Quo Vadis the IMF?

The original articles of agreement of July 22, 1945, establishing the IMF enjoined it inter alia to promote exchange stability, to maintain orderly exchange arrangements among members, and to avoid competitive depreciation. Article IV, which is currently the raison d’être of the IMF’s surveillance of members, empowered the IMF in those halcyon post-World War II days with oversight of the Bretton Woods par values that determined the panoply of fixed exchange rates of the world in those times in terms of parity with the gold content of the US dollar ($35 per troy ounce). The IMF prescribed margins around par values for the purchase and sale of gold and bands for exchange rates. Members were obliged to collaborate with the IMF to fulfil its mandate: exchange stability.

That fundamental purpose of the IMF remains in letter to the present day. But much water has flown under the bridge. When the US repudiated gold convertibility of the US dollar in 1971, the IMF underwent an existential crisis. It lost its main moorings.

At a press conference at its headquarters in March 1978, when the watershed second amendment to its articles of agreement was fully ratified, an IMF official offered a brave face-saver of what the amendment meant for the institution: “It makes possible…a virtually full range of free choice for members as to the exchange rate system they will adopt. But it also gives the Fund powers of surveillance over the conduct of exchange rate policies by its members.” This translated into a world in which each member country would conduct an exchange rate policy of its choice consistent with exchange rate stability, maintaining orderliness in exchange rate arrangements and avoiding competitive depreciation. If the RBI’s conduct of exchange rate management today is evaluated against this precept, all the boxes would be ticked. Stability is the operative term. 

With regard to the definition of exchange rate arrangement, the IMF official clarified in the same press conference: “It is, of course, flexible; there is no precise formulation in the Articles.” With regard to the IMF’s surveillance, each member is required to notify the exchange arrangement it intends to apply in fulfilment of these obligations and any changes therein. This is referred to by the IMF as the de jure exchange rate arrangement of the member.

More recently, from 2009 and more virulently since 2020, the IMF staff has started labelling a member country’s exchange rate arrangement retroactively under a de facto classification based on “a backward-looking” approach that relies on past exchange rate movement and historical data from the first day of the year in which the decision of reclassification takes place, usually the past six months. According to the IMF’s annual report on exchange arrangements and exchange restrictions, the de facto classification is based on the analysis by its staff. It is not explicitly provided for in its Articles of Agreement and may differ from countries’ officially announced de jure arrangements.

So, is this a violation by overreach of the IMF’s surveillance function? What purpose does it serve? It has serious implications for exchange rate stability. By labelling mostly emerging and developing economies, and moving within a couple of years in labelling from managed float to stabilised arrangement to crawl-like arrangements in India’s case, it appears to be undermining the stability of the rupee, contrary to the fundamental purpose of the IMF. Labels, especially from the watchdog, are a succulent invitation to speculators to attack. There is already anecdotal evidence that since this labelling began, carry trade relating to the rupee has increased.

The Freudian slip of the IMF shows up in its India Article IV consultation report. Its real grouse is about the use of foreign exchange interventions, despite the fact that its 2012 Integrated Policy Framework recognises interventions as a legitimate part of the policy toolkit. In a world of large global spillovers, there cannot be any hierarchy or pecking order of policies to protect national macroeconomic stability.

In the face of destabilising forces, no policy instrument can be off the table or lined up in descending order of priority. Should India wait for conditions to turn dire before intervening? Really? The IMF’s own working paper on the Integrated Policy Framework and India concludes that the RBI has been intervening to cushion the impact of external shocks, smooth market volatility, preclude the emergence of disorderly market conditions and opportunistically replenish its reserves. The IMF’s schizophrenic view in the India Article IV report that exchange rate flexibility would absorb external shocks, reduce the need for costly reserve accumulation, encourage market development, strengthen incentives to hedge currency risk and help moderate liquidity fluctuations in the domestic financial system is a recipe for a currency crisis.

The IMF’s inability to call out the US dollar is glaring in contrast, in spite of well-telegraphed instances of engineered depreciations in the past, right up to the current tariff tirade. As stated earlier, the IMF’s perverse labelling actions stand out in the face of the US Treasury removing India from the currency manipulation watchlist and India’s stated position published in the IMF’s Article IV Consultations report that “the INR/USD exchange rate has been market determined without the targeting of any particular level…exchange rate movements largely reflected India’s favourable fundamentals, with interventions, if and when undertaken, aimed at containing excessive volatility.”

In the interests of market sensitivities, therefore, India should seriously consider withholding permission to the publication of backward-looking and short-horizon analyses by the IMF’s staff as opposed to the de jure positions required to be reported by member countries to the IMF in accordance with Article VIII of its Articles of Agreement. It is pertinent to note that the IMF’s biggest member in terms of voting power, the US, did not allow the publication of its Article IV consultations report till 2000. China, the second biggest member, did not allow the publication of its 2009 report and often held back publication in earlier years. In fact, no Article IV reviews were conducted in 2007 and 2008. End

This article is Part V of a six-part series on exchange-rate policy and financial stability by Dr Michael Debabrata Patra.

Part I set out the competing narratives on the rupee and the case for exchange-rate stability. Click here.
Part II examined why floating exchange rates have often amplified crises in emerging economies. Click here.
Part III examined how volatile capital flows, rather than trade fundamentals, now dominate currency movements and shape central bank behaviour. Click here.
Part IV set out a proposal for strengthening the RBI’s foreign exchange intervention toolkit and reserve strategy. Click here.

Part VI will bring the argument full circle, asking what India’s fundamentals imply for the rupee, stability and policy credibility in an uncertain world.