IMF reclassifies India’s de facto exchange rate regime from “floating” to “stabilized arrangement” for period December 2022 to October 2023

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For this classification IMF sighted following reasons:

Based on Foreign exchange intervention (FXI) data that the RBI publishes on a monthly basis, IMF concluded that the RBI has been using FXI to cushion the impact of external shocks, smooth market volatility, preclude emergence of disorderly market conditions (DMC), and opportunistically replenish its FX reserves. IMF Further reported that during December 2022-October 2023, the Rupee-U.S. Dollar exchange rate moved within a very narrow range, suggesting that FXI likely exceeded levels necessary to address disorderly market conditions. The observed stability of the exchange rate prompted staff to reclassify India’s de facto exchange rate regime from “floating” to “stabilized arrangement” for that period, while the de jure classification remained “floating” (see Informational Annex). 

Implications:

IMF & Currency Manipulation:

The new language of Article IV, which went into effect in 1978, said that countries should seek, in their foreign exchange and monetary policies, to promote orderly economic growth and financial stability and they should avoid manipulation of exchange rates or the international monetary system to prevent effective balance of payments adjustment or to gain unfair competitive advantage over other members. Some countries claim that their exchange rate policies are not in violation of Article IV because they are not seeking to gain competitive advantage (though this may be the result of their actions) but rather to stabilize the value of their currency in order to prevent disruption to their domestic economic system.

Classification as a stabilized arrangement may put currency exchange regime in direct conflict with countries obligations as a part of IMF charter.

The IMF can exercise “firm surveillance” but it cannot compel a country to change its exchange rate. Nor can it order commercial foreign exchange dealers to change the prices at which they trade currencies. 

WTO & Currency Manipulation:

Whether currency disputes fall under the WTO’s jurisdiction is a debatable issue. The WTO rules specify that countries may not provide subsidies to help promote their national exports. Most analysts agree that an undervalued currency lowers a firm’s cost of production relative to world prices and therefore helps to encourage exports. It is questionable, however, where currency undervaluation is an export subsidy under the WTO’s current definition of the term.

The term “subsidy” has a precise definition in the WTO. It requires that there must be a financial contribution by a government to the exporter or some other form of income or price support. Government financial support can take a variety of forms, such as direct payments to the exporter, the waiver of tax payments or special government purchases or the provision of low-cost goods or services (other than general infrastructure) that lowers the cost of production. Currency manipulation would not appear to qualify under the WTO definitions. 

In addition, an export subsidy is a subsidy that is “contingent on export performance.” In the case of an undervalued currency, everyone who exchanges money will be affected by the current exchange rate no matter whether they are buying or selling and no matter whether or not they are involved in international trade. While subsidies must be “specific to an industry” to be actionable in the WTO, a prohibited subsidy, such as an export subsidy, is considered to be specific per se.

Stabilized arrangement:

Classification as a stabilized arrangement entails a spot market exchange rate that remains within a margin of 2% for six months or more (with the exception of a specified number of outliers or step adjustments), and is not floating. The required margin of stability can be met either with respect to a single currency or a basket of currencies, where the anchor currency or the basket is ascertained or confirmed using statistical techniques. Classification as a stabilized arrangement requires that the statistical criteria are met, and that the exchange rate remains stable as a result of official action (including structural market rigidities). The classification does not imply a policy commitment on the part of the country authorities.  

Floating Arrangement:  

A floating exchange rate is largely market determined, without an ascertainable or predictable path for the rate. Foreign exchange market intervention may be either direct or indirect, and serves to moderate the rate of change and prevent undue fluctuations in the exchange rate, but policies targeting a specific level of the exchange rate are incompatible with floating. Floating arrangements may exhibit more or less exchange rate volatility, depending on the size of the shocks affecting the economy. 

Free floating:

A floating exchange rate can be classified as free floating if intervention occurs only exceptionally, aims to address disorderly market conditions, and if the authorities have provided information or data confirming that intervention has been limited to at most three instances in the previous six months, each lasting no more than three business days. If the information or data required are not available to the IMF staff, the arrangement will be classified as floating. 

Reference:

  1. 2023 ARTICLE IV CONSULTATION—PRESS RELEASE;STAFF REPORT; AND STATEMENT BY THE EXECUTIVEDIRECTOR FOR INDIA - IMF
  2. Article IV of the Fund’s Articles of Agreement: An Overview of the Legal Framework - IMF
  3. Articles of Agreement of the International Monetary Fund
  4. Currency Manipulation: The IMF and WTO, Congressional Research Service, US Government
  5. Revised System for the Classification ofExchange Rate Arrangements - IMF

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