Thursday, May 28, 2009

The China Manipulates Currency Allegation: Failings of a Political Argument

by M. Ulric Killion

For various reasons, China’s pegged yuan (RMB - China currency: Renminbi) controversy is considered a violation of WTO standards that can be brought before the WTO's DSB, rather than the International Monetary Fund (IMF).

The WTO criterion for an actionable subsidy is a finding of a requisite contribution that benefits a specific Chinese industry. The Uruguay Round Agreement on Subsidies and Countervailing Measures, Articles 1-9, or the WTO SCM Agreement, at Article 2.1, provides that a subsidy must be “specific to an enterprise or industry or group of enterprises or industries (i.e., referred to in this Agreement as ‘certain enterprises’).

A requisite contribution normally consists of some form of payment or price support for the industry. Article 1.1 of the WTO SCM Agreement deems a subsidy to exist if:
(a)(1) there is a financial contribution by a government or any public body within the territory of a Member (referred to in this Agreement as ‘government’), i.e. where:
(i) a government practice involves a direct transfer of funds (e.g. grants, loans, and equity infusion), potential direct transfers of funds or liabilities (e.g. loan guarantees);
(ii) government revenue that is otherwise due is foregone or not collected (e.g. fiscal incentives such as tax credits);
(iii) a government provides goods or services other than general infrastructure, or purchases goods;
(iv) a government makes payments to a funding mechanism, or entrusts or directs a private body to carry out one or more of the type of functions illustrated in (i) to (iii) above which would normally be vested in the government and the practice, in no real sense, differs from practices normally followed by governments;
(a)(2) there is any form of income or price support in the sense of Article XVI of GATT 1994; and (b) a benefit is thereby conferred. (WTO SCM Agreement, Article 1.1(a)).
The difficulty in fulfilling this requirement is to be able to link the pegging of the yuan to a direct benefit to the industry in the form of payments and price supports. According to the WTO SCM, Articles 1.1(a) and 2(b), the key language is: “[A] benefit is thereby conferred.” “Asserting that a lack of a currency exchange market in China in which the value of the yuan is determined by supply and demand,” as Benitah earlier explained, “attenuates arguments that the yuan is manipulated for the benefit of a specific industry.” 
Additionally, the International Monetary Fund (IMF), through its Articles of Agreement at Article IV, has primary jurisdiction over foreign exchange rate policies, and prohibits unfair advantage by currency manipulation. More particularly, the Articles of Agreement of the international monetary fund or the IMF Agreement, at Article IV sec. 3(a), provides that “The Fund shall oversee the international monetary system in order to ensure its effective operation, and shall oversee the compliance of each member with its obligations under Section 1 of this Article.”

While a challenge could be mounted against China based upon Article XV, paragraph 4, of the GATT 1994, which bars participating members from using "exchange rate action" to frustrate the intent of the WTO Agreement, as long as China's exchange rate policy is in conformity with the IMF Agreement such as Article IV sec. 3(a), such a dispute will not be subject to jurisdiction of the WTO DSB. In particular, GATT 1947, at Art. XV, provides, “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 International Monetary Fund.” 

The IMF agreement, at XXIX. Interpretation, (a), also provides, “Any question of interpretation of the provisions of this Agreement arising between any member and the Fund or between any members of the Fund shall be submitted to the Executive Board for its decision. If the question particularly affects any member not entitled to appoint an Executive Director, it shall be entitled to representation in accordance with Article XII, Section 3(j).” Under such circumstances, the DSB is precluded from determining whether the yuan is being manipulated or being grossly overvalued.

For these reasons, the pegged yuan is therefore currently not considered to be in violation of the IMF Agreement and GATT. The IMF Agreement, at Article. IV sec. 2(b)-(c), also reads: “To accord with the development of the international monetary system, the Fund, by an eighty-five percent majority of the total voting power, may make provision for general exchange arrangements without limiting the right of members to have exchange arrangements of their choice consistent with the purposes of the Fund and the obligations under Section 1 of this Article.”

Rather, China's currency regime is considered to be prima facie in compliance with the IMF agreement. Therefore, China, pursuant to IMF agreement, Article IV sec. 2 (b)-(c), may maintain its currency exchange regime as it deems appropriate. China, however, is not precluded from being brought before the IMF and GATT for manipulating its currency for purposes of unfair competition. 

The problem of proving such manipulation is the IMF's lack of dispute settlement procedure and the prerequisite of IMF action before issues of currency exchange can be brought before the DSB. Article XXIX of the IMF Agreement, as Denters earlier explained, “is not intended to settle disputes between members as a WTO dispute settlement panel might resolve a trade dispute.”  

The earlier findings of the Senate in the Fair Currency Enforcement Act of 2003 (US S. 1592, 108th Cong. 2, 2003) at sections 2 (18) and (19) on the other hand, do offer a basis upon which action can be taken against China. According to the Fair Currency Enforcement Act, assuming it has not been subject to amendment, manipulations of currency by under-valuation are actionable subsidies and countervailing measures distorting fair competition. 

The Fair Currency Enforcement Act of 2003 requires negotiation and appropriate action with respect to certain countries that engage in currency manipulation and the relevant portions read as follows:
(18) Deliberate currency manipulation by nations to significantly undervalue their currencies also may be interpreted as a violation of the Agreement on Subsidies and Countervailing Measures of the World Trade Organization (as described in section 101(d)(12)) of the Uruguay Round Agreements Act, which could lead to action and remedy under the World Trade Organization dispute settlement procedures.
(19) Deliberate, large-scale intervention by governments in currency markets to significantly undervalue their currencies may be a nullification and impairment of trade benefits precluded under Article XXIII of the General Agreement on Tariffs and Trade, and subject to remedy.
In addition, the Fair Currency Enforcement Act of 2003 at Sections 2 (16) and (17) also incorporates Article IV of the IMF agreement.
(16) Article IV of the Articles of Agreement of the International Monetary Fund prohibits currency manipulation by a member for the purposes of gaining an unfair competitive advantage over other members, and the related surveillance provision defines "manipulation' to include ‘protracted large-scale intervention in one direction in the exchange market.’
(17) Under Article XV of the Exchange Agreements of the General Agreement on Tariffs and Trade, all contracting parties "shall not, by exchange action, frustrate the intent of the provisions of this Agreement, nor by trade action, the intent of the Articles of Agreement of the International Monetary Fund.' Such actions are actionable violations. The intent of the General Agreement on Tariffs and Trade Exchange Agreement, as stated in the preamble of that Agreement, includes the objective of ‘entering into reciprocal and mutually advantageous arrangements directed to substantial reduction of tariffs and other barriers to trade, and currency manipulation may constitute a trade barrier disruptive to reciprocal and mutually advantageous trade arrangements.’
International Monetary and Financial Committee

Section 2 (16) of the Fair Currency Enforcement Act, however, more broadly defines the prohibited acts of the IMF Articles of Agreement as “protracted large-scale intervention in one direction in the exchange market.” This is because IMF Agreement Article. VIII sec. 3, reads:
No member shall engage in, or permit any of its fiscal agencies referred to in Article V, Section 1 to engage in, any discriminatory currency arrangements or multiple currency practices, whether within or outside margins under Article IV or prescribed by or under Schedule C, except as authorized under this Agreement or approved by the Fund. If such arrangements and practices are engaged in at the date when this Agreement enters into force, the member concerned shall consult with the Fund as to their progressive removal unless they are maintained or imposed under Article XIV, Section 2, in which case the provisions of Section 3 of that Article shall apply.
The exchange rate frustrating the intent of the IMF and GATT is also addressed in section 2(17) of the Fair Currency Enforcement Act as “exchange action,” and not as “exchange rate action,” as it appears in the applicable rules of the IMF and GATT.

The shortcoming of the Fair Currency Enforcement Act, as DeRosa earlier observed, is that it has been inconsistent with previous Treasury Department inquiries into China's foreign exchange rate regime. The Treasury Department, as required by the Omnibus Trade and Competitiveness Act of 1988 (22 U.S.C. 5304-5305, 1988), has annually analyzed the exchange rate policies of China including China's pegged yuan, which has been a problem since 1994. 

Under this Act, the Treasury Department seeks to determine whether China manipulates the currency exchange rate between the yuan and the dollar for purposes of preventing effective balance of payments adjustments, or for gaining an unfair competitive advantage in international trade. In Treasury Department reports (Rep. to Congress on Int'l Econ. Exch. Rate Policies) to Congress on International Economic and Exchange Rate policies, Treasury Secretary Snow routinely reported that while China has pegged its currency since 1994 at 8.28 to the dollar, this practice does not meet the criteria in the Trade Act to warrant formal sanctions.

Source: Killion, M. Ulric. 2004. China’s Foreign Currency Regime: The Kagan Thesis and Legalification of the WTO Agreement, 14 Minn. J. Global Trade 43 (Winter).

Copyright © Protected - All Rights Reserved M. Ulric Killion, 2009.

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