral trade remedies or filing a claim at the WTO. However,

any nominal undervaluation of the exchange rate has real trade effects equivalent to import

tariffs and export subsidies only under very specific circumstances, namely when prices are not

entirely flexible19 and if producers price their products in their own currency.20

18 As elaborated in detail by Staiger and Sykes,21 the underlying economic mechanisms of

misaligned exchange rates are fraught with complexity, which renders it almost impossible to

develop generally valid policy recommendations in this field. However, although it is important

to be aware of the complexity of the matter, one should keep in mind that policymakers in

countries wishing to manipulate their exchange rates for trade purposes usually very well

understand the economic mechanisms underlying their policies. In other words, policymakers

around the world know that, in order to secure real trade effects from a nominal undervaluation,

it is essential to keep inflation down and to prevent prices from adjusting upwards.

19 The following example might be a useful, and timely, illustration. The authorized uses of

foreign exchange in China are strictly controlled and restricted by the government. Both China’s

19 According to the economic law of one price: “In an efficient market, all identical goods must have only one price.” However, there is a considerable amount of empirical evidence suggesting that the law of one price fails dramatically at the international level. For a review of this literature, see Charles Engel, Expenditure Switching and Exchange Rate Policy, 17 NBER MACROECONOMICS ANNUAL 231. 20 For a detailed analysis, see Robert Staiger & Alan O. Sykes, “Currency Manipulation” and World Trade, Stanford Law and Economics Olin Working Paper No. 363 (June 13, 2008), http://ssrn.com/abstract=1151942. 21 Id. at 4-25.

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capital and current account are in surplus, which implies that the supply of foreign exchange in

China’s domestic market is increasing at the same time that the use of (and thus the demand for)

foreign exchange is strongly constrained by governmental regulation. In the absence of such

regulation, market forces would dictate that the excess supply of foreign currency in China lead

to an increase in the value of the RMB. Such a shift would occur as a result of Chinese market

participants converting foreign exchange holdings (for which there are only limited authorized

uses) into RMB (which are freely usable). Faced with an ever-growing foreign exchange surplus,

which in fact constitutes demand for RMB, China appears to have reacted with massive capital

controls and its central bank has become a persistent buyer of foreign exchange in order to

absorb existing excess supply of foreign exchange.

20 Besides capital controls combined with sterilization measures (i.e. open market

interventions22 in order to counteract the effect of exchange market interventions on a country’s

monetary base) countries wishing to hold inflation down can also have recourse to increased

reserve requirements. As a general matter, any policy aimed at contracting the money supply will

contribute to holding inflation down. Finally, direct measures of outright price control are an

additional, obviously less subtle since perfectly visible, means in order to maintain an artificially

low price level.

21 Considerable measurement uncertainties make it of course extremely difficult to

determine to what extent shifts in trade flows have been caused by a specific real exchange rate

as simple correlations say little about actual causation. In addition, assessing if, and to what

extent, an exchange rate is under- or overvalued compared to its economic equilibrium level is a

very difficult task for which no commonly accepted technique exists.

22 The IMF’s latest Article IV consultation with China provides a perfect illustration of the

great difficulty to come up with a precise and reliable assessment of the degree to which an

exchange rate might be under- or overvalued. With respect to the value of the Chinese exchange

rate, the staff report merely states that IMF staff “believe that the renminbi remains substantially

below the level that is consistent with medium-term fundamentals” without giving any

22 I.e. the buying and selling of government securities by the central bank in order to control the money supply.

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quantitative estimate of the identified undervaluation.23 Furthermore, it emerged from the

assessment of the staff report by the Fund’s Executive Board that, while several Directors agreed

with the staff’s view that the RMB was undervalued, a number24 of others thought this

assessment was wrong.25

23 With these economic mechanisms and caveats in mind, I will now turn to examining how

the IMF approaches misaligned exchange rates.

2. An assessment of the IMF’s revised approach to exchange rate misalignment

24 This section will focus on the multilateral code of monetary conduct as enshrined in IMF

Article IV:1 prior to analyzing the changes that have been introduced in 2007 with the reform of

the IMF’s bilateral surveillance mechanism. As part of its assessment of the extent to which this

revised legal framework ensures a satisfactory legal treatment of alleged scenarios of currency

manipulation, this section will also have to look at important conceptual differences between the

IMF and WTO legal frameworks.

2.1 The code of monetary conduct under IMF Article IV:1

25 As stated in the chapeau of IMF Article IV:1:

Recognizing that the essential purpose of the international monetary system is to provide a framework that facilitates the exchange of goods, services, and capital among countries, and that sustains sound economic growth, and that a principal objectives is the continuing development of the orderly underlying conditions that are necessary for financial and economic stability [IMF members have undertaken] to collaborate with the Fund and other members to assure orderly exchange arrangements and to promote a stable system of exchange rates. …

23 IMF, Staff Report for the 2010 Article IV Consultation with the People’s Republic of China (July 9, 2010), at para. 22, http://www.imf.org/external/pubs/ft/scr/2010/cr10238.pdf. 24 Qualifiers commonly used in summings up of meetings of the Fund’s Executive Board have been given a specific meaning in order to convey significant nuances in the Boards view in the absence of a formal decision. According to this established practice, the above-used qualifier “a number of Directors”, for example, refers to about six to nine Directors out of the 24 total (see IMF, Qualifiers Used in Summings Up of Executive Board Meetings, http://www.imf.org/external/np/sec/misc/qualifiers.htm). 25 IMF, PIN No. 10/100, IMF Executive Board Concludes 2010 Article IV Consultation with China (July 27, 2010), http://www.imf.org/external/np/sec/pn/2010/pn10100.htm.

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26 After its chapeau, IMF Article IV:1 sets out four specific obligations whose performance

is considered to be of particular relevance to the general obligation to collaborate. “In particular,

each member shall”:

(i) endeavor to direct its economic and financial policies toward the objective of fostering orderly economic growth with reasonable price stability, with due regard to its circumstances;

(ii) seek to promote stability by fostering orderly underlying economic and financial conditions and a monetary system that does not tend to produce erratic disruptions

(iii) avoid manipulating exchange rates or the international monetary system in order to prevent effective balance of payments adjustment or to gain an unfair competitive advantage over other members.’

(iv) follow exchange policies compatible with the undertakings under [IMF Article IV:1]. 26

27 The first two obligations have been introduced by the Second Amendment of the IMF

Agreement (entered into force on 1 April 1978) “given the important relationship between a

member’s domestic policies and its exchange rate.”27 As becomes evident through their moderate

language, “these obligations are of a particularly ‘soft’ nature, out of recognition that members

should not have to give up a significant degree of sovereignty with respect to policies that, while

they may have an international impact, are of domestic nature.”28 “Unlike these two ‘best-effort’

obligations with respect to domestic policies, the obligation [under paragraph (iii) to avoid

pursuing policies that are designed to either interfere with the adjustment of the balance of

payments or to gain an unfair competitive advantage over other members] is of a ‘hard’ nature,

reflecting the international nature of [exchange rate policies].”29

28 Concerning the obligation spelt out in paragraph (iv), it seems quite uncertain, and this

despite its formulation as “a ‘hard’ obligation that is expressed in terms of achieving results,”30

whether and to what extent it creates an additional obligation. According to the Fund, “the 26 IMF Article IV:1 (all emphases added). 27 IMF, Article IV of the Fund’s Article of Agreement: An Overview of the Legal Framework 2 (June 28, 2006), http://www.imf.org/external/np/pp/eng/2006/062806.pdf. 28 Id. 29 Id. 30 Id, at 16.

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legislative history reveals that, at the time of its adoption, there was some uncertainty as to its

meaning.”31 It appears convincing to interpret the term “exchange policies” in IMF Article

IV:1(iv) in a way that is distinct from “exchange rate policies”. According to the Fund, “such an

interpretation would serve to confirm that, while [IMF] members have the general right to

maintain exchange controls that are consistent with their obligations under [IMF] Article VIII,”

they may not use such controls “in a manner that is inconsistent with their obligations under

[IMF Article IV:1].”32 However, in the absence of a formal interpretation by the Fund and since

the legislative history of the Second Amendment of the IMF Agreement does not appear to

contain any evidence that IMF Article IV:1(iv) was indeed intended to subject the use of

exchange controls to the set of obligations under Article IV:1, the precise meaning and practical

relevance of this paragraph (iv) remains ambiguous.33

29 Due to their introduction by the words “in particular, each member shall,” adherence to

these four specific obligations under IMF Article IV:1(i)-(iv) “does not necessarily mean that [an

IMF member] will always be in compliance with the general obligation to collaborate [with the

Fund and other members to assure orderly exchange arrangements and to promote a stable

system of exchange rates].”34 The chapeau of IMF Article IV thus contains a net residue with

respect to the type conduct that would conform to IMF Article IV:1 as a whole. With its 1977

Decision on Surveillance over Exchange Rate Policies, and, in particular, with the substantial

update of its bilateral surveillance mechanism in 2007 and its strengthened focus on

contemporary scenarios of currency manipulation, the IMF has provided its members with

valuable guidance on how to comply with IMF Article IV:1.

2.2 The changes introduced with the 2007 Surveillance Decision

30 IMF Article IV:3(a) provides the basis for what has become known as multilateral and

bilateral surveillance by the IMF. According to this provision, “[t]he Fund shall oversee the

international monetary system in order to ensure its effective operation” and “shall oversee the 31 IMF, supra note 27, at 16. 32 Id. 33 Id. 34 Id, at 13.

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compliance of each member with its obligations under [IMF Article IV:1].” Section 3(b) further

provides, that, “in order to fulfill its functions [under section 3(a)], the Fund shall exercise firm

surveillance over the exchange rate policies of members, and shall adopt specific principles for

the guidance of all members with respect to those policies.” It is on this basis that the IMF has

set up, in 1977, its bilateral surveillance mechanism, which, in 2007, has undergone a significant

overhaul aimed at increasing the Fund’s efficiency with respect to the surveillance of

international monetary conduct.35 The Fund’s 2007 Decision on Bilateral Surveillance (“2007

Surveillance Decision”) provides valuable interpretation and guidance, but does not create

additional obligations to, or obligations stricter than, those contained in IMF Article IV.36

31 The 2007 Surveillance Decision refocuses the Fund’s bilateral surveillance activities on

how to deal with contemporary scenarios of exchange rate under- and overvaluation. As

explained by the Fund:

[the] updating was needed because the 1977 Decision did not address the developments that have most challenged the stability of the system in the past thirty years. Reflecting the period when it was drawn up, it focused on potential exchange rate manipulation undertaken for balance of payments reasons and on short-term exchange rate volatility. By contrast, the most prevalent exchange rate-related problems since 1977 have been the maintenance, for domestic reasons, of overvalued or undervalued exchange rate pegs and, more recently, capital account vulnerabilities often arising from balance sheet imbalances.37

32 Pursuant to IMF Article IV:3(b) as quoted above, the Fund has adopted the following

principles for its bilateral surveillance mechanism in order to guide IMF members on how to

conduct exchange rate policies in compliance with IMF Article IV:1. The first three of these

principles were already part of the 1977 Decision; principle D is new. They read as follows:

A. A member shall avoid manipulating exchange rates or the international monetary system in order to prevent effective balance of payments adjustment or to gain an unfair competitive advantage over other members.

B. A member should intervene in the exchange market if necessary to counter disorderly conditions, which may be characterized, inter alia, by disruptive short-term movements in the exchange rate of its currency.

35 IMF, supra note 12. 36 Id. 37 Id.

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C. Members should take into account in their intervention policies the interests of other members, including those of the countries in whose currencies they intervene.

D. A member should avoid exchange rate policies that result in external instability.

33 As becomes immediately obvious, principle A merely restates the strict legal obligation

contained in IMF Article IV:1(iii) that IMF members “shall avoid manipulating exchange rates

or the international monetary system in order to prevent effective balance of payments

adjustment or to gain an unfair competitive advantage over other members.” As a consequence, a

finding of breach of IMF Article IV:1(iii) would have to directly and immediately follow from a

finding of non-observance of principle A.

34 According to the annex of the 2007 Surveillance Decision, an IMF member would only

be acting inconsistently with IMF Article IV:1(iii) “if the Fund determined both that: (a) the

member was manipulating its exchange rate or the international monetary system and (b) such

manipulation was being carried out [either in order to prevent effective balance of payments

adjustment or to gain an unfair competitive advantage over other members].” The same annex

further provides valuable definitions of some key terms:

(a) “Manipulation” of the exchange rate is only carried out through policies that are targeted at – and actually affect – the level of an exchange rate. Moreover, manipulation may cause the exchange rate to move or may prevent such movement.38

(b) A member that is manipulating its exchange rate would only be acting inconsistently with [IMF Article IV:1(iii)] if the Fund were to determine that such manipulation was being undertaken “in order to prevent effective balance of payments adjustment or to gain an unfair competitive advantage over other members.” In that regard, a member will only be considered to be manipulating exchange rates in order to gain an unfair competitive advantage over other members if the Fund determines both that: (A) the member is engaged in these policies for the purpose of securing fundamental exchange rate misalignment in the form of an undervalued exchange rate39 and (B) the purpose of securing such misalignment is to increase net exports.

38 Emphasis added. 39 This explicit limitation to scenarios of undervaluation has most likely been included out of awareness that exchange rate overvaluation does, if anything disadvantage a country in its efforts to trade internationally, and that the competitive advantages addressed by IMF Article IV:1(iii) are those arising exclusively from scenarios of undervaluation.

16

35 According to the Fund’s Executive Board, “exchange rate manipulation can take many

different forms, including intervention in the exchange markets and the imposition of capital

controls for the purpose of directly targeting the exchange rate.”40

36 The Fund frankly admits that “the potential applicability of the obligation to avoid

manipulation is constrained by the need to determine intent [‘in order to…’]”.41 In assessing this

“intent”, the member concerned is to be given “the benefit of any reasonable doubt”, although

“this determination … is made independently by the Fund and is not exclusively based on the

member’s representation of its motives.”42 However, one cannot overlook that showing that an

IMF member manipulates its exchange rate with the intention to achieve an unfair competitive

advantage remains as difficult under the 2007 Surveillance Decision as before since the “intent”

requirement continues to be enshrined in IMF Article IV:1(iii) whose wording has remained

unchanged since the Second Amendment of the Fund’s Articles.

37 In contrast to principle A, non-observance of principles B, C, and D of the 2007

Surveillance Decision would not automatically constitute a breach of obligation. Several steps

would be necessary before such a non-respect of principles B, C and D could lead to a finding of

breach of the general obligation of collaboration contained in the chapeau of IMF Article IV:1:

First, the Fund [i.e. through a decision of its Executive Board] would need to adopt a policy of general applicability that provided that observance of the conduct contemplated in the recommendation, i.e. engaging in or refraining from a particular action, is required for members to comply with the general obligation of collaboration under [IMF Article IV:1]. This decision would need to be general in application because the principle of uniformity of treatment would preclude the Fund from requiring certain conduct from one country and only recommending it [to] another in the exact same circumstances. After such a policy was introduced, members, having been placed on notice that the conduct in question is now mandatory, would also need to be given a reasonable time to engage in or refrain from such conduct. Only if a member were to fail to do so would it be open to the Fund (i.e. the Executive Board) to adopt a decision finding the member to be in breach.43

40 IMF, supra note 12. 41 IMF, supra note 27, at 2. 42 Id. 43 IMF, Review of the 1977 Decision on Surveillance over Exchange Rate Policies–Further Considerations 22-3 (January 11, 2007), http://www.imf.org/external/np/pp/2007/eng/fc.pdf.

17

38 At the end of all these steps, the Fund’s options would be quite limited. The IMF has no

dispute settlement procedure similar to the one existing at the WTO, and according to IMF

Article XXVI, IMF members can be punished for violations of their obligations only through a

curtailment of their access to Fund resources, suspension from membership, and, ultimately,

expulsion from the Fund.

39 Whereas for small and weak economies these limited options might constitute powerful

threats, the economic, though not necessarily the reputational, leverage might have to be

regarded as quite small with respect to larger economies like, for example, the US, Japan, and

China. Up to the present day, not a single IMF member has ever been found by the IMF to be in

breach of IMF Article IV.44 Obviously, this should not necessarily be read as implying that the

IMF has succeeded in keeping every single member of the organization in full compliance with

the code of monetary conduct throughout every moment of the Fund’s long history. The

imprecise language of IMF Article IV:1, the many economic measurement uncertainties and the

tremendous political cost of finding a member in breach of IMF Article IV:1(iii) due to its

“intent” component as elaborated above make it very difficult to eventually reach a finding of

breach, even in relatively obvious scenarios.

40 In light of the persisting difficulties with IMF Articles IV:1(iii) and its “intent” element,

the introduction of principle D might be regarded as the key innovation of the 2007 Surveillance

Decision: “A member should avoid exchange rate policies that result in external instability.”

With this new principle, the IMF provides additional guidance on what needs to be understood

by the chapeau obligation under Article IV:1 “to collaborate with the Fund and other members to

assure orderly exchange arrangements and to promote a stable system of exchange rates.”45

41 Principle D extends the scope of the IMF’s bilateral surveillance mechanism to any

scenario of “external instability” that is the result of exchange rate policies. In other words, the

44 Michael Mussa, IMF Surveillance over China’s Exchange Rate Policy 40 (Peterson Institute of International Economics, October 19, 2007). 45 It should be noted that, in the future, the IMF might very well chose to adopt additional guiding principles in order to further specify the meaning of the chapeau obligation under IMF Article IV:1. The IMF does not claim that the existing four principles as contained in the 2007 Surveillance Decision exhaust the chapeau obligation, which appears to be a sensitive position seen the flexible and very broad language of that chapeau.

18

member’s reasoning behind a specific set of exchange rate policies is irrelevant for the purpose

of principle D, only the result matters. In applying this new principle, the Fund “will focus on

those policies of members that can significantly influence present or prospective external

stability, [which is defined as] a balance of payments position, that does not, and is not likely, to

give rise to disruptive exchange rate movements.”46 The Fund has further declared that it will

assess whether these policies are promoting external stability and will advise the member

concerned on policy adjustments necessary for this purpose.47

42 Finding a member in nonobservance of Principle D requires, “beyond any reasonable

doubt”, that:

(i) there is external instability;

(ii) the member has exchange rate policies; [defined by the Fund as “intervention policies and certain other policies conducted for the purpose of influencing the balance of payments and hence the exchange rate”48]; and finally that:

(iii) those exchange rate policies are a significant contributor to the external instability.49

43 In order to identify such “external instability” as stated in principle D, the Fund looks,

among other factors, for so-called “fundamental exchange rate misalignment”. According to the

2007 Surveillance Decision, an exchange rate is fundamentally misaligned when the underlying

current account (stripped of cyclical and other temporary factors) is not in equilibrium, i.e. not in

line with fundamentals. It should be noted, however, that in June 2009, in its latest operational

guidance note on the application of the 2007 Surveillance Decision, the IMF has removed “the

requirement to use specific terms such as ‘fundamental exchange rate misalignment’”50 and has

advised its staff to revert to using the plain economic terms “under- or overvaluation”.51

46 IMF, supra note 12. 47 Id. 48 IMF, The 2007 Surveillance Decision: Revised Operational Guidance 12 (June 22, 2009), http://www.imf.org/external/np/pp/eng/2009/062209.pdf. 49 Id. 50 Id. 51 This change does not substantially affect the operation of the 2007 Surveillance Decision and appears to be essentially one of semantics. Throughout this paper, I therefore continue to make use of the term “fundamental

(continued)

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44 From a finding that the exchange rate of a specific IMF member is fundamentally

misaligned it does not automatically follow that that member is breaching IMF Article IV. For

that the IMF would have to determine that the misalignment does not merely result from an

external shock and that the member concerned is conducting its exchange rate policy with the

intent to prevent balance of payments adjustment or to gain an unfair competitive advantage over

other members.52 Furthermore, IMF Article IV:1(iii) can be breached without there being

fundamental exchange rate misalignment in the first place. This would be the case if an IMF

member were found to manipulate its exchange rate with the intent to obtain one of the purposes

outlawed under Article IV:1(iii), independent of whether such an intentional manipulation

resulted in fundamental misalignment.

45 The IMF defines exchange rate policies as “intervention policies and certain other

policies conducted for the purpose of influencing the balance of payments and hence the

exchange rate,” principles A and D are thus “not relevant for countries that do not intervene or

take other actions aimed at affecting the level of the exchange rate,” i.e. countries with a floating

exchange rate misalignment” designating a significantly under-or overvaluation of an exchange rate. The term is still officially enshrined in the 2007 Surveillance Decision, but should no longer be regarded as an IMF-specific technical term in light of the just mentioned operational guidance note of June 2009. 52 Again, fundamental exchange rate misalignment is not the only economic factor that will alert the Fund. According to the 2007 Surveillance Decision, with respect to “the observance by members of the Principles [A to D], the Fund shall consider the following developments [with fundamental exchange rate misalignment being only one of them (see (v) below)] as among those which would require thorough review and might indicate the need for discussion with a member:”

(i) protracted large-scale intervention in one direction in the exchange market; (ii) official or quasi-official borrowing that either is unsustainable or brings unduly high

liquidity risks, or excessive and prolonged official or quasi-official accumulation of foreign assets, for balance of payments purposes;

(iii) (a) the introduction, substantial intensification, or prolonged maintenance, for balance of payments purposes, of restrictions on, or incentives for, current transactions or payments, or (b) the introduction or substantial modification for balance of payments purposes of restrictions on, or incentives for, the inflow or outflow of capital;

(iv) the pursuit, for balance of payments purposes, of monetary and other financial policies that provide abnormal encouragement or discouragement to capital flows;

(v) fundamental exchange rate misalignment; (vi) large and prolonged current account deficits or surpluses; and (vii) large external sector vulnerabilities, including liquidity risks, arising from private capital

flows.

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exchange rate.53 However, a floating exchange rate could nevertheless be found to be under- or

overvalued under the terms of the 2007 Surveillance Decision.54 According to the Fund, this

might happen, as a result:

of domestic policies (e.g., a depreciation induced by large fiscal surpluses), 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).55

46 The above statement clearly shows that the IMF takes into account that most countries

with floating exchange rate regimes do occasionally intervene in exchange markets or take other

actions aimed at the exchange rate. As a consequence, even for official “floaters” observance of

the principles contained in the 2007 Surveillance Decision is not excluded from becoming an

issue in Article IV consultations if the member concerned takes occasional actions aimed at the

exchange rate.

47 Finally, principles B and C, though also providing guidance on the meaning of the

chapeau obligation under IMF Article IV:1, are only of minor importance and can be neglected

for the purposes of this paper. Generally, it can be noted that principles B, C, and any additional

recommendations issued by the Fund in its annual Article IV consultations with every member

provide helpful guidance for IMF members on what is acceptable to the Fund in the promotion of

external stability. As explained by the Fund:

[N]otwithstanding that the principles do not cover all policies that may be of relevance to the promotion of external stability [i.e. the residue of obligation contained in the chapeau of IMF Article IV and explicitly stated by principle D], a member that follows all of the recommendations issued by the Fund would be deemed to be in compliance with its obligations under [Article IV:1]. Observance of the principles [therefore constitutes] a “safe harbor”.56

48 So far, this section has given a first overview of how, on the basis of the rules set out in

IMF Article IV and the 2007 Surveillance Decision, the IMF deals generally with scenarios of

53 IMF, supra note 48, at 12. 54 As noted above, before the June 2009 operational guidance note, the IMF would have used the terms “fundamentally misaligned” instead of the plain economic terms “under- or overvalued”. 55 IMF, supra note 48, at 11. 56 IMF, supra note 43, at 22.

21

exchange rate under- or overvaluation and, in particular, with the issue of currency manipulation.

I will now turn to examining the main conceptual differences between the IMF and WTO legal

frameworks, which will further inform the assessment undertaken in this section of the IMF’s

approach to currency manipulation.

2.3 Conceptual differences between the IMF and WTO legal frameworks

49 The legal nature of the rights and obligations flowing from the WTO agreements on the

one side and the IMF Agreement on the other is fundamentally different. It is commonly

accepted that the rights and obligations created by the WTO agreements flow horizontally, i.e.

between WTO members.57 This means that whenever a WTO member breaches a specific

obligation under one of the WTO agreements, those of its trading partners who suffer an adverse

effect through the governmental measure at issue, have a legal claim against the state that

imposed that measure since their own legal rights have been violated.

50 The elaborated dispute settlement procedure at the WTO, providing WTO members with

the possibility to seek withdrawal of a contested measure, should be regarded as a logical

consequence of that horizontal nature of the rights and duties created by the WTO agreements.

The WTO’s Dispute Settlement Body (“DSB”) may even authorize the complaining member to

impose countermeasures against the respondent in order to offset the trade distorting effects and

to push the respondent into withdrawal of the contested measure if it refuses to bring the

measure(s) found to be inconsistent with WTO rules into compliance.58

51 The situation at the IMF is distinctly different. The rights and obligations established by

the IMF Agreement exist only as between every IMF member and the Fund as an institution, and 57 In addition, there are of course some obligations that flow vertically between the WTO as an institution and its members, like for example the obligation for WTO members under Article 25 of the Agreement on Subsidies and Countervailing Measures (“ASCM”) to notify the WTO on a yearly basis on the entire set of subsidies that fall within the scope of ASCM Article 1.1. Although these notification requirements are certainly important, they are of minor importance compared to the major obligations under the WTO agreements that flow only between members. This becomes obvious when considering the fact that the WTO as an institution does not have the right to establish a panel against a member state for an alleged breach of the WTO agreements without this being requested by a WTO member on the basis that it is itself adversely affected by a specific governmental measure taken by another member. 58 See Article 22 of the Dispute Settlement Understanding (“DSU”) for detailed guidance on the issue of compensation and suspension of concessions or other obligations.

22

not between IMF members.59 This vertical flow of rights and obligations has major

consequences. For example, the obligation for IMF members not to manipulate their exchange

rate in order to obtain an unfair competitive advantage is owed by each IMF member to the Fund

as an institution, but not to other members bilaterally. In other words, if an IMF member

undertakes a massive competitive devaluation that violates this obligation, this is a violation of

an obligation that is owed to the Fund, but not to other member states. As a consequence,

violations of the IMF Agreement do not give rise to legal claims for individual IMF members

against each other.

52 Since IMF members have no legal claim against each other based on a breach of the IMF

Agreement, it is important that there are mechanisms to ensure that the Fund’s governing body

becomes aware of instances of alleged breach. According to rule K-1 of the IMF’s By-Laws,

Rules and Regulations,60 the Fund’s Managing Director is required to bring instances of breach

of obligation to the Executive Board. In addition, any individual executive director may at any

time bring a complaint to the attention of the Executive Board, or the board itself may raise the

matter. It is interesting to note, however, as has been done elsewhere,61 that in practice this has

only rarely happened.

53 The absence of an elaborated dispute settlement body at the IMF thus appears in a

different light. As mentioned earlier, the possible sanctions provided for in IMF Article XXVI:2

are limited to the number of three: ineligibility to use the Fund’s resources, suspension of voting

rights, and expulsion from the Fund. As equally noted, due to their relatively extreme nature,

imposing these sanctions in practice is an economically and politically highly sensitive issue.

54 In practice, however, the draconian options under IMF Article XXVI:2 are not the only

means by which the Fund can operate in order to ensure that its members comply with their

obligations under the IMF Agreement. The Fund permanently monitors the compliance by its

59 This is the point of view that has always been adhered to by the Fund itself and that has been defended in large parts of the literature, see for example ALEXANDER KERN, RAHUL DHUMALE & JOHN EATWELL, GLOBAL GOVERNANCE OF FINANCIAL SYSTEMS: THE INTERNATIONAL REGULATION OF SYSTEMIC RISKS 89, 90 (OUP 2006). 60 IMF, By-Laws, Rules and Regulations, Rule K-1 (58th issue, 2001). 61 Deborah Siegel, Legal Aspects of the IMF/WTO Relationship: The Fund’s Articles of Agreement and the WTO Agreement 96 THE AMERICAN JOURNAL OF INTERNATIONAL LAW 561 (2002), at note 14.

23

member states with the most important obligations under the Fund’s Articles; the annual Article

IV consultations are certainly the outstanding example in this respect. This gives the Fund many

subtle possibilities, via policy advice and recommendations, combined with peer pressure, to

motivate a member to change a contested policy without even having to proceed to an official

finding of breach with regard to that member.

55 It should be added that the above view of verticality of rights and obligations under the

IMF Agreement is not unanimously accepted. Proctor, for example, notes:

It may … be argued that membership of an international organization involves a mutuality of rights and obligations among the member states, which should themselves be enforceable by the members individually, [this right being based] upon an analogy with the position of shareholders in a private company. It is true that the [IMF Agreement] provide[s] the Fund itself with certain sanctions against the member state in default, but this does not necessarily lead to the conclusion that other member states are deprived of the rights and remedies usually available to them following the breach of a treaty by another party [e.g., the right to apply proportionate countermeasures against the part in default].62

56 Although the idea of such a mutuality of rights and obligations, enforceable by the

member states individually, might be appealing at first sight, it has to be dismissed for the

following reasons. First, such a point of view is clearly contrary to what the IMF itself, speaking

for the community of its members, has always claimed. Second, the lack of any IMF-internal

dispute settlement procedure supports the view that this was considered as not necessary by the

founding states, since a breach of the IMF Agreement does not give rise to legal claims for

individual members. Third, one could argue that the Fund as an institution, and thanks to its

regular dialogue with every single one of its members, possesses the best information in order to

intervene in an appropriate and balanced manner whenever action by one member threatens to

damage global monetary stability. Finally, and most important, through becoming a member of

an international organization, states renounce on their right to take unilateral sanctions for

matters that are now being regulated multilaterally, unless the international organization

expressly provides its member with the possibility to act unilaterally, like in the case of unilateral

trade remedies. The catalogue of sanctions in IMF Article XXVI:2 is exhaustive; it does not

provide IMF members with the possibility to take unilateral countermeasures. As a consequence, 62 PROCTOR, supra note 3, at 560.

24

and contrary to the view advanced by Proctor above, any attempt by an IMF member to impose

unilateral sanctions based on an alleged violation of the IMF Agreement would have to be

regarded as an outright breach of international law.

57 Another major conceptual difference between the IMF and WTO legal frameworks

concerns the way how, if at all, the motives underlying a contested policy measure is taken into

account. On the WTO’s side, when deciding whether or not a WTO member has breached a

specific provision under the WTO agreements, the competent dispute settlement panel will only

be interested in examining the existence of an objective adverse effect created by a clearly

identifiable governmental measure. The intention behind the contested policy measure is

irrelevant for this assessment. An obligation under the WTO agreements, like for example the

one that prohibits export subsidies, might therefore very well be regarded as an international type

of “obligation of result.”

58 Under the IMF Agreement, by contrast, the “intent” with which IMF members pursue

specific policies or take specific actions is given much greater attention. The outstanding

example is obviously Article IV:1(iii). As discussed above, finding a member in breach of this

provision does not even require that the member effectively managed to prevent balance of

payments adjustment or that it gained a measurable competitive advantage through its exchange

rate manipulation. Demonstrating that the latter was guided by the purposes of preventing

effective balance of payments adjustment or gaining an unfair competitive advantage over other

members is, at least theoretically, sufficient for a finding of breach.63 It is the intention to engage

in certain beggar-thy-neighbor policies that is prohibited, independent of the extent to which the

member succeeds in achieving the unfair results it is aiming for. Overall, describing the

obligation under Article IV:1(iii) as an international type of “obligation of conduct” appears

therefore appropriate.64

63 In this sense, see FRANCOIS GIANVITI, Stabilité et Manipulation des Taux de Change, in LE DROIT INTERNATIONAL ECONOMIQUE A L’AUBE DU XXIème SIECLE 113, at 126 (Jean-Marc Sorel ed., 2009). 64 In practice it would probably be quite difficult, if not impossible, to prove that an IMF member manipulated its exchange rate for the purposes stated in IMF Article IV:1(iii) unless it effectively manages to do so. This appears particularly true since, as noted in the previous section of this paper, in assessing whether a member complies with the obligations under IMF Article IV:1, the IMF accords its members the benefit of any reasonable doubt.

25

59 Although the “intent” element is nowhere as obvious as in IMF Article IV:1(iii), this

provision is not an isolated example for the fact that the IMF does not have to wait until certain

policies have actually produced adverse results in order to be able to step in with policy advice

and possibly even a finding of breach. The new principle D of the 2007 Surveillance Decision,

intended to provide guidance to member states on the full content of the obligation to collaborate

under the chapeau of IMF Article IV:1 illustrates this very well.

60 Such a statement might surprise at first sight, seen that according to the Fund, and as

noted above, this new principle recommends “that members avoid exchange rate policies that

result in external instability, regardless of their purpose.”65 There is no doubt that a finding of

non-observance of Principle D requires that certain policies have actually already resulted in

external instability. However, the precise manner in which external instability is defined takes

into account the possibility of disruptive exchange rate movements in the future, which enables

the Fund to intervene with policy recommendations without having to wait for these disruptive

movements to occur. As put by the Fund in the 2007 Surveillance Decision:

[t]he Fund will focus [in its bilateral surveillance] on those policies of members that can significantly influence present or prospective external stability. The Fund will assess whether these policies are promoting external stability and [will] advise the member on policy adjustments necessary for this purpose.66

61 In this statement the IMF leaves no doubt that it will not wait until certain policies have

actually resulted in external instability in order to step in with advice for appropriate policy

changes. It can be expected that, based on the expertise acquired over the more than six decades

of its existence, the IMF has quite clear ideas on the types of policies “that can significantly

influence present or prospective external stability” and that it will therefore not hesitate to advise

its members on “policy adjustments” early on if it finds that certain of the policies pursued by

that member might ultimately result in external instability. Whether or not IMF members will

always and immediately follow the advice thus issued by the Fund is a different question.

62 These contrasting IMF and WTO standards can be coherently commented on as follows.

Through its much stronger focus on conduct, the IMF can, at least in theory, intervene at a much 65 IMF, supra note 12 (emphasis added). 66 Id. (emphasis added).

26

earlier stage than the WTO. The IMF does not have to wait for adverse effects of exchange rate

policies to produce measurable effects prior to stepping in with advice on policy adjustments.

This possibility for the IMF to intervene early on is crucial in light of the precise legal nature of

the obligations under the IMF Agreement. As explained above, IMF members will never have a

legal claim against each other based on an alleged violation of the IMF Agreement. In order to

avoid conflicts between IMF members, and to limit the temptation for each of them to have

recourse to unilateral sanctions, it is indeed important that the IMF is in a position to push its

members more or less gently into policy adjustments before the contested policy produces any

major economic harm for another member or for the global monetary system.

63 It remains to be seen to what extent the changes introduced with the 2007 Surveillance

Decision will contribute to achieving meaningful results with respect to the treatment of

contemporary scenarios of alleged currency manipulation, like the contested Chinese exchange

rate policy, with respect to which the IMF is perceived by many observers as being essentially

powerless.

64 The more nuanced approach introduced with the new principle D might be a helpful step

towards making IMF surveillance more efficient, but even after the 2007 reform bilateral

surveillance remains an essentially cooperative and consultative process. The Fund’s toolset

might have been refined in a sensible manner, but its teeth have clearly not been strengthened.

The increased possibility for the IMF to step in early with policy advice might turn out to be a

very helpful change with respect to good-faith scenarios of unintended exchange rate

misalignment. It seems, however, that for scenarios where an IMF member deliberately seeks an

unfair trade advantage in breach of IMF Article IV(iii), the Fund is essentially left as powerless

as before in ensuring full compliance with the existing multilateral code of monetary conduct due

to the “intent” element as analyzed in this section, and the huge political stigma that would arise

from a finding of breach. IMF members might therefore be well advised to seriously consider

eliminating the “intent” element from Article IV:1(iii) via an amendment of the Fund’s Articles

in order to render that important provision of international law workable at last.

65 Seen that the IMF is currently left with very limited possibilities to put an end to

sophisticated scenarios of currency manipulation and thus to ensure the respect of a key rule of

27

international monetary cooperation, it is understandable that policymakers around the world have

started to look beyond the scope of the IMF and to examine to what extent legal redress against

alleged currency manipulation could be sought in a forum outside the IMF.

66 As elaborated earlier in this paper, currency manipulation has the potential to affect real

trade flows.67 This explains why a government looking for alternative ways of legal action

outside the IMF framework might consider bringing a case to the WTO. This situation might

arise if a specific WTO member were convinced that another WTO member promotes its exports

by the means of an undervalued real exchange rate and that doing so breaches a specific WTO

rule. Nothing in the IMF Agreement or the WTO agreements would deprive the DSB to examine

whether governmental measures taken as part of the exchange rate policy of a WTO member

violate a specific WTO rule. However, whether the economic effects of maintaining an

undervalued exchange rate constitute actionable economic harm under a specific rule contained

in one of the WTO agreements is far from obvious. In addition, the precise way in which a WTO

panel/the Appellate Body and the IMF would have to interact in a potential WTO dispute on

currency manipulation raises major systemic questions. With the conceptual differences between

the IMF and WTO legal frameworks as examined above in mind, the following section aims to

shed light on these and related issues.

3. Tackling currency manipulation under the trade law? Thee key issues

67 This section begins with identifying the type of governmental measures that a potential

WTO dispute on exchange rate manipulation would have to deal with before providing a detailed

analysis of several elements of GATT Article XV, the key provision of IMF-WTO interaction,

which is affected by significant ambiguity and thus legal uncertainty. Subsequently, this section

assesses whether currency manipulation might be successfully attacked at the WTO as a

prohibited export subsidy. Finally, the section discusses the relevant international law issues that

arise from the potential imposition of unilateral trade remedies in a context of alleged currency

manipulation.

67 See section 1 above. It should be recalled that quantifying these real trade effects in a concrete scenario and proving their causation by specific policy measures can be expected to be an extremely complicated undertaking.

28

3.1 Identification of the relevant governmental measures

68 Bringing a case to the WTO is not a viable option for any shifts in the exchange rate that

have been caused by external economic shocks without any governmental intervention. As a

general matter, relief under WTO rules can only be sought for adverse effects that originate in

measures taken by another Member.68 According to DSU Article 3.3:

[T]he prompt settlement of situations in which a Member considers that any benefits accruing to it directly or indirectly under the covered agreements are being impaired by measures taken by another Member is essential to the effective functioning of the WTO and the maintenance of a proper balance between the rights and obligations of Members.69

69 This phrase is usually referred to as “governmental measures” and needs to be read in a

sufficiently broad manner in order to capture measures by any public entity under a specific

WTO member’s control. The fact that central banks are often granted formal independence, with

the consequence that neither the executive nor the legislature can directly control their

interventions, is thus not a valid reason why measures taken by central banks should not be

regarded as “measures taken by another Member”. Independent of the economic merits of such a

choice, sovereign states are free to choose whether and to what extent they wish to isolate their

central banks from political pressure. If a state opts to do so, it can obviously not hide away from

its responsibility for potential violations of international legal rules that might result from

measures taken by its central bank.

70 A WTO member wishing to bring a case to the WTO based on the adverse effects of an

undervalued real exchange rate would most likely have to complain about a whole set of

measures, depending on the precise economic circumstances. As analyzed in the brief economic

overview provided earlier in this paper,70 in order for an undervaluation to produce real effects

on trade, a country would have to maintain an artificially low price level. As noted, achieving

this goal would require that the country concerned takes specific steps. Capital controls

68 The legal regime of Safeguards measures under GATT Article XIX constitutes a notable exception to the general rule that requires, first, the identification of a specific governmental measure, and, second, a demonstration that this governmental measure breaches a specific WTO rule. 69 Emphasis added. 70 See section 1 above.

29

combined with sterilization, increased reserve requirements and outright price controls are

among the most notable measures that a country wishing to manipulate its exchange rate for

protectionist purposes might have recourse to in order to keep inflation down. The precise

scenario might vary from case to case, of course, and the existence of the relevant measures

might be very difficult to prove depending on the precise circumstance. For the purposes of this

paper it is sufficient to stress that it would be a crucial prerequisite for the viability of a potential

WTO claim against alleged currency manipulation that the claimant succeed in showing that the

contested undervaluation of the real exchange rate has been caused and is being maintained by

clearly identifiable measures taken by the respondent.

71 This section will now turn to examining relevant aspects of GATT Article XV. This key

provision of the IMF-WTO relationship raises major systemic questions and appears to be

fraught with significant legal uncertainty that might very well lead to the breakdown of a

potential WTO dispute on currency manipulation.

3.2 The enigmas of GATT Article XV

72 In the following, I will analyze the ambiguities surrounding the consultation requirement

in GATT Article XV:2, the exception under GATT Article XV:9(a) and the question whether

GATT Article XV:4 might serve as an independent basis for a claim against currency

manipulation.

3.2.1 The ambiguities surrounding the consultation requirement in GATT Article XV:2

73 GATT Article XV:2 states in relevant part: “In all cases in which the [WTO]71 [is] called

upon to consider or deal with problems concerning monetary reserves, balances of payments or

foreign exchange arrangements, [it] shall consult fully with the International Monetary Fund.”72

71 This quotation of GATT Article XV has been adapted according to GATT Article 2(a), which stipulates that all references to ‘contracting party’ in the now incorporated provisions of the GATT 1947 shall be deemed to read ‘Member’. In addition, the quoted parts of GATT Article XV are among those provisions for which, according to GATT Article 2(b), references to the CONTRACTING PARTIES acting jointly shall be deemed to be references to the WTO. Subsequent quotes of GATT provisions in this paper have been changed accordingly without additional express notice. 72 Emphasis added.

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The major problem with Article XV:2 is that it broadly obliges the WTO to fully consult the IMF

on the matters listed, without further specification whether or not this obligation extends to

dispute settlement proceedings.

74 In particular with respect to one of the subject matters listed in Article XV:2 – balances

of payments – the precise meaning remains ambiguous and lends some support to interpreting

the WTO’s obligation to “consult fully with the IMF” as only extending to the consultations

carried out by the competent WTO body, the Committee on Balance-of-Payments Restrictions

according to GATT Articles XII and XVIII,73 the Understanding on the Balance-of-Payments

Provisions of the General Agreement on Tariffs and Trade 1994, the Declaration on Trade

Measures Taken for Balance-of-Payments Purposes adopted on 28 November 1979,74 as well as

the relevant consultation procedures.75

75 Such a reading of GATT Article XV is supported by the provision in the General

Agreement on Trade in Services (“GATS”) dealing with balance-of-payments restrictions in the

context of trade in services, GATS Article XII. After stating, in Article XII:5(a), the obligation

for Members that make use of balance-of-payments restrictions, to consult with the Committee

on Balance-of-Payments Restrictions, paragraph 5(e) of the same Article further specifies, in

language extremely close to the above-cited GATT Article XV:2:

In such consultations, all findings of statistical and other facts presented by the International Monetary Fund relating to foreign exchange, monetary reserves and balance-of-payments, shall be accepted and conclusions shall be based on the assessment by the Fund of the balance-of-payments and the external financial situation of the consulting Member.76

73 Any Member applying new balance-of-payments restrictions or substantially intensifying existing ones is obliged to consult with the WTO Committee on Balance-of-Payments Restrictions (GATT Articles XII:4(a) and XVIII:12(a)). Any Member maintaining such restrictions is required to consult annually (Article XII:4(b)) or biennially (Article XVIII:12(b)). A third type of consultations may be initiated on the basis of a complaint by a Member adversely affected by restrictions maintained by another, if these are inconsistent with the relevant provisions relating to these restrictions (Articles XII:4(d) and XVIII:12(d)). 74 Declaration on Trade Measures Taken for Balance-of-Payments Purposes (28 November 1979) BISD 26S/205-209. 75 The so-called “full consultation procedures” (BISD 18S/48-53) and “simplified consultation procedures” (BISD 20S/47-49). 76 GATS Article XII:5(e) (emphasis added).

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76 Unfortunately, this obvious ambiguity created by the corresponding provisions in the

GATT and the GATS is not limited to scenarios of balance-of-payments-restrictions, but extends

to all other subject matters addressed in GATT Article XV, i.e. also those for which the Fund

does not merely provide a technical service to the WTO as is the case for trade restrictions to

safeguard the balance of payments, but for which there is a potential for conflicting rights and

duties of Members common to both organizations.77

77 The 1996 Agreement Between the International Monetary Fund and the World Trade

Organization (“IMF-WTO Cooperation Agreement”)78 would have been a great opportunity to

clarify whether the obligation to consult the Fund in exchange matters extends to panel

proceedings or not. And at first sight, it appears that the drafters of the IMF-WTO Cooperation

Agreement intended to provide at least some degree of clarification in this matter, since

paragraph 8 of the IMF-WTO Cooperation Agreement states in relevant part: “The Fund shall

inform in writing the relevant WTO body (including dispute settlement panels) considering

exchange matters within the Fund’s jurisdiction whether such measures are consistent with the

Articles of Agreement of the Fund.”79

78 However, in a separate decision80 on the implementation and interpretation of the IMF-

WTO Cooperation Agreement, the WTO General Council specified, among many other things:

4(b) In light of … in particular, [GATT] Article XV:2 and [GATS] Articles XI and XII of the … [:] whenever the IMF wishes to submit its views to a panel on whether an exchange measure within its jurisdictions is consistent with the IMF’s Articles of Agreement, it shall submit these views by directing a letter containing those views to the Chairman of the DSB. The Chairman of the DSB shall inform

77 As pointed out by Deborah Siegel, trade restrictions imposed to safeguard a Member’s balance-of-payments do not involve a jurisdictional overlap between the Fund and the WTO, since these restrictions do not involve exchange measures subject to Fund jurisdiction. In balance-of-payments matters the Fund is consulted for its recognized technical expertise in the subject matter, therewith providing a service to the WTO, not in order to avoid conflicting rights and obligations for Members common to both organizations as in other scenarios. See Siegel, supra note 61, at 576. 78 Agreement between the International Monetary Fund and the World Trade Organization, adopted by IMF Executive Board decision No. 11381-(96/105) (November 25, 1996) and by WTO General Council decision WT/L/194 (November 18, 1996), Selected Decisions and Selected Documents of the International Monetary Fund (32nd issue, Washington, DC, December 31, 2007) 852. 79 Emphasis added. 80 WT/L/194 (November 18, 1996), http://docsonline.wto.org.

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the chairman of the panel of the availability of this communication which, unless the panel decides otherwise, shall remain confidential to the panel and to the parties to the dispute.

Nothing in this Decision nor in the Agreement shall affect the rights and obligations of Members under the Dispute Settlement Understanding, including those provided in Article 13 thereof.

79 This specification given by the WTO General Council, in particular the explicit reference

to DSU Article 13 (“Each panel shall have the right to seek information and technical advice

from any individual or body which it deems appropriate. …”) leaves little doubt that, although it

does not say so explicitly, the WTO General Council considers that panels are allowed to, but are

not obliged to consult the IMF under Article XV:2 of the GATT 1994 and Article XII of the

GATS.

80 The IMF has never made an official statement as to whether it considers that the

consultation requirement extends to panel proceedings, but it appears to have been concerned

about the position taken by the WTO General Council, since it formulated its own approval81

(postdating the WTO’s) of the IMF-WTO Cooperation Agreement in the following terms:

The Executive Board approves the [IMF-WTO Cooperation Agreement] … on the understanding that decisions taken by either party for the implementation of the [IMF-WTO Cooperation Agreement] will not prevent [its] effective application in accordance with its provisions.

81 Unfortunately, and although the consultation requirement under GATT Article XV:2 has

already three times been covered by panel proceedings, WTO dispute settlement has not

contributed, at least not so far, to clarifying this persisting ambiguity in the legal texts.

82 The first of these three disputes, Argentina – Textiles and Apparel82 involved, among

other measures, an import surcharge by Argentina, which was claimed to violate GATT Article

VIII:1(a), but which Argentina argued – unsuccessfully – was part of the commitments it had

undertaken in the context of its IMF adjustment programme and should therefore not lead to a

81 IMF Executive Board decision No. 11381-(96/105) (November 25, 1996), Selected Decisions and Selected Documents of the International Monetary Fund (32nd issue, Washington, DC, December 31 2007) 852. 82 WTO, Argentina – Measures Affecting Imports of Footwear, Textiles, Apparel and other Items (short title: Argentina – Textiles and Apparel), Panel Report WT/DS56/R and Appellate Body Report WT/DS56/AB/R with Corrigendum WT/DS56/AB/R/Corr.1 (adopted 22 April 1998).

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finding of violation under WTO rules. With respect to the consultation requirement, Argentina

had argued on appeal that the Panel had failed to make “an objective assessment of the matter”,

as required by DSU Article 11, by not acceding to the request of the parties to seek information

from, and consult with, the IMF so as to obtain its opinion on specific aspects of the matter

concerning the contested statistical tax.83

83 The Appellate Body upheld the Panel’s finding and recalled that there is a requirement

for the WTO to consult on the matters specified in GATT Article XV:2, but that measures

included in an economic adjustment programme sponsored by the IMF are not among them.84

The Appellate Body observed, however, that it “might perhaps have been useful for the Panel to

have consulted with the IMF on the legal character of the relationship or arrangement between

Argentina and the IMF in this case,”85 which it could have done based on its discretionary right

under DSU Article 13 to seek information and technical advice from outside sources.

Unfortunately, all this merely confirmed issues that had been well understood already before and

did not shed light on the consultation requirement in GATT Article XV:2.

84 The second dispute, India – Quantitative Restrictions,86 concerned quantitative

restrictions imposed by India due to alleged balance-of-payments difficulties. Whether the

requirement under GATT Article XV:2 extends to panels was debated at length before the Panel

in this dispute and the parties expressed divergent views on the issue. As put by the Panel:

The United States was of the opinion that the Panel had before it sufficient evidence, but should consult the IMF if the Panel had any doubts. For the United States, the terms of [GATT] Article XV:2 require the WTO to consult with the IMF in specific matters, and the WTO includes panels. For India, on the contrary, to interpret the terms of Article XV to refer to panels ignores the division of functions between the different bodies of the WTO, and only the General Council and BOP Committee are covered by this provision.87

83 WTO, Argentina – Textiles and Apparel, supra note 82, Appellate Body Report, at para. 82. 84 Id, at para. 84. 85 Id, at para. 86. 86 WTO, India – Quantitative Restrictions on Imports of Agricultural Textile and Industrial Products (short title: India – Quantitative Restrictions), Panel Report WT/DS90/R and Appellate Body Report WT/DS90/AB/R (adopted September 22, 1999). 87 Id, Panel Report, at para. 5.11 (emphasis added).

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85 Eventually, however, the Panel circumvented the crucial issue and stated that it did not

find it necessary, for the purposes of this case, to decide whether or not the consultation

requirement under GATT Article XV extends to panel proceedings.88 Instead, the Panel decided

to consult the IMF “as a recognized body with extensive expertise in [balance-of-payments]

matters”89, based on its discretionary authority under DSU Article 13. The Appellate Body

abstained from taking any position on this issue since it was not appealed.90

86 Through relying on its discretionary authority under DSU Article 13, the Panel indirectly

dealt with the consultation of the IMF under GATT Article XV:2 as if it were confronted with a

simple amicus curiae brief. As has been pointed out plainly elsewhere,91 in conformity with the

logic followed by the panel in India – Quantitative Restrictions, in the future a panel might

choose not to consult the Fund at all or, which would be in open conflict with GATT Article

XV:2, to consult the IMF but without accepting its findings (as it could do with an amicus curiae

brief).

87 Very interestingly, however, in a more recent case, Dominican Republic – Import and

Sale of Cigarettes,92 the Panel resisted the temptation to take the easy path and to consult the

IMF merely as an expert under DSU Article 13. In this dispute, the Panel found that the

imposition by the Dominican Republic of a foreign exchange fee on imports of cigarettes was

not justifiable as an exchange restriction within the meaning of GATT Article XV:9(a), but that

it constituted “another charge or duty” inconsistent with GATT Article II:1(b).

88 The Panel in this dispute was the first to consult with the IMF on the basis of GATT

Article XV:2. The Panel explained its move as follows:

The Panel considered during the proceedings that it needed to seek more information on the precise legal nature and status of the foreign exchange fee

88 WTO, India – Quantitative Restrictions, supra note 86, at para. 5.13. 89 Id, at para. 5.12. 90 Id, Appellate Body Report, at para. 152. 91 Siegel, supra note 61, at 581. 92 WTO, Dominican Republic – Measures Affecting the Importation and Internal Sale of Cigarettes (short title: Dominican Republic – Import and Sale of Cigarettes), Panel Report WT/DS302/R and Appellate Body Report WT/DS302/AB/R (adopted May 19, 2005).

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measure in the stand-by arrangement between the IMF and the Dominican Republic. Secondly, since the Dominican Republic argues that the fee is an exchange restriction and it is imposed in accordance with the Articles of Agreement of the IMF, the Panel considered that it needed to consult with the IMF based on paragraph 2 of Article XV to verify such an argument for a determination by the Panel on whether the measure is justified under [GATT] Article XV:9(a). The core issue in this regard is whether the foreign exchange measure constitutes an “exchange restriction” in the package of the stand-by arrangement. If the answer is positive, the next issue then is whether the foreign exchange fee is “in accordance with” the Articles of Agreement of the IMF and hence justified under [GATT] Article XV:9(a).93

89 Unfortunately, the language employed by the Panel leaves some doubt. What would the

Panel have done had it considered that it did not need more information on the precise legal

nature of the foreign exchange fee at issue? Would it then still have considered that it needed to

consult with the IMF? It very much seems that although the Panel in this dispute formally opted

to consult the IMF on the basis of GATT Article XV:2, it did so without considering that it was

obliged to do so. In other words, although the Panel formally consulted under Article XV:2, it

appears to have reasoned as if it was consulting an amicus curiae under its discretionary

authority under DSU Article 13.

90 In summary, all three of these disputes, in particular the latter two, should therefore be

regarded as having underlined the urgent need for a concerted clarification, by both the WTO

and the IMF, of whether or not the consultation requirement in GATT Article XV:2 and in

GATS Article XII extends to dispute settlement proceedings and to draw a clear line between

such consultations and a panel’s discretionary right under DSU Article 13 to seek information

and technical advice. As has been argued convincingly by the United States in India –

Quantitative Restrictions, accepting an interpretation of GATT Article XV:2 that would leave

panels less constrained by the rules of the GATT 1994 than other bodies of the WTO (like

notably the Committee on Balance-of-Payments Restrictions) might be regarded as introducing

inconsistency between panels and the rest of the WTO.94

93 WTO, Dominican Republic – Import and Sale of Cigarettes, supra note 92, Panel Report, at para. 7.139 (emphasis added). 94 WTO, India – Quantitative Restrictions, supra note 86, Panel Report, at para. 3.309.

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91 This paper proceeds on the assumption that if a case on alleged currency manipulation

were to be brought to the WTO, the panel (and potentially the Appellate Body) hearing that case

would be obliged to consult the IMF on the basis of GATT Article XV:2 contrary to having the

mere option to do so. As elaborated in detail above, however, this issue remains somewhat

ambiguous and contested under the current state of the treaty framework.

92 It is essential to stress, that the requirement under GATT Article XV:2 to consult the IMF

in exchange matters does not imply that the WTO has to hand over its complete decisional power

to the Fund with respect to the issues covered by the consultation.95 GATT Article XV:2 rather

distinguishes between factual findings within the Fund’s assigned competence, notably balance

of payments, and legal determinations made by the Fund regarding the consistency of exchange

measures with the IMF Agreement:

In such consultations, the [WTO] shall accept all findings of statistical nature and other facts presented by the Fund relating to foreign exchange, monetary reserves and balances of payments, and shall accept the determinations of the Fund as to whether action by a [Member] in exchange matters is in accordance with the Articles of Agreement of the International Monetary Fund, or with the terms of a special exchange agreement between that [Member] and the [WTO]. …96

93 The determinations made by the Fund in response to a consultation are thus to be treated

by the WTO as either a factual or a legal finding depending on the context in which the IMF has

been consulted. The WTO relies on factual information, like for example the level of a state’s

foreign exchange reserves, in order to apply correctly the balance-of-payments exception as set

forth in GATT Article XII. In such a scenario, the IMF is consulted for its special expertise due

to the regular and detailed statistical work it undertakes on the subject matter. The Fund’s task in

this scenario is not to rule whether the balance-of-payments exception of Article XII applies, but

to provide the factual basis for the legal assessment that will be undertaken independently by the

competent WTO panel.

94 In contrast, and this might be of crucial relevance for a potential WTO dispute on

currency manipulation, the determination made by the Fund whether a specific action in

95 For detail on this point see Siegel, supra note 61, at 570. 96 Emphasis added.

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exchange matters is consistent with the IMF Agreement, has to be regarded as a legal finding.

Other WTO rules, aiming at avoiding inconsistent legal rulings and conflicting rights and

obligations for members common to both organizations depend upon such case-by-case

determinations by the Fund.97

95 Unfortunately, a review of previous disputes raises significant doubts as to whether the

distinction between the Fund’s factual determinations (which will flow into a panel’s

independent legal assessment) and the Fund’s legal findings on the consistency of a contested

exchange measure with the Fund’s Articles (from which, according to GATT Article XV:2, the

WTO cannot deviate) has been properly understood. Only two panel reports, both from disputes

discussed earlier in this section, India – Quantitative Restrictions98 and Dominican Republic –

Import and Sale of Cigarettes99 are relevant here.

96 The Panel in India – Quantitative Restrictions, by circumventing GATT Article XV:2

and consulting the IMF on the basis of DSU Article 13, not only eluded the question whether the

requirement to consult the IMF extends to panels but also the question whether a panel would

have to regard as dispositive the Fund’s determinations.100 In contrast, and as discussed above,

the Panel in Dominican Republic – Import and Sales of Cigarettes, did at least formally consult

the IMF on the basis of GATT Article XV:2. However, the relevant passage in the Panel Report

points to a wrong understanding of the legal value of the Fund’s determinations:

The Panel fully agrees with the opinion of the IMF. … [C]onsidering the opinion expressed by the IMF, the Panel finds that the foreign exchange fee measure as it is currently applied by the Dominican Republic does not constitute an “exchange restriction” within the meaning of [GATT] Article XV:9(a).101

97 As this language indicates, and although it formally consulted the IMF under GATT

Article XV:2, the Panel in Dominican Republic – Import and Sales of Cigarettes appears to have

97 The best known of these provisions is GATT Article XV:9(a), which will be analyzed in more detail in section 3.2.2 below. 98 WTO, India – Quantitative Restrictions, supra note 86. 99 WTO, Dominican Republic – Import and Sale of Cigarettes, supra note 92. 100 WTO, India – Quantitative Restrictions, supra note 86, at paras. 5.12-5.13. 101 WTO, Dominican Republic – Import and Sale of Cigarettes, supra note 92, at para. 7.146 (emphasis added).

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to attached to the IMF’s findings no greater legal value as to those expressed in an amicus curiae

brief which stands in implicit contrast to the language of GATT Article XV:2 (“shall accept the

determination of the Fund…”). Unfortunately this issue was not appealed.

98 Overall, one cannot but stress that the question as to how precisely a WTO panel hearing

a potential future dispute on currency manipulation would have to interact with the IMF is

fraught with ambiguity. The latter arises from what might be termed sub-optimal drafting of

GATT Article XV:2 and from misleading legal reasoning by the competent panels in previous

WTO disputes as examined in detail above.

3.2.2 The exception under GATT Article XV:9(a)

99 Article XV:9(a) provides in relevant part that: “Nothing in this Agreement shall preclude:

(a) the use by a [Member] of exchange controls or exchange restrictions in accordance with the

Articles of Agreement of the International Monetary Fund or with that [Member’s] special

exchange agreement with the [WTO][.] …” It can be expected that this provision, by essentially

prescribing that exchange controls or exchange restrictions that are IMF-consistent cannot lead to

a finding of breach under the GATT, would play a key role in a potential WTO dispute on

currency manipulation.

100 Most of the measures that a country would typically rely upon in order to achieve and

maintain an undervaluation of the real exchange rate, such as capital and exchange controls as

well as increased reserve requirements, could thus only be found to violate the GATT if they

were not imposed consistently with the IMF Agreement. Whether outright price controls as

means of keeping inflation down would have to be regarded as a governmental measure that is

covered by GATT Article XV:9(a) seems at least questionable. In a concrete case, any decision

as to whether a specific measure has to be regarded as falling under the scope of the exception of

GATT Article XV:9(a) (“exchange controls or exchange restrictions”) could obviously only

result from a detailed analysis of both its legal and economic characteristics.

101 The IMF defines exchange restrictions on the basis of a technical criterion that has been

set up in 1960 by a ministerial decision of the Fund and that contains a test based on “whether

[an exchange restriction] involves a direct governmental limitation on the availability or use of

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exchange as such.”102 Under IMF Article VIII:2(a), IMF members are prohibited from imposing

restrictions on the making of payments and transfers for current international transactions

without approval of the Fund.103 Unless an exchange restriction is approved by the IMF under

Article VIII or maintained under the transitional provisions of Article XIV of the IMF

Agreement it constitutes a breach of the IMF Agreement and would thus definitely not be

covered by the exception contained in GATT Article XV:9(a).

102 However, the WTO accepts as being consistent with the IMF Agreement not only the

exchange restrictions that have been approved under Article VIII or that are maintained under

Article XIV of the IMF Agreement. This situation comes from the fact that GATT Article

XV:9(a) also refers to “exchange controls” and the corresponding GATS Article XI to “exchange

actions”. Whereas it can be said with certainty that these terms go both beyond the scope of

“exchange restrictions”, it remains at least questionable whether “actions” and “controls” should

be understood as synonyms. According to François Gianviti, a former head of the IMF Legal

Department, the scope of such measures becomes clear by reference to the purpose of the Fund

and various other provisions in the IMF Agreement. Since the concept of exchange control

regulation in IMF Article VIII:2(b) is broader than the concept of exchange restrictions, so

Gianviti convincingly, it might be regarded as extending to other kinds of regulation on current

transactions as well as capital controls.104

103 As a consequence, at least for those governmental measures that fall within the quite

vague scope of “exchange controls and exchange restrictions”, a finding of breach of the IMF

Agreement appears to be a prerequisite for any finding of breach under WTO law. Since it

appears unlikely that the measures involved in sophisticated scenarios of currency manipulation

violate some other provision in isolation (like, for example, Article VIII:2(a)), the treaty rule that

is most likely to become relevant in this context is once again IMF Article IV:1(iii).

102 IMF, Decision No. 1034-(60/27) (June 1, 1960, as updated on June 30, 2006), http://www.imf.org/external/pubs/ft/sd/index.asp?decision=1034-(60/27). 103 For a detailed analysis of the precise terms of the provisions contained in Articles VIII and XIV of the IMF Agreement, see Siegel, supra note 61, at 584-590. 104 François Gianviti, Réflexions sur l’article VIII, section 2(b) des Statuts du Fonds Monétaire International, 62 RCDIP, 471-87, 643-45 (1973).

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104 The exception contained in GATT Article XV:9(a) thus appears to have the effect of

introducing the inoperable “intent” element of IMF Article IV:1(iii) into WTO dispute settlement

on matters for which there exists a jurisdictional overlap between the IMF and WTO. As a

consequence, provided that the IMF were to be properly consulted by the panel hearing a future

WTO dispute on currency manipulation and provided that that same panel would indeed treat the

IMF’s determination as to the IMF-consistency of the contested exchange measure as a legal

finding from which it cannot deviate, the chances that such a dispute would lead to a finding of

breach of WTO law appear to be very small.

105 Additional complexity arises from the fact that the exception under GATT Article

XV:9(a) is introduced by the words “Nothing in this Agreement…”.105 As a consequence,

whether that exception extends beyond the GATT to potential violations under other multilateral

agreements on trade in goods (contained in annex 1A of the WTO Agreement), like notably the

ASCM, or even beyond that scope to the entire body of WTO law, appears at least questionable.

106 One might be tempted to argue that the Declaration on the Relationship of the World

Trade Organization with the International Monetary Fund106 has provided sufficient relief to this

dilemma. After noting the “close relationship” between the Contracting Parties to the GATT

1947 and the Fund, and the provisions of the GATT 1947 governing that relationship, especially

Article XV, that Declaration

reaffirm[s] that, unless otherwise provided for in the Final Act, the relationship of the World Trade Organization with the International Monetary Fund, with regard to the areas covered by the Multilateral Trade Agreements in Annex 1A of the WTO Agreement, will be based on the provisions that have governed the relationship of the Contracting Parties of the GATT 1947 with the International Monetary Fund.

107 However, when reflecting on the hierarchy of sources of the WTO legal framework it

appears very problematic to maintain that a simple ministerial declaration should have the effect

of modifying the substantial scope of the provisions contained in the multilateral trade

agreements in Annex 1A of the WTO Agreement. Under the present state of the WTO legal

105 Emphasis added. 106 Declaration on the Relationship of the World Trade Organization with the International Monetary Fund (15 April 1994).

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framework, it remains thus at least ambiguous whether the exception enshrined in GATT Article

XV:9(a) applies in the same manner across all multilateral WTO agreements on trade in goods,

including the ASCM. All of that creates additional legal uncertainty for a potential WTO dispute

on currency manipulation.

3.2.3 GATT Article XV:4 as an independent basis for a claim?

108 GATT Article XV:4 and the related explanatory Ad note read as follows:

[Members] shall not, by exchange action, frustrate* the intent of the provisions of this Agreement, nor, by trade action, the intent of the provisions of the [IMF] Agreement.

Ad Article XV:4

The word “frustrate” is intended to indicate, for example, that infringements of the letter of any Article of this Agreement by exchange action shall not be regarded as a violation of that Article if, in practice, there is no appreciable departure from the intent of the Article. Thus, a contracting party which, as part of its exchange control operated in accordance with the Articles of Agreement of the International Monetary Fund, requires payment to be received for its exports in its own currency or in the currency of one or more members of the International Monetary Fund will not thereby be deemed to contravene Article XI or Article XIII. Another example would be that of a contracting party which specifies on an import licence the country from which the goods may be imported, for the purpose not of introducing any additional element of discrimination in its import licensing system but of enforcing permissible exchange controls.

109 It has not yet been clarified by WTO dispute settlement whether GATT Article XV:4

would prevail as lex specialis107 over the exception under Article XV:9(a) or vice versa.108 At

least arguably, the fundamental rule in GATT Article XV:9(a) saying that exchange controls or

exchange restrictions that are consistent with the Fund’s Articles cannot lead to a finding of

breach under the GATT (“Nothing in this Agreement…”109) appears to be the more specific

107 According to the rule generalia specialibus non derogant. 108 In the dispute Dominican Republic – Import and Sale of Cigarettes, one of the third parties, China, had expressed its hope that the Panel would provide clarification on the relationship between GATT Articles XV:4 and XV:9(a) (WTO, Dominican Republic – Import and Sale of Cigarettes, supra note 92, Panel Report, at paras. 5.56-5.58), but the Panel did not address this issue at all in its findings. 109 The comments made in the preceding section 3.2.2 with respect to the question whether the exception in GATT Article XV:9(a) applies across all multilateral agreements on trade in goods in Annex 1A of the WTO Agreement are equally relevant with respect to GATT Article XV:4, which also explicitly refers to “this Agreement”.

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provision. Contrary to GATT Article XV:4, which refers to “exchange action” generally,

paragraph 9(a) refers more specifically to “exchange controls and exchange restrictions in

accordance with the [IMF Agreement]”. The drafting history of the GATT has also been

convincingly interpreted elsewhere as to indicate an affirmative intention that GATT Article

XV:9(a) not be limited by its paragraph 4.110

110 Furthermore, the very general language of Article XV:4 appears to suggest that this

provision could not serve as an independent basis for a claim arising from an alleged scenario of

exchange rate manipulation, but in the absence of a single panel decision on the matter, the issue

remains obviously somewhat speculative.

111 What is then the purpose of this paragraph 4 of GATT Article XV? It has been proposed

in the literature to read Article XV:4 as merely giving effect to the principle that treaty

obligations be observed and performed in good faith.111 Adopting this point of view would

ultimately mean, however, that GATT Article XV:4 would be entirely redundant, which would

be contrary to the principle of effective treaty interpretation requiring that a treaty be interpreted

in a manner that gives effective meaning to each of its provisions.

112 It seem to me that the above-cited explanatory Ad Note can indeed be read convincingly

in a way that sheds light on the meaning of GATT Article XV:4. Ad Article XV:4 clearly states

that “infringements of the letter of any Article [of the GATT] by exchange action shall not be

regarded as a violation of that Article if, in practice, there is no appreciable departure from the

intent of the Article.” This means that in order for an exchange measure to be found to breach the

GATT there needs to be, in the first place, a distinct infringement of the letter of a specific rule

contained in the GATT. Therefore, what Article XV:4 essentially achieves is to clarify that WTO

110 As summarized by Deborah Siegel:

In the original draft of the GATT, paragraph 9 of Article XV began with the qualifying words, “Subject to the provisions of paragraph 4 of this Article”. The text was amended by the Contracting Parties at their first and second sessions in 1948 to take account of the most important changes in the Charter for the International Trade Organization made at the Havana Conference. These amendments included deletion of this qualifying clause to conform to a similar deletion in Article 24 of the ITO Charter that addressed the relationship of the ITO with the Fund. (GATT Analytical Index (6th ed 1994) 407-08). (Siegel, supra note 61, at note 131).

111 PROCTOR, supra note 3, at 570.

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Members cannot be found to breach a provision contained in the GATT for employing exchange

measures (be they consistent or inconsistent with the IMF Agreement) that infringe upon the

literal meaning of that specific GATT provision, but that do not serve any protectionist purpose,

in a way similar to the two examples given by Ad Article XV:4.

113 Bearing in mind the major legal uncertainty that arises from the numerous ambiguities

surrounding GATT Article XV as analyzed in detail in this section, this paper now turns to

assessing whether currency manipulation could be successfully attacked as a prohibited export

subsidy under the rules of the ASCM.

3.3 Currency manipulation as a prohibited export subsidy?

114 The legal treatment of subsidies constitutes a particularity under WTO law because WTO

members are not limited to action on the multilateral level when seeking legal relief against

harmful subsidization by another member. Upon a written, argued application by or on behalf of

an industry branch,112 a WTO member may opt to open national investigations (that would have

to conform to procedural rules set by the WTO, though113) that can lead to the unilateral

imposition of so-called countervailing duties. The WTO member against whom countervailing

duties have been imposed can of course contest the legality of these countervailing duties before

a WTO panel, thus bringing the case to the multilateral level.

115 WTO members have the possibility to pursue both procedures in parallel, but final

countervailing duties (unilaterally imposed) and compensation (as authorized by the DSB) must

not be cumulated. Contrary to multilateral WTO action against an alleged prohibited subsidy, a

WTO member that wishes to impose countervailing duties also needs to determine that the effect

of the subsidization is such “as to cause or threaten material injury to an established domestic

industry, or is such as to retard materially the establishment of a domestic industry”.114 If

addressed on the multilateral level, there is no need to show injury for the category of

“prohibited subsidies” due to the fact that they are prohibited per se.

112 ASCM Article 11. 113 Set out in ASCM Articles 10-23. 114 GATT Article VI:6(a).

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116 In this following, I look at both scenarios separately: to begin with, I will consider the

case where a country goes to the WTO directly claiming that a specific scenario of alleged

currency manipulation has real trade effects equivalent to an export subsidy. Further down the

focus will be put on countervailing duties as part of the arsenal of unilateral trade remedies.115

117 As stated in ASCM Article 1, a subsidy under WTO rules is deemed to exist if it can be

shown that there is a “financial contribution by a government or any public body” to exporters or

if there is “any other form of income or price support” in the sense of GATT XVI (dealing with

subsidies) and if “a benefit is thereby conferred”.

118 In addition, the WTO allows remedies (both multilateral and unilateral) only against

subsidies that fulfill any of the “specificity requirements” listed in ASCM Article 2. However,

according to ASCM Article 2.3, subsidies falling within the category of “prohibited subsidies”

under ASCM Article 3 are automatically deemed to be specific; they do not need to separately

fulfill any of the other characteristics listed in ASCM Article 2. A plain reading of the specificity

requirements in ASCM Article 2 reveals that the subsidization that allegedly arises from the

maintenance of an undervalued real exchange rate might only be “specific” if one could

successfully argue that it constitutes a prohibited export subsidy, i.e. a subsidy that is

“contingent, in law or in fact, upon export performance” (ASCM Article 3.1(a) combined with

Article 2.3). I shall look into all these requirements in detail below.

119 The Panel in the dispute US - Softwood Lumber III116 described in detail what has to be

understood by the concept of “financial contribution” under ASCM Article 1.1(a)(1):

[ASCM] Article 1.1(a)(1) provides that the first element of a subsidy is a “financial contribution by the government”. Subparagraphs (i) through (iv) then explain that a financial contribution can exist in a wide variety of circumstances including, of course, the direct transfer of funds. But subparagraphs (ii) and (iii) show that a financial contribution will also exist if the government does not collect the revenue which it is entitled to or when it gives something or does something for an enterprise or purchases something from an enterprise or a group of enterprises. Subparagraph (iv) ensures that government directed transfers

115 See section 3.4 below. 116 WTO, United States – Preliminary Determinations with Respect to Certain Softwood Lumber from Canada (short title: US – Softwood Lumber III), Panel Report WT/DS236/R (September 27, 2002, mutually agreed solution notified on October 12, 2006).

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affected through a private entity do not thereby cease to be government transfers. In other words, [ASCM] Article 1.1(a)(1) provides that a financial contribution can exist not only when there is an act or an omission involving the transfer of money, but also in case goods or certain services are provided by the government.117

120 The type of measures that can be expected to be employed in achieving and maintaining

an undervaluation of the real exchange rate do clearly not enter into any of the four categories

identified in ASCM Article 1.1(a)(1)(i)-(iv). Besides that, the wording of ASCM Article 1

supports the view that this list of categories is exhaustive. Even in the abstract it seems thus

possible to say that a “financial contribution” in the sense of the ASCM does not exist in the

context of currency manipulation.

121 As already indicated, however, under the rules of the ASCM it is not absolutely necessary

to identify a “financial contribution” by the government in order for a contested measure to

amount to a subsidy. Alternatively, a subsidy may also result from “any form of income or price

support in the sense of [GATT] Article XVI” (ASCM Article 1.1(a)(2), i.e. “any form of income

or price support, which operates directly or indirectly to increase exports of any product from, or

to reduce imports of any product into [the territory of the subsidizing member].”118

122 These terms have not yet been formally interpreted by a panel, but they might

conceivably be given a meaning broad enough to encompass anything that boosts the income of

the purportedly subsidized entity.119 If it can be shown that a specific export branch has been

able to raise its income due to increased exports and that this increase in exports has been caused

by the contested exchange measures, than the requirement of ASCM Article 1.1(a)(2) should be

regarded as satisfied. As noted earlier,120 such a chain of causation might indeed be identifiable,

though difficult to measure, in the context of an artificial undervaluation of the real exchange

rate, depending on the specific circumstances of a potential future dispute. 117 WTO, US – Softwood Lumber III, supra note 116, Panel Report, at para. 7.24. 118 GATT Article XVI:1. 119 This observation is made, but rejected by Staiger & Sykes, supra note 20, at 57. I do not agree, however, with these authors’ view that the terms “any form of income or price support” should be read narrowly, therewith limiting them to programs specifically geared to provide price support like in the agricultural sector. To me, such a narrow reading appears unjustified in light of what appears to be a very broad and flexible provision. 120 See section 1 above.

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123 Assuming that the contested exchange measures can somehow be found to enter into

ASCM Article 1.1(a), in order to qualify as “subsidy” under the ASCM, it needs further to be

shown that a benefit has been conferred by the contested measure. Previous WTO disputes

provide guidance on what needs to be understood by a “conferral of benefit”. In the dispute

Canada - Aircraft,121 the Appellate Body approved the Panel’s focus on the recipient of the

subsidy in its interpretation of the term “benefit” under ASCM Article 1.1(b):

[T]he ordinary meaning of “benefit” clearly encompasses some form of advantage. … In order to determine whether a financial contribution … confers a “benefit”, i.e., an advantage, it is necessary to determine whether the financial contribution places the recipient in a more advantageous position than would have been the case but for the financial contribution. …122

124 It agreed with the Panel’s findings that rejected an interpretation of benefit based on

whether there was a “net cost” to the government. The Appellate Body also confirmed the

Panel’s focus on the recipient of a subsidy in determining the existence of a benefit:

A “benefit” does not exist in the abstract, but must be received and enjoyed by a beneficiary or a recipient. … This provides textual support for the view that the focus of the inquiry under [ASCM] Article 1.1(b) should be on the recipient and not on the granting authority.123

125 The Appellate Body further held that a determination whether a benefit exists for the

subsidy recipient implies a comparison with market conditions:

[T]here can be no “benefit” to the recipient unless the “financial contribution” makes the recipient “better off” than it would otherwise have been, absent that contribution. In our view, the marketplace provides an appropriate basis for comparison in determining whether a “benefit” has been “conferred”, because the trade-distorting potential of a “financial contribution” can be identified by determining whether the recipient has received a “financial contribution” on terms more favourable than those available to the recipient in the market.124

126 In the context of alleged currency manipulation the following would have to be shown in

accordance with the above decisions: a clearly identifiable industry branch on the territory of the

121 WTO, Canada – Measures Affecting the Export of Civilian Aircraft (short title: Canada – Aircraft), Panel Report WT/DS70/R, Appellate Body Report WT/DS70/AB/R (August 2, 1999), DSU Article 21.5 Panel Report WT/DS70/RW, DSU Article 21.5 Appellate Body Report WT/DS70/AB/RW (July 21, 2000). 122 Id, Appellate Body Report, at para. 149. 123 Id, at para. 154. 124 Id, at para. 157.

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WTO member maintaining the undervalued real exchange rate must be “better off” thanks to the

undervaluation, its situation being distinctly better than it would have been absent the artificial

undervaluation.

127 Such a “benefit” does certainly not exist if prices are perfectly flexible and have adjusted

to eliminate all real effects of a contested nominal undervaluation. Likewise, as has been

demonstrated in detail by Staiger and Sykes,125 a “benefit” might also not be identifiable if the

exporter does not realize an increase in profits or income as a result of the undervaluation. An

industry branch will only benefit from the increased international competitiveness that arises

from an undervalued real exchange rate if it can both produce more in order to raise its exports

and if these increased sales will eventually lead to increased profits. Whether or not this will be

the case very much depends on the characteristics of every single industry branch, like notably

existing production technologies and capacity restraints. For example, an industry branch that

already operates with the newest technology and under full use of its capacities will be unable, at

least in the short run, to increase its production in order to benefit from increased export

opportunities that might arise from an undervalued exchange rate.

128 Overall, it does not appear entirely unrealistic to expect that a “conferral of benefit”

satisfying the ASCM might be identifiable in the context of alleged currency manipulation.126 In

order for this to happen, it would be of utmost importance to demonstrate that prices have not

entirely adjusted upwards due to specific measures aimed at keeping inflation low and that it is

therefore possible to identify real trade effects of the contested measures. In addition, however,

the claimant would also have to show that the identified rise in exports would not have otherwise

occurred and that it was currency manipulation that put another WTO member’s exporting

branch in a position where it could realize higher profits.

129 One additional hurdle would have to be taken by a claim that the maintenance of an

undervalued real exchange rate amounts to a prohibited export subsidy under the ASCM. Any

125 Staiger & Sykes, supra note 20, at 32. 126 As previously noted, contrary to the quite general and abstract assessment provided in this paper, a thorough analysis of both the legal and economic characteristics of the contested exchange measures would have to be conducted in a concrete case in order to reach a conclusion.

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subsidy in the sense of the ASCM, needs to be “specific to an enterprise or industry” in order for

it to qualify as either a prohibited subsidy under ASCM Article 3 or as an actionable subsidy

under ASCM Articles 5-7.127 As mentioned earlier, faced with an undervalued exchange rate

with real trade effects, it might be possible to successfully argue that the underlying exchange

rate policy constitutes a subsidy that is “contingent, in law or in fact, upon export performance”

(ASCM Article 3.1(b) combined with ASCM Article 2.3) which would satisfy the specificity

requirement. At the same time such a subsidy would fall into the category of prohibited subsidies

under ASCM Article 3.

130 Confronted with the economic effects of an undervalued real exchange rate, any

contingency upon export performance in law can be directly dismissed. By contrast, a potential

contingency in fact upon export performance needs to be examined more closely. In this respect,

footnote 4 to ASCM Article 3.1(a) states:

[The standard of contingency in fact] is met when the facts demonstrate that the granting of a subsidy, without having been made legally contingent upon export performance, is in fact tied to actual or anticipated exportation or export earnings. The mere fact that a subsidy is granted to enterprises which export shall not for that reason alone be considered to be an export subsidy within the meaning of this provision.128

131 Since this criterion of “factual contingency upon export performance” has not yet been

analyzed by a WTO panel with respect to the potential real trade effects of an undervalued

exchange rate we are left with at least some uncertainty on how to interpret it. Hufbauer, Wong

and Sheth, for example, take the view that the above-cited footnote “can be interpreted to mean

that a favorable exchange rate with no other strings attached is no more a prohibited export

subsidy than any other beneficial economic ‘climate’, such as a concessionary tax rate that

127 As mentioned previously, an important additional requirement applies in order for a subsidy to be actionable in the sense of ASCM Articles 5-7 and in order for unilateral countervailing duties to be imposable. As stated by GATT Article VI:6(a), no countervailing duties shall be levied, unless the WTO member wishing to impose such tariff-surcharges unilaterally can determine that the effect of the subsidization “is such as to cause or threaten material injury to an established domestic industry, or is such as to retard materially the establishment of a domestic industry.” ASCM Article 15 establishes how this determination of injury in the sense of GATT Article VI has to be made. ASCM Article 16 specifies the definition of a domestic industry for the purposes of GATT Article VI. 128 Emphasis added.

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applies to all new plan and equipment investment by foreign firms.”129 I do not find this

interpretation very convincing. In order to benefit from the export-promoting effects created by

an undervalued exchange rate, i.e. in order to be put in a position of increased competitiveness,

local producers need to export their products. This appears to be precisely the scenario of factual

contingency addressed by ASCM Article 3.1(a) and its footnote 4.

132 Footnote 4 simply serves to prevent that a subsidy, which is granted more or less

coincidentally to exporters, be found to be a prohibited subsidy in the sense of ASCM Article 3.

In the case of a persisting undervaluation of the real exchange rate, however, the necessary

causal and exclusive relationship between being an exporter and benefiting from a subsidy can

be clearly identified. In the context of an undervalued real exchange rate, a local producer

benefits from the subsidization only and exclusively if he exports, and only with respect to

products sold abroad. In addition, since the size of such a subsidy is proportional to export

volumes and thus varies from one exporter to another, it seems plausible to regard such a subsidy

indeed as being “contingent in fact upon export performance”.

133 This point of view appears to be in line with the findings in several previous WTO

disputes. With respect to the interpretation of the term “contingent in fact”, the Panel in Australia

– Automotive Leather II130 established a standard of “close connection” between the grant and

maintenance of a subsidy and export performance. It added that a subsidy, in order to be “export

contingent in fact”, must be “conditioned” upon export performance:

The text of Article 3.1(a) also includes footnote 4, which states that the standard of “in fact” contingency is met if the facts demonstrate that the subsidy is “in fact tied to actual or anticipated exportation or export earnings”. The ordinary meaning of “tied to” is “restrain or constrain to or from an action; limit or restrict as to behavior, location, conditions, etc.”. Both of the terms used – “contingent ... in fact” and “in fact tied to” – suggest an interpretation requiring a close connection between the grant or maintenance of a subsidy and export performance.131

129 Gary Clyde Hufbauer, Yee Wong & Ketki Sheth, The Revaluation Debate, US-CHINA TRADE DISPUTES: RISING TIDE, RISING STAKES, 78 POLICY ANALYSES IN INTERNATIONAL ECONOMICS 11, 22 (Peterson Institute for International Economics 2006). 130 WTO, Australia – Subsidies Provided to Producers and Exporters of Automotive Leather (short title: Australia – Automotive Leather II), Panel Report WT/DS126/R (May 25, 1999), DSU Article 21.5 Panel Report WT/DS126/RW (January 21, 2000). 131 WTO, Australia – Automotive Leather II, Panel Report, at para. 9.55.

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134 In the previously mentioned dispute Canada – Aircraft, the Panel also considered the

“tied to” language of footnote 4 to be equivalent to a relationship of “conditionality” between the

grant of a subsidy and export performance.132 The Appellate Body in that dispute agreed with the

term “conditioned” and linked it to the concept of contingency under Article 3.1(a).133

135 Even in light of these narrow interpretations of the criterion of “contingency in fact upon

exports”, the above conclusions do not appear to break down. It appears reasonable to assume

that the subsidizing effect that potentially arises form the maintenance of an undervalued real

exchange rate might be found to satisfy the standard of “contingency in fact upon exports”.134 As

a consequence, such a subsidy would fit into the category of prohibited subsidies under ASCM

Article 3 and would thus automatically be “specific” according to ASCM Article 2.3.

136 Overall, and with all due caution that has to accompany such an abstract assessment, the

very substance of GATT Article XVI and the relevant ASCM rules as analyzed above might

provide a viable basis for a potential future claim aiming to attack the maintenance of an

undervalued real exchange rate as a prohibited export subsidy.135

137 As repeatedly noted, however, any such claim would have to overcome major economic

measurement difficulties that might result in its breakdown. In addition, the previously analyzed

ambiguity surrounding the legal value of the requirement under GATT Article XV:2 to consult

the IMF and, in particular, the major impact of the exception under GATT Article XV:9(a),136

would turn any WTO claim against currency manipulation into an endeavor with, at best, a very

uncertain outcome.

132 WTO, Canada – Aircraft, supra note 121, Panel Report, at para. 9.331. 133 Id, Appellate Body Report, at para. 171. 134 Staiger & Sykes, supra note 20, at 31, appear to share this point of view although these two authors are not convinced by the merits of a subsidy claim with respect to currency manipulation for the other reasons pointed out earlier. However, they do not appear to see any problems arising from the “contingency in fact upon export performance” criterion, which they deal with approvingly a single paragraph. 135 This finding stands in contrast to the conclusions drawn by other parts of the legal literature, see, for example, Staiger & Sykes, supra note 20, and Matthew R. Leviton, Is It a Subsidy? An Evaluation of China’s Currency Regime and Its Compliance with the WTO (June 26, 2005), bepress Legal Series, Working Paper 660, http://law.bepress.com/expresso/eps/660 136 See sections 3.2.1 and 3.2.2 of this paper.

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3.4 Unilateral trade remedies against currency manipulation?

138 This final section considers the main legal questions that arise from the potential use of

unilateral trade remedies (countervailing and antidumping duties as well as safeguard measures)

against currency manipulation. In this context, I will also briefly discuss some key issues of

related proposals for new legislation in the US.

139 In order for the unilateral imposition of countervailing duties to be consistent with WTO

rules, the related national investigation needs to respect the same strict criteria as those analyzed

in the preceding section of this paper: whether there has been a “financial contribution by a

government or any public body” to exporters or if “any other form of income or price support”

has occurred and whether a “benefit has thereby been conferred”. The “specificity” requirement

is equally applicable.

140 In addition, however, as set forth by GATT Article VI:6(a):

No contracting party shall levy any anti-dumping duties or countervailing duty on the importation of any product of the territory of another contracting party unless it determines that the effect of the dumping or subsidization, as the case may be, is such as to cause or threaten material injury to an established domestic industry, or is such as to retard materially the establishment of a domestic industry.

141 This requirement makes that the legal hurdles for successfully attacking currency

manipulation as an export subsidy are not the same depending on whether a WTO member opts

for opening a countervailing duty investigation or for attacking the contested policy as an export

subsidy by bringing a case before the WTO as analyzed in detail in the preceding section. This

stems from the fact that, on the multilateral level, export subsidies fall into the category of

“prohibited subsidies” for which no showing of injury is required. For unilateral action, by

contrast, the “injury” requirement under GATT Article VI:6(a) applies for any type of subsidy.

142 In light of the major economic complexity of the matter, providing a satisfactory

demonstration of the “injury” requirement would not be easy. The required standard might be

met if it can be shown that the increase of imports coming from a country with an undervalued

real exchange rate has provoked the breakdown of an entire industry branch. It would be crucial

to show that this breakdown has been caused by a decline of local sales caused by increased

imports and not by factors unrelated to the contested exchange rate undervaluation.

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143 Whereas subsidies are a trade distorting state practice, the term “dumping” designates

unfair firm-level behavior.137 This is the reason why GATT Article VI:5 clearly states that “no

product … shall be subject to both anti-dumping and countervailing duties to compensate for the

same situation or export subsidization.”

146 As noted earlier, numerous bills on how to tackle currency manipulation have been

introduced in recent sessions of US Congress. The leading current proposal is the Currency

Exchange Rate Oversight Reform Act of 2010, introduced on March 17, 2010 by a bipartisan

group of senators led by Charles Schumer (D-NY), Debbie Stabenow (D-MI), and Lindsey

Graham (R-SC) (“Schumer-Stabenow-Graham Bill”).138 This bill bridges between the two main

competing legislative approaches since 2007.139

147 One of the key provisions of the Schumer-Stabenow-Graham Bill is a requirement that

exchange rate undervaluation be taken into account when calculating the margin of dumping in

anti-dumping investigations.140 The bill requires the Commerce Department, which administers

the US anti-dumping laws, to “ensure a fair comparison between the export price and the normal

value by adjusting the price used to establish export price or constructed export price to reflect

137 Firms practicing dumping (usually private companies, but these firms could also be publicly owned) offer exceptionally attractive prices (often below production costs) on one market, but not on others. Such a practice is harmful since it is not sustainable. The abnormally low prices are not due to lower production costs but a deliberate sacrifice assumed in order to damage competitors. Certainly, in the beginning consumers will benefit from the low dumping prices, but in the long run, once the aim of ruining competitors has been achieved, prices are likely to rise and to become higher than they would have been if dumping had never occurred. For a detailed discussion of the economic effects of dumping, see Wilfried J. Ethier, Dumping, 90 JOURNAL OF POLITICAL ECONOMY 487 (1982). For a succinct overview of both the economic and legal literature, see Alan O. Sykes, Trade Remedy Laws, U of Chicago, John M. Olin Law & Economics Working Paper No. 240 (April 2005). 138 S.3134, 111th Cong. (2009–2010), available at http://thomas.loc.gov/cgi-bin/query/z?c111:S.3134: (providing the full text of the Schumer-Stabenow-Graham bill as submitted, and of other legislation cited in this paper). 139 The first of these approaches is best represented by the Currency Exchange Rate Oversight Reform Act of 2007, S.1607, 110th Cong. (2007), available at http://thomas.loc.gov/cgi-bin/query/z?c110:S.1607:. This Schumer-Graham Bill was approved by the Senate Finance Committee, but went no further due to a jurisdictional conflict with the Senate Banking Committee. It was reintroduced in the current Congress on June 11, 2009, as the Currency Exchange Rate Oversight Reform Act of 2009, S.1254, 111th Cong. (2009). The Currency Reform for Fair Trade Act of 2009, S.1027, 111th Cong. (2009), available at http://thomas.loc.gov/cgi-bin/query/z?c111:S.1027: (introduced under the leadership of Senators Debbie Stabenow (D-MI) and Jim Bunning (R-KY)) stands for the second approach. 140 The Schumer-Stabenow-Graham bill requires such an adjustment only when a country whose currency has previously been designated for “priority action” fails to eliminate the identified “fundamental misalignment” of its currency. For a detailed assessment of the key legal issues arising from this bill, see Zimmermann, supra note 4.

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the fundamental misalignment of the currency of the exporting country.” A similar requirement

had already appeared in previous bills.141

148 However, the punitive and automatic nature of the price adjustment thus undertaken

undercuts any argument that it provides for a “fair comparison ... between the export price and

the normal value” for the products concerned as required under Article 2.4 of the WTO Anti-

dumping Agreement (“ADA”). ADA Article 2.4.1 provides that when this price comparison

requires a conversion of currencies, the exchange rate shall be “the rate of exchange on the date

of sale”, which appears clearly to refer to the nominal exchange rate and not to some “medium

term equilibrium” that would very much depend on measurement uncertainties.142

149 In addition, and even more important, it is conceptually misguided to adjust dumping

margins for exchange rate misalignment. Dumping is a matter of companies’ product pricing

decisions, which have nothing to do with the macro-level governmental measures that lead to

exchange rate misalignment. If exchange rate undervaluation were to be taken into account in

anti-dumping calculations, a product that is not dumped (under normal rules) will suddenly have

a dumping margin, which would amount to a violation of the ADA.143

150 With respect to safeguards, finally, GATT Article XIX provides that, if as a result of

unforeseen developments any product is being imported into the territory of a WTO member in

such increased quantities and under such conditions as to cause or threaten serious injury to

domestic producers in that territory of like or directly competitive products, the WTO member

concerned may, under the conditions spelled out in the Agreement on Safeguards (“AS”), impose

safeguard measures144 (i.e. withdraw tariff concessions) for a limited amount of time.

141 S.1607, supra note 139. This bill was proposed in a previous session of Congress. Sessions of Congress last two years; at the end of each session all proposed bills and resolutions that have not passed are cleared from the books. 142 For a similar view, see Staiger & Sykes, supra note 20, at 37. 143 Id. 144 The WTO provisions on safeguards have given rise to lots of criticism in the economic and legal literatures. See, for example, Joost Pauwelyn, The Puzzle of WTO Safeguards and Regional Trade Agreements, 7 JIEL 109 (2004) and Alan O. Sykes, The Safeguards Mess: A Critique of WTO Jurisprudence, U of Chicago, John M. Olin Working Paper No. 187 (June 2003).

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151 In light of the potential trade effects of an undervalued real exchange rate, a WTO

member might indeed be tempted to impose safeguard measures. Such a step would have to be

understood as an attempt to afford temporary support to industry branches that have been facing

a huge decline in their exports to the country that allegedly manipulates its exchange rate while

the imports of competing products from that country have risen.

152 However, safeguard measures have not been intended by the drafters of the GATT and

today’s WTO members as providing a remedy against unfair competitive behavior. They

constitute a device to gain some additional time for national industries struggling to adapt to

changing international competition without there being any unfair behavior in the first place. A

competitive devaluation, however, and, at least arguably, the maintenance of an undervalued

exchange rate peg, are guided by protectionist intentions and would therefore have to be

addressed, if at all, by the means of countervailing duties or a multilateral WTO claim against a

prohibited export subsidy as considered earlier in this paper.

153 Approaching the end of this section, one additional comment needs to be made

concerning the absence of any legal obligation for national authorities investigating the

imposition of unilateral trade remedies against currency manipulation to consult the Fund on the

contested exchange rate policy and to take its view duly into account, contrary to the WTO’s

obligations under GATT Article XV as analyzed earlier in this paper.145

154 The picture appears under a different light, though, if one takes into account that the

IMF’s point of view would eventually have to be given full consideration if the country against

which unilateral trade measures are imposed were to challenge their legality by bringing a case

to the WTO. With the issue moving from the unilateral to the multilateral level, GATT Article

XV, with all the legal uncertainty that arises from it, would come into play. It appears thus highly

likely that the inoperable “intent” element of IMF Article IV:1(iii) would once again enter the

stage and become an indirect part of the scrutiny of the WTO-consistency of a unilateral trade

remedy imposed against alleged currency manipulation. As a consequence, the chances for any

such unilateral trade remedy to “survive” a legal challenge at the WTO seem very slim.

145 See sections 3.2.1 and 3.2.2 above.

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Conclusion

155 Under the current state of international law it would be unrealistic to expect that conflicts

about sophisticated scenarios of alleged currency manipulation, like notably the maintenance of

an undervalued real exchange rate in order to promote export-led growth, will eventually be

resolved by an enforcement of the applicable legal obligations. As analyzed in this paper, this

paralysis of the law arises from a number of factors:

156 First, IMF Article IV:1(iii) prohibits currency manipulation essentially only to the extent

that it is undertaken with the intent to gain an unfair advantage over other IMF members, in other

words, with the intent to cause economic harm to other members. This standard makes it

practically impossible for the IMF to formally find a member in breach of this provision; the

political cost of doing so would be too high. The 2007 Surveillance Decision with its new focus

on external stability appears to have increased the efficiency of bilateral surveillance for good

faith scenarios of exchange rate misalignment and should therefore be welcomed. At present,

however, the “intent” element remains firmly enshrined in IMF Article IV:1(iii), which makes it

illusory to hope that really contested scenarios of currency manipulation will end with a legal

solution.

157 Second, although the maintenance of an undervalued real exchange rate has the potential

to affect international trade flows, it appears highly likely that a potential WTO claim arguing

that such currency manipulation amounts to a prohibited export subsidy would break down. The

two main reasons for this are: (a) the major legal uncertainty that arises from the ambiguous

elements of GATT Article XV:2, the poorly drafted key provision of the IMF-WTO relationship,

and (b) the exception under GATT Article XV:9(a) preventing a finding of breach under the

GATT, and, at least arguably, under all multilateral agreements on trade in goods (including the

ASCM), for any exchange controls and restrictions that are IMF-consistent. As a consequence,

the inoperable “intent” requirement of IMF Article IV:1(iii) would extend its paralyzing effects

beyond the IMF legal framework into WTO dispute settlement.

158 Third, acting unilaterally against currency manipulation via the imposition of

countervailing duties will not dissolve the paralysis of the law that arises from IMF Article

IV:1(iii), and this despite the fact that national authorities are under no international obligation to

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consult the IMF in a way similar to the WTO under GATT Article XV:2. This comes from the

fact that, as soon as the imposition of countervailing duties were to be challenged at the WTO,

the obligation to consult the IMF, the exception of GATT Article XV:9(a) and, with it, IMF

Article IV:1(iii) would once again come into play, rendering it likely that any previously

imposed countervailing duties be struck down as WTO-inconsistent.

159 In light of this obvious paralysis of the law it appears more than likely that the current

conflict about China’s contested exchange rate policy will ultimately be resolved by political

power play resulting in a diplomatic deal that all sides can live with, maybe similar to what

happened in the time leading up to the Plaza Agreement in 1985. The various proposals by US

lawmakers to legislate on the issue of currency manipulation seem to be an essential part in this

saber rattling. It seems more than likely that if China effectively returns to a path of revaluation

following its latest policy shift back to a managed float,146 all these proposals for new legislation

and the accompanying anti-China rhetoric will quickly fade away.

160 Overall, all these difficulties to effectively deal with currency manipulation underline that

exchange rate policies continue to be a highly sensitive issue for most states and are regarded by

those in power as a key element of monetary sovereignty. At the G-20 Toronto Summit (June 26-

27, 2010), an explicit statement welcoming China’s announced policy shift was thus dropped

from the final version of the Summit Declaration upon Chinese request as China insisted that its

exchange rate policy was a purely domestic issue.147 Whereas a week before the summit, the

Chinese exchange rate had promised to overshadow everything else,148 the Summit Declaration

now merely states that emerging surplus economies “will undertake reforms tailored to country

circumstances” in order to, among other things, “[e]nhance exchange rate flexibility to reflect

underlying economic fundamentals.149 On the same issue, US President Barack Obama told

reporters at the G-20 Summit that the US “didn’t expect 20% revaluation in a week,” but that it 146 As noted in more detail in the introduction to this paper, this shift was announced on June 19, 2010. 147 Brian Love & David Storey, G20 Drops China-Sensitive Plaudits on Yuan Reform, REUTERS, June 27, 2010, available at http://www.reuters.com/article/idUSTRE65Q1AQ20100627. 148 Heather Scott, G20: Obama, Harper Confident China to Follow Thru on FX Policy, IMARKETNEWS.COM, June 27, 2010, available at http://imarketnews.com/node/15593. 149 The G-20 Toronto Summit Declaration, Annex I, § 12 (June 26-27, 2010), available at http://g20.gc.ca/toronto-summit/summit-documents/the-g-20-toronto-summit-declaration/.

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will be watching over the next “several months,” expecting to see the RMB/USD rate

appreciate.150

161 The political struggle between the US and China over a revaluation of the RMB towards

the USD is thus likely to continue for yet some time, in particular as the current state of

international law appears to render an effective legal treatment of sophisticated scenarios of

alleged currency manipulation literally impossible.

162 Anything but a formal amendment of the Fund’s Articles, removing the stigmatizing, bad

faith element in the prohibition of currency manipulation, will not resolve this dilemma. The new

focus of a revised IMF Article IV:1 might instead be put on ensuring that IMF members conduct

their fiscal, monetary, and exchange rate policies in a way that avoids excessive global

imbalances. Such an obligation might be linked to increased possibilities for the IMF to require a

policy change whenever the objective of avoiding excessive imbalances is not achieved, but

without there being any blame for alleged bad faith behavior. The objective effects of a policy, or

absence thereof, should be all that matters. The stakes are high and go well beyond the harmful

effects of currency manipulation itself. Persisting paralysis within a legal framework can be

expected to seriously undermine the credibility and ultimately even the legitimacy of the

institution(s) in charge of it.

150 Scott, supra note 148.