More research on exchange rate mainpulation

For those following the currency exchange manipulation debate, a recent Congressional Research Study (CRS) analyses some of the important issues involved. Pointing out the debate on possible intervention in the WTO, the author states:

"Given the relationship between exchange rates and trade, some have argued that the World Trade Organization (WTO) has a role to play in responding to currency disputes. Some analysts and lawyers have examined whether WTO provisions allow for recourse against countries that are unfairly undervaluing its currency. 

One aspect of the debate is whether WTO agreement on export subsidies applies to countries with undervalued currencies. The WTO Agreement on Subsidies and Countervailing Measures specifies that countries may not provide subsidies to help promote their national exports, and countries are entitled to levy countervailing duties on imported products that receive subsidies from their national government. Some economists maintain that an undervalued currency lowers a firm’s cost of production relative to world prices and therefore helps encourage exports. Some argue, then, that an undervalued currency should count as an export subsidy. It is not clear, however, whether intentional undervaluation of a country's currency is an export subsidy under the WTO's specific definition of the term, and thus is eligible for recourse through countervailing duties under WTO agreements. For example, the subsidy must be, among other things, specific to an industry and not provided generally to all producers. There is debate over whether intentional undervaluation of a currency is “industry specific” because it applies to everyone.  

Another aspect of the debate relates to a provision in the GATT (the WTO agreement on international trade in goods), which states that member countries “shall not, by exchange action, frustrate intent of the provisions” of the agreement.Some analysts argue that policies to undervalue a currency are protectionist policies, and thus should count as an exchange rate action that frustrates the intent of the GATT. Others argue that the language is too vague to apply to undervalued currencies. Specifically, they argue that the language was written to apply to an international system of exchange rates that no longer exists (the system of fixed exchange rates, combined with capital controls, that prevailed from the end of World War II to the early 1970s).  

No dispute over exchange rates has been brought before the WTO, and whether currency disputes fall under the WTO's jurisdiction remains a contested issue."

I have blogged on this quite a bit. For the moment, there seems to be no immediate appetite for a WTO intervention, either at the negotiating table or at dispute settlement. However, one can never rule out possibilities in international law and politics.

Exchange rates and WTO

The relationship between exchange rate volatility as well as undervaluation and over-valuation of currencies with international trade has been discussed in this earlier blog. The interplay in the multilateral trading system has consequences for the extent to which WTO can intervene in the matter since the IMF is perceived as the international institution to address issues related to exchange rate volatility and currency valuation.


Lucas Ferraz, Emerson Marcal and Vera Thornstensen have argued in Vox Eu that WTO should play a more proactive role in addressing exchange rate misalignments. They conclude by linking it to a violation of the MFN status that is the cornerstone of multilateral trade jurisprudence by stating,


" This reality brings into question the effectiveness of the MFN principle established by GATT Article I, that “any advantage, favour, privilege or immunity granted by any contracting party to any product originating in or destined for any other country shall be accorded immediately and unconditionally to the like product originating in or destined for the territories of all other contracting parties.” Persistent exchange-rate misalignments cannot but create potentially infinite variations of market-access conditions among WTO members. This situation is directly the opposite of what the multilateral system sought with the establishment of the MFN principle.

The effects of misalignments are also distorting many other rules and instruments negotiated under the WTO, such as antidumping, subsidies, safeguards, rules of origin, GATT articles I, II, III, and XXIV.

The WTO can no longer ignore what is happening behind its magnificent structure of complex trade rules. The persistence of opposite exchange-rate misalignments, of countries with overvalued currencies and others with undervalued ones, for long periods is eroding the multilateral trading system. The WTO cannot remain silent to such reality. The core principles of its construction – transparency, predictability and confidence – are under question. The strengthening of trade rules, with the negotiation of instruments to neutralise the effects of exchange rates, is fundamental to the existence of the WTO. Otherwise, the WTO might become a diplomatic-juridical fiction – void of economic reality."

A detailed study of the complex relationship between trade and exchange rate fluctuation has been rather cautious of the relationship. Robert Staiger and Alan Sykes have expressed, in the context of China's exchange rate policy their doubts as to whether this would amount to violation to WTO commitments.

It would be interesting to see the Dispute Settlement Body of the WTO adjudicating on this issue if a member were to bring it up before the Panel.

Of currency valuation and international trade

The WTO recently released a report on the possible linkage between exchange rate and international trade. The issue of fluctuating exchange rates on international trade has been a topic of serious discussion.

Undervaluation of one's currency benefits one's exports since it would be cheaper to export and the good becomes more competitive in the international market. Similarly it adversely affects imports.

Recently Brazil made a strong case for the WTO to study the relationship between exchanges rates and international trade, with an oblique reference to China. Brazil's Ambassador to the WTO, Roberto Azeverdo said,

"What we’re looking for, in temporary circumstances, is the effect or the impact that certain currency misalignments may have on particular segments of one country’s economy,” he said today in a phone interview from Geneva. “In the future we may have an agreement on what the problem is, whether this kind of problem needs some kind of remedy, whether we already have the remedy in the WTO agreements.”

Issues of which international institution will deal with this complicated matter have also been raised. the IMF as an international institution deals with exchange rate issues between countries. The WTO needs to engage with the IMF on issues of exchange rate matters. A fairly insightful analysis of the issue was made here. A Congressional Research Service Report on this matter also throws some light on the competing jurisdictions of the IMF and WTO and suggested amendments to the Agreements to address the issue.

Would undervaluation of one's currency and hence helping one's exports amount to export subsidies that are violative of the obligations under the WTO relating to subsidies? Opinions that the issue of alleged currency devaluation of the Chinese Yuan cannot be addressed "legally" in either the fora of the IMF or WTO, but has to be tackled "politically". A very effective piece on this is by Christoph Hermann.

The WTO report is a detailed, comprehensive one and concludes on the issue as follows:

"76. On the issue of the level of exchange rates (misalignments), theoretical and empirical studies over the years show that the relationship between the level of a currency and trade is so multi-faceted and complex that it is hard to take a firm line in any particular direction. Economic theory suggests that when markets are free of distortions, an exchange rate misalignment has no long-run effect on trade flows, as it does not change relative prices.  But long-run effects are predicted in models that assume market distortions, such as information problems or product market failures. In the short-run, when some prices in the economy can be sticky, movements in nominal exchange rates can alter relative prices and affect international trade flows. These short-run trade effects, however, are not straightforward, as they are likely to depend on specific characteristics of the economy, including the currency in which domestic producers invoice their products and the structure of trade (for example, the prominence of global production networks). On the empirical side, the complexity of the relationship between exchange rate misalignments and trade yields mixed findings. For instance, a currency undervaluation is sometimes found to have a positive impact on exports, but the presence, size and persistence of these effects are not consistent across different studies."

Does this strengthen China's case? ...