VoxEU Column Exchange Rates

Retaliating against exchange-rate manipulation under WTO rules

What legal basis is there for retaliating against China’s exchange-rate policy? This column says that IMF rules are likely inadequate to rule against China, while its policy does not constitute a WTO-punishable export subsidy. It argues that exchange-rate conflicts should be handled by a proposed IMF dispute settlement mechanism, not the WTO.

Exchange-rate-based trade measures have gained prominence in recent years. Commentators observe such measures not only in the People’s Republic of China, but across a broad range of countries. Competitive devaluations are very much alive as a tool of economic statecraft, especially in the wake of the financial crisis. Mattoo and Subramanian (2008) argue that a fundamentally misaligned exchange rate is the most mercantilist, protectionist policy imaginable. At first sight, one would expect WTO rules to regulate such trade-distorting measures. In reality, however, WTO agreements leave the monetary sovereignty of WTO members largely untouched.

Let us assume that the IMF has determined that the the country of Heterodoxia’s currency is fundamentally misaligned. We are therefore able to focus exclusively on the law, taking the facts as given. In reality, of course, such factual determinations will be at least as complex, if not more complex, than the qualification of a given exchange-rate policy under international law. But this simplification allows us to focus on the central question: does a fundamental exchange-rate misalignment give rise to actionable claims under WTO law?

The principle of monetary sovereignty

It is a long established principle of international law that states are entitled to regulate their own currency. In The Emperor of Austria v. Day and Kossuth (1861), the English Court of Appeal in Chancery found that the Emperor of Austria had, as the King of Hungary, the sole and exclusive right of issuing and regulating currency in Hungary, including the right to regulate the currency and to determine its value in relation to other currencies. Similarly, the Permanent Court of International Justice in the Serbian Loans case (1929) and the US Supreme Court in Juillard v. Greenmann (1884) also affirmed a broad principle of monetary sovereignty. The right to define the exchange rate vis-à-vis other currencies is a central element of monetary sovereignty.

The IMF Articles of Agreement

Despite this, it is without doubt that the relative value of currencies is an international policy concern of the first order. Under the IMF Articles, unilateral acts to restore the balance of payments, such as restrictions on current payment, are prohibited, as are multi-currency and discriminatory currency practices – the obligation to maintain a unified exchange system. IMF members have therefore voluntarily accepted some restrictions on their monetary sovereignty.

Under the Bretton Woods system of fixed exchange rates, there also used to be an obligation to maintain a par value of the national currency – but that obligation was abolished by amendment to the IMF Articles in the 1970s. The principle of monetary sovereignty remains by and large good law today. Devaluations are not unlawful under international law, absent special circumstances. Thus, as a general rule, there is no legal basis for challenging another state’s exchange-rate policy.

The IMF is responsible for exercising firm surveillance over exchange-rate policies. Article IV(1)(iii) IMF Articles contains a rule on competitive devaluations: “Each member state shall avoid manipulating exchange rates … in order [to] ... gain an unfair competitive advantage over other members.” However, the IMF Articles contain no definition of “manipulating exchange rates”. From the text, we discern an objective element (“manipulating exchange rates”) and a subjective element (“in order”). The 2007 Decision on Bilateral Surveillance over Members’ Policies sheds some light on the objective element – the notion of exchange-rate manipulation.

The relevant parts of the 2007 Decision are not binding however. It is made clear that member states are given the benefit of any reasonable doubt. Subparagraph (ii) refers to the “excessive and prolonged official or quasi-official accumulation of foreign assets”; subparagraph (v) lists examples of “fundamental exchange rate misalignments”, and subparagraph (vi) adds “large and prolonged current account deficits or surpluses”. The Annex to the Decision provides further guidance.

The second, subjective element is the intent of gaining an unfair competitive advantage. The burden of proof lies on the alleging state – a burden that is difficult to meet with respect to China. More generally, proving the intention that the exchange rate was manipulated in order to obtain trade advantages is almost impossible in practice.

Perhaps WTO agreements hold out greater hope for a country that feels aggrieved as a result of an alleged exchange-rate undervaluation by another country, a question that is addressed in the following section.

Exchange-rate manipulation and the GATT

Article XV(4) of the General Agreement on Tariffs and Trade (GATT) states that the “contracting parties shall not, by exchange action, frustrate the intent of the provisions of [WTO law], nor, by trade action, the intent of the provisions of the [IMF Agreement]”. Note that this article refers to “exchange action”, not “exchange-rate policy.” This difference is important.

The IMF Articles draw a distinction between exchange policies (convertibility) and exchange-rate policies (Denters 2003). Article XV(4) presumably refers only to exchange policies. At the time member states negotiated the GATT, any change to par values required the IMF’s approval, rendering unnecessary the need to include any provision against the harmful trade effects of exchange-rate manipulation in the GATT. This is the likely explanation for this apparent gap in the WTO rules in relation to the relative values of currencies.

Even if exchange-rate policies fell under Article XV(4), the complaining member state would still need to show the violation of an explicit GATT prohibition. It is often argued that the economic effect of exchange-rate undervaluation amounts to an export subsidy. But the GATT does not operate on the basis of a broad effects doctrine. Rather, member states have negotiated a series of specific legal undertakings that provide the sole yardstick for assessing compliance with their obligations.

There is no general prohibition on export subsidies in the GATT. An export subsidy under the GATT “results in the sale of such product for export at a price lower than the comparable price charged for the like products to buyers in the domestic market”. With an undervalued exchange rate, no wedge between the export price and the domestic price of a good exists. Therefore, we are unlikely to have an export subsidy in such a case.

WTO Agreement on Subsidies and Countervailing Measures

The broader question is whether a state could lawfully resort to countervailing measures if a financial measure, such as a deliberate strategy to keep a currency below its equilibrium value, has economic effects equivalent to an export subsidy and is consistent with the IMF Articles. Such measures need to conform to the rules contained in the WTO Agreement on Subsidies and Countervailing Measures (SCM Agreement).

The SCM Agreement strengthens the regime on subsidies considerably. Export subsidies are banned. However, the agreement also does not rely on a broad effects test, but rather contains a specific legal definition of export subsidies. This definition has three elements:

  • A governmental financial contribution,
  • contingent, in law or fact, upon export performance, that
  • confers a benefit on recipients.

It is difficult to qualify a fundamentally undervalued exchange rate as an export subsidy.

  • First, Article 1 of the SCM Agreement contains a closed list of financial contributions, and exchange-rate valuations do not feature in this list.
  • Second, the benefit to Chinese exporters as a result of the allegedly undervalued yuan is ambiguous. These benefits are also not sector-specific, but broadly shared.
  • Third, even if a benefit is conferred, it does not appear to be contingent on export performance. This is because the exchange-rate applies across the board to various types of transactions.
IMF-WTO collaboration

Perceived enforcement difficulties in the IMF, the central multilateral forum for international monetary affairs, are insufficient grounds for bypassing the IMF for the highly developed Dispute Settlement Body of the WTO. The inability of the IMF surveillance system to effectively police certain obligations under IMF Articles certainly does not imply that recourse to the highly developed dispute settlement system of the WTO is warranted as a matter of law. Whether such recourse as a matter of policy is desirable is a separate question.

The IMF Articles of Agreement assign competence for determining whether exchange rates are undervalued to the IMF, and not to dispute settlement panels under WTO auspices. In specific cases, WTO panels and the Appellate Body would be obliged to consult the IMF on whether an exchange rate is fundamentally misaligned. Each institution has its respective jurisdiction. Conflicts ought to be avoided in order not to imperil the respective task of each institution.

There are good reasons for this allocation of responsibilities. Dispute settlement panels would resolve disputes on exchange rates in a piecemeal fashion – hardly a conducive recipe for international monetary stability and uniformity in exchange-rate regimes. As the quintessential macroeconomic policy, exchange-rate policy is of such paramount importance, complexity, and sensitivity that its conduct ought to remain beyond review by WTO panels. WTO panels would encounter questions that cannot be adjudicated by a judicial body whose function is limited to deciding particular disputes between defined parties. It is also apparent that the GATT/WTO drafters had no intention to confer jurisdiction on WTO panels to decide such disputes.

Policy options for the way forward

Mattoo and Subramanian (2008) advocate a new WTO covered agreement specifically on exchange-rate manipulation. The implementation of this proposal would likely undermine the central role of the IMF in international finance. The better route is to develop a robust dispute settlement mechanism in the field of international finance itself, including if member states so desire, for exchange rates. We currently lack such a system by design. Member states have so far been unwilling to confer such powers on an international organisation and accept greater restrictions on their monetary sovereignty.

In international monetary affairs, the international community relies mainly on informal means of co-operation. The IMF plays an important role in this informal policy coordination. But these mechanisms may fail to constrain policymakers who under strong domestic pressures seek to re-orient their economic policies inwards, including, among others, by competitive devaluations. Countries may violate their obligations under the IMF Articles, with relative impunity, in part because we lack a robust dispute resolution mechanism.

The currently available sanctions may also be inadequate. The toolbox is limited to the declaration of ineligibility for IMF resources, the suspension of voting rights and a request to withdraw from the Fund in extreme cases. A more effective system of sanctions for countries that do not respect their IMF obligations might hence be desirable as a further measure to improve compliance with obligations under the IMF Articles.


Denters, Eric (2003), “Manipulation of Exchange Rates in International Law: The Chinese Yuan”, ASIL Insight 118.

Mattoo, Aaditya and Arvind Subramanian (2008), "Currency Undervaluation and Sovereign Wealth Funds: A New Role for the World Trade Organization", World Bank Policy Research Working Paper, no. WPS 4668.

Staiger Robert W and Alan O Sykes, “”Currency Manipulation” and World Trade”, NBER Working Paper 14600.

Zimmermann, Claus D (2008), "Fundamental Exchange Rate Misalignment and International Law", University of Oxford and International Monetary Fund.

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