The Legality of Exchange Rate Undervaluation Under WTO Law
A memorandum presented to Mrs. Vera Thorstensen, Getúlio Vargas Foundation
Clinic: Graduate Institute, Spring 2011
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This memorandum is the result of a request submitted by the Center on Global Trade and Investment of the Getúlio Vargas Foundation (FGV) in Brazil in the framework of the Trade Law Clinic at the Graduate Institute of International and Development Studies, Geneva. The following questions concerning primarily the legal effects, under international trade law, of exchange rate policies aimed at currency undervaluation, were posed by the client:
Under what legal basis could a claim against a country practicing exchange-rate devaluation be argued within the WTO Dispute Settlement Body?
Which trade remedies could a developing country impose against a WTO member that practices exchange-rate devaluation?
Which form of legal action would be more effective against a WTO member that practices exchange-rate devaluation?
In analyzing the questions above and as instructed by the client, this paper presupposes that (a) the hypothetical dispute at hand would involve a developing country as claimant and the People’s Republic of China as respondent; and (b) China’s currency, the RMB, is kept, by government policy, at a value 25% below what its free float-exchange rate would be. Nevertheless, it should be kept in mind that calculating an exact level of over or under-valuation is an extremely difficult task, and this paper presupposes 25% undervaluation based on our client’s suggestion. Whether the RMB is actually undervalued by 25% is not a question we answer here, but rather one we leave to economists.
With regard to potential offensive legal action in the sense of challenging the exchange rate action before of a WTO Panel this paper examines, whether a policy of undervaluation violates Articles II, XV, XXIII of the General Agreement on Tariffs and Trade and/or it constitutes a prohibited subsidy or actionable subsidy under to the Subsidies and Countervailing Measures. This memorandum concludes that such a measure could indeed be contrary to the provisions of GATT Article XV or GATT Article XXIII.
The decisive factor in determining which norm is violated is the interpretation of “exchange action” under GATT Article XV:4. If “exchange action” is found to comprise exchange rate policies aiming at undervaluing the domestic currency – as it is argued in this paper - then it might breach Article XV inasmuch as the ‘intent’ of another GATT obligation is found to have been frustrated, otherwise GATT Article XXIII. However, according to the findings in this study a currency undervaluation is unlikely to amount to a breach of the SCM. A very broad understanding of financial contribution would be a necessary condition to find a subsidy. In the event that this can be achieved this memorandum finds the elements of an export subsidy are likely to be fulfilled, whereas we find that this is improbable in relation to an actionable subsidy. Finally, it is unclear whether currency undervaluation amounts to a breach of GATT Article II—if so, it would only do so on a de facto basis, not on a de jure basis. Concerning the ability to pursue defensive legal action under WTO law it is examined, whether a developing country could impose countervailing duties, anti- dumping duties or amend its customs valuations methods so as to compensate for the manipulated currency. In line with the arguments that speak against a subsidy it is found that imposing countervailing duties would most likely represent illegal action under the SCM agreement. With regard to anti-dumping duties the economic uncertainties involved in calculating the “normal value” make a clear-cut answer difficult. However, case law allows for wide discretion, which is why this paper concludes that anti-dumping duties might offer scope to address certain issues pertaining to monetary devaluation under WTO law. With regard to the CV agreement, this paper concludes that a state could not amend its method of customs valuation to compensate for RMB undervaluation unless this very state took the drastic action of pegging its own currency against the RMB. Furthermore, considering the specific case of China, this paper approaches the possibility of imposing safeguards on the term of China’s Protocol of Accession to the WTO as a viable option for a country whose industries have been affected.
Due to the complete absence of jurisprudence on this specific matter, the findings in this memorandum are mostly based upon legal interpretation methods and doctrine. Most importantly, the present analysis depends on macro-economic assumptions that need to be verified before any legal action is carried out.
General Advise, if legal action is sought:
With regard to the potential offensive action discussed in this memorandum we find that the most reasonable claim would be based on GATT Article XV:4 together with GATT Article XXIII:1 (b) in the alternative.
In terms of the examined defensive measures we find it most feasible to impose Anti-Dumping duties.