VoxEU Column Exchange Rates

Is the contemporary Chinese exchange-rate regime "WTO-legal"?

How might the US take action through the WTO over China’s alleged currency manipulation? This column analyses three potential legal issues: legality of exchange-rate policy under the GATT rules, legality under the subsidy rules, and the feasibility of non-violation complaints. It concludes that any WTO resolution will be difficult to achieve because the organisation is not designed to deal with alleged exchange-rate manipulation.


Pegging an exchange rate to a key currency is not per se illegal nor irrational.1 But, in the case of China, its unprecedented current account surplus and dollar accumulation supported by alleged “exchange rate misalignment” or “protracted large-scale intervention in one direction in exchange markets” have provoked huge controversy over the legality under its international treaty obligations, especially the WTO and the IMF. Although the IMF seems to have a more direct jurisdiction over this exchange-rate matter, massive trade consequences of exchange-rate policies compellingly demand remedial trade measures under the auspices of the WTO, which has more effective enforcement mechanisms.

Here I analyse three potential legal issues focusing on the WTO agreements: legality of exchange-rate policies under the GATT rules, their legality under the subsidy rules, and the feasibility of non-violation complaints. I argue that although the current Chinese exchange-rate regime may be found to be inconsistent with GATT provisions, it will be still very difficult to address the problems concerning its exchange-rate regime in the WTO system. That is not because the Chinese system is complicated but primarily because the WTO rules are not devised to deal with alleged exchange-rate manipulation.

Frustrating the intent of the WTO or IMF?

Generally speaking, application of Article XV of the GATT, which stipulates rules on exchange-rate arrangements for current WTO members, requires special caution because the underlying international financial system has changed dramatically. When Article XV was first devised, the IMF meticulously implemented the fixed exchange rate system. In contrast, a majority of WTO members, especially developed country members, today have floating exchange-rate arrangements. Nevertheless, Article XV has significant relevance to exchange-rate policy issues in the current context.

Article XV of the GATT requires cooperation with the IMF regarding a broad range of exchange-rate questions such as monetary reserves, balance of payments or foreign exchange arrangements. For example, Article XV(2) provides that “in all cases” in which the WTO considers or deals with problems concerning foreign-exchange arrangements, the WTO “shall consult fully” with the IMF. Moreover, in such consultations, the WTO “shall accept all findings” of statistical and other facts presented by the IMF relating to foreign exchange, as well as determination of the IMF as to whether action by a WTO Member in exchange matters is in accordance with the Articles of Agreement of the IMF.2

In addition to the consultation requirement in Article XV(2), Article XV(4) provides more substantive obligation for WTO Members as follows:

Contracting parties 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 Articles of Agreement of the IMF.

Addenda of Article XV(4) provides that

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.

So, the key question from Article XV is whether China, by its exchange actions, frustrates the intent of GATT provisions.3 This leads to three legal issues:

  • Is China’s current exchange-rate policy tantamount to “exchange action”?,
  • What is the intent of the pertinent GATT provisions?
  • Is that intent frustrated?

Some commentators argue that “exchange action” in Article XV(4) should be narrowly interpreted to cover liberalisation of payments or convertibility (see Koops 2010 and Denters 2003). They point out that “exchange action” should be different from “exchange-rate action”. However, at the time of drafting GATT, currency par value manipulation was a well known measure to protect domestic markets. Therefore, in GATT drafting, the US delegates “felt constrained to include some protection against them in the tariff agreement, even though the IMF articles contained some similar provisions.” (Jackson 1969). That implies that exchange action could well encompass the exchange-rate policy of WTO members to fix its currency value at a certain level. Moreover, what the US government is complaining about is not the adoption of crawling peg system per se, but rather “maintaining” the current exchange rate for a prolonged period of time despite huge trade and financial consequences. This specific governmental policy choice can be understood as “exchange action”, although adoption of crawling peg system may not be qualified for deliberate and specific nature connoted from “exchange action”.

Second, the intent of GATT provisions is indeed hard to know. The “intent” may or may not be an “objective”. The preamble of GATT is often discussed to draw “intent” of GATT, although the subsequent analysis seems to focus on broad economic goals mentioned therein. Or it is assumed that the intent of GATT must be obviously trade liberalisation or even balanced trade. For example, some argue that intent of GATT should be “balanced trade among its members on a multilateral basis” (see Hufbauer et al. 2006 for a critical analysis). However, instead of aiming to achieve economic goals such as raising living standards or full employment, “intent” of GATT provisions may be interpreted to embrace more “legal” aspects. For example, the intent of GATT provisions may be to stipulate articulated rule of conducts for commercial transaction so that the bargained competitive conditions for members’ markets are not arbitrarily disturbed. If the intent of the GATT provisions is understood this way, the focus of the analysis will be more on structure and design of the GATT rather than economic or trade performance. Actually, the goal or objective of the GATT system may be to achieve better economic performance through free trade, whereas the intent to devise elaborated GATT provisions may be to establish a more rule oriented system in which bargained competitive conditions among members will not be arbitrarily or unjustifiably disturbed.

Lastly, what constitutes “frustration” of the intent of GATT provisions? In fact, the expression “shall not frustrate the intent” is exceptional not only in GATT/WTO law, but also in public international law. But, if the above understanding for the intent is adopted, prolonged arbitrary misalignment of exchange rates can be seen to frustrate it since the exchange action deliberately employed by the Chinese government resulted in appreciable departure from what would have happened otherwise.

It was also argued that Addenda to Article XV(4) demands specific GATT article to be frustrated in an important way (Hufbauer et al. 2006). But, this argument ignored that Addenda present only examples, not the definitive explanation.

On the other hand, Article XV(9a) provides that “nothing in this Agreement shall preclude the use by a contracting party of exchange controls or exchange restrictions in accordance with the Articles of Agreement of the IMF.” The scope of measures dealt in this article is limited, certainly not covering China’s exchange-rate policy. Historically, exchange controls or restrictions related to convertibility were permitted by specific decisions of the IMF as special measures to address balance of payment problems of its members. So, “exchange controls or exchange restrictions” in accordance with the Articles of Agreement of the IMF would mean more specific exchange policies adopted pursuant to the IMF decision. A grand scale exchange-rate policy to fix its currency value is not covered by Article XV(9) exception clause.

Although this interpretation of Article XV may be one possible way to legally challenge China’s exchange-rate policy, it raises another controversial issue in terms of enforcement. In case China does not comply with the recommendation by the WTO Dispute Settlement Body, the retaliation becomes prohibitively difficult or impractical due to the technical problems of injury calculation. What should be the proper exchange rate not to frustrate the intent of the GATT provisions raises the whole new sets of questions and legal issues. There is no consensus even on whether the IMF can or should deal with those questions.

Illegal subsidy?

Economically speaking, an undervalued exchange rate works as an import tax and an export subsidy. So, it is natural that the WTO Agreement on Subsidies and Countervailing Duties (SCM Agreement) is invoked to address trade problems caused by devalued exchange rates.

The most important legal element under the SCM Agreement is that the measure at issue – in this case, China’s exchange-rate policy – must be a subsidy under Article 1. In order for China’s exchange-rate policy to be regarded as subsidy, the following criteria must be met:

  • there must be financial contribution by a government,
  • benefit is conferred, and
  • the subsidy must be specific. Financial contribution is made by direct transfer of funds, foregone government revenues, the provision or purchase of goods or services other than general infrastructure, or payment to a funding mechanism.

The first obstacle to invoke the SCM Agreement in relation to exchange rate policies is to prove financial contribution. Although it is argued that China’s exchange-rate policy somehow provides financial contribution, those arguments are not tenable. For example, some argue that exchange of currency at an undervalued rate can be seen as direct transfer of funds and foregone government revue. This is, however, partial consideration of the full market situation. The same exchange rate applies to not only exporters, but also all other people and products. It means that unlike normal financial contribution situation which absolutely improve financial states of recipients, the manipulation of exchange rate affects relative prices of traders and thereby balances off gains.

Next, it is very difficult to argue that China’s exchange-rate policy satisfies the specificity requirement by affecting only a small number of enterprises or industries. It is often argued that China’s exchange-rate policy is a prohibited export subsidy that is deemed to be specific. Although undervalued exchange rates crucially promote exporting, it is untenable to argue that China’s exchange-rate policy is a subsidy contingent upon export performance. The fact that the fairly detailed illustrative list for export subsidy in Annex I does not mention this well known – probably the most important – contributing factor for export promotion indicates the boundary of export subsidies envisioned for multilateral disciplines.

Lastly, whether benefit is conferred critically hinges on market elasticity and production structure. Since market prices tend to adjust to exchange-rate regimes, benefits may not be readily conferred (see Staigner and Sykes 2008 for a rigorous analysis). This issue may be more controversial relative to the above legal elements of a subsidy. But, in any case, it will be very difficult to demonstrate that China’s exchange-rate policy is a measure to be disciplined under the SCM Agreement simply because it has export promoting effects.

Non-violation complaints

Alternatively, a WTO member can raise a “non-violation” complaint in Article XXIII(1b) if any benefit accruing to it directly or indirectly from the GATT is nullified or impaired or the attainment of any objective of the GATT is impeded by any measure of another member, “whether or not it conflicts with the GATT provisions”. Since there is no explicit violation of GATT provisions, a WTO member losing the dispute based on a non-violation complaint has no obligation to withdraw the measure at issue but still must make a mutually satisfactory adjustment that may include compensation arrangement (see WTO, Understanding on Rules and Procedures Governing the Settlement of Disputes (DSU), Article 26.1.).

Although a non-violation complaint appears to be intriguing in the textual languages especially for complainants whose violation claims are not robust, WTO jurisprudence has established the rigorous legal elements that must be demonstrated by a complainant:

  • application of a measure by a WTO Member;
  • a benefit accruing under the relevant agreement; and
  • nullification or impairment of the benefit as the result of the application of the measure (WTO 1998).

A benefit accruing under the relevant agreement is typically that of legitimate expectations of improved market-access opportunities arising out of and at the time of relevant tariff concessions (WTO 1998). In the case of China’s exchange-rate policy, it will be unattainable to demonstrate that other WTO Members cannot legitimately expect China to maintain basically the same exchange-rate policy as that retained prior to the WTO accession. Accordingly, it is unlikely that a non-violation complaint can be successfully raised in the case of China’s exchange-rate policy.

Policy recommendation

As shown above, addressing China’s exchange-rate policy with WTO rules would be a formidable task, although it may not be completely impossible. This issue appears to be a kind of “political question” in the WTO system, rather than a legal problem to be judged by the dispute settlement system. Therefore, litigation of this issue is unlikely to produce proper solutions. Accordingly, the US and China should find other more “politically” attuned forum, such as G20 meeting, more suitable to resolve this conflict.

The difficulty of using WTO rules to deal with China’s exchange-rate policy has already caused considerable problems in the world trading system. Frustration has led to more antidumping and countervailing duties, and recently even transitional product-specific safeguard measures, from the US. It has provoked many retaliatory trade remedy actions by China against the US products (see Evenett 2010). This situation highlights the need of more cooperation among G20 states whose roles are crucial to contain the protectionist sentiment.


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1 Currently, 79 IMF members adopt pegging exchange rate arrangements. China is one of eight members that adopt the crawling peg arrangement anchored on the dollar pursuant to the IMF classification. See here.

2 The legal issues concerning the IMF rules are not the scope of this paper. Those issues are addressed in Seigel (2002).

3 Some have argued that China’s exchange-rate policy should be regarded as “trade action” since it had significant implication and effect for trade. But, considering the general practice to divide works of the GATT and the IMF based on the technical nature of government measures rather than on the effect of these measures, China’s exchange-rate policy must be regarded as exchange action (see WTO 1995).


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