IMF currency plan under fire

21/06/2007 | Sid Verma

Analysts warn of risks in redefining exchange rate role as China speaks out

A new IMF proposal for a more formalized surveillance of global exchange rate policies could undermine the institution’s credibility, analysts have warned, as China yesterday rejected the move. Just days after IMF managing director Rodrigo de Rato announced plans for a new currency framework, Beijing warned that the IMF must not lend its weight to US demands for a faster appreciation of the renminbi.

In a statement, China’s central bank said that the IMF “should carry out its duties based on mutual understanding and respect”, especially for the views of developing countries. It added that the multilateral should step up supervision of members issuing “major reserve currencies that play a pivotal role on the global systemic stability”. (For details of the IMF proposals, click here).

Analysts have expressed concern that IMF could undermine its authority by lurching into a politically fraught dispute. Moreover, there is unease over whether the IMF will be able to secure any consensus on its new plans.

“The IMF has to be very cautious, as strong pressure would lead to a very negative reaction from Asian states. This is unlikely to be effective as the body has no enforcement powers,” said Oliver Stoenner-Venkatarama, emerging markets strategist at fund manager Cominvest in Frankfurt.

Plans for survelliance reform announced last Friday will expand its coverage of currencies to “all major emerging market currencies.” The IMF proposal has been widely interpreted as a response to pressure from US policymakers, who have complained that China is maintaining an artificially cheap exchange rate, giving Chinese exporters an unfair advantage.

The Fund’s new rules state that member countries, as well as avoiding currency manipulation and intervention, should avoid policies “that result in external instability”. Any indication that member states are failing in this duty would lead to “special consultations.”While Stoenner-Venkatarama anticipated further upward revaluations in the yuan, not least to combat inflationary pressures in China, he warned that US expectations are unrealistic.

“A gradual appreciation of 3%-5% is manageable and is what the market has in mind, but the US is clearly pressurizing for a lot more. But China will take a very gradual approach and will try to stop upward pressure on the yuan in the run up to the communist party congress in October,” he told Emerging Markets.

This view was echoed by Gavin Redknap, international economist at Standard Chartered in London, who noted that wider Chinese economic policy considerations, rather than international urging, were the most likely source for a more flexible exchange rate policy.

“A reduction in capital controls to allow the development of local markets is gradually being implemented; this will inevitably cause the currency to appreciate... IMF pressure by itself at this time won’t change anything, but pressure may build over time and force China’s hand,” he told Emerging Markets.

By contrast, Yusuke Horiguchi, Chief Economist at global banking association the Institute of International Finance, believes that the IMF could be the right vehicle for tackling a truly global challenge.

“Measures to address global imbalances must be done through the multilaterals to ensure meaningful and credible change,” Horiguchi told Emerging Markets.

But Redknap at Standard Chartered warned that “the IMF must beware not to pressurize too far as they need to remember that China’s economic policy is all about jobs, and they will not do anything to endanger this.” Moreover, one currency strategist and former IMF economist pointed to previous failed attempts in the G8 to address global imbalances. He saw these as a sign that the multilateral is unlikely to fair any better.

“Whenever the US asks China about its exchange rate, the Chinese will ask about US efforts to rein in fiscal deficits and external debt. If you cannot get agreement between the big players, then there is not much the IMF can do,” he told Emerging Markets.

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