China's Fixed Exchange
Rate for the Yuan: Could the United States Challenge It
in the WTO as a Subsidy? (corrected version)
By Marc Benitah
October 2003
On September 24, 2003, members of the
Congressional-Executive Commission on China urged
a U.S. trade official to consider challenging China's
fixed currency exchange rate at the World Trade
Organization (WTO). Rep. James A. Leach (R-Iowa),
chairman of the Commission, put forward the idea
that China's currency could be "a subsidies
issue under the WTO, so it's not exactly a non-WTO
issue." [1]
U.S. manufacturers have strongly
criticized China for maintaining an artificial
exchange rate with the dollar. Groups such as
the National Association of Manufacturers argue
that China's currency, the Yuan, is undervalued
by 40 percent because the Chinese government has
fixed its value in dollars. The lower Yuan makes
Chinese exports to the United States less expensive,
and conversely makes U.S. exports to China more
expensive. Before his trip to Asia, President
Bush underlined that "we expect the markets to
reflect the true value of [a] currency" and "countries
need to be mindful that we expect fair trade." [2]
The question is whether a WTO panel
would regard the Chinese fixed exchange rate system
as a "subsidy." According to WTO texts, a practice
is an "actionable" subsidy (a subsidy that can
be challenged) if it satisfies three criteria.
First, it must be "specific." Second, it must
entail a governmental "financial contribution,"
and third, it must confer a "benefit" on its recipient.
In order successfully to challenge the Chinese
fixed exchange rate system as a subsidy, the United
States would have to demonstrate that these criteria
are simultaneously satisfied.
A program is deemed specific if it
is granted selectively, in law or in fact, to
an enterprise or group of enterprises. In other
words, if it is available for all the sectors
of the economy, it is not specific and therefore
not an actionable subsidy. A first glance, it
may appear that the Chinese fixed exchange rate
is not targeted selectively toward a special sector
of the Chinese economy, but on the contrary, is
available for all sectors of the Chinese economy.
Therefore it would not be specific and thus not
actionable.
This first impression is misleading
if we take into account the fact that the Chinese
fixed exchange rate system would most likely be
challenged as a prohibited de facto export subsidy,
under Article 3 of the WTO Subsidies and Countervailing
Measures Agreement ("SCM Agreement").
Article 3 prohibits subsidies contingent, in law
or in fact, on export performance. According
to the WTO commentary to Article 3, this de facto
standard is met when the facts demonstrate that
the granting of a subsidy, without having been
made legally contingent upon export performance,
is in fact tied to actual or anticipated exportation
or export earnings. Article 2.3 of the SCM Agreement
would then take effect. It stipulates that "Any
subsidy falling under the provisions of Article
3 shall be deemed to be specific."
The specificity criterion thus does
not seem to be an insurmountable legal obstacle
to challenging the Chinese fixed exchange rate
as a de facto export subsidy. In other words,
if the United States demonstrates that the Chinese
fixed exchange rate system is a de facto export
subsidy, then automatically the specificity
criterion would be satisfied.
With regard to the "benefit" criterion,
it is surprising not to find it defined in Article
1 of the SCM Agreement, which defines a subsidy
in general terms. Article 1 indicates only that
the fact that a "benefit is . . . conferred" is
a necessary condition for identifying a subsidy.
However, a case law definition of this criterion
has emerged, determining that a benefit exists
when a governmental financial contribution:
makes the recipient "better off"
than it would otherwise have been, absent that
contribution. In our view, the marketplace provides
an appropriate basis for comparison in determining
whether a "benefit" has been "conferred",
because the trade-distorting potential of a
"financial contribution" can be identified
by determining whether the recipient has received
a "financial contribution" on terms
more favourable than those available to the
recipient in the market. [3]
This definition is sufficient in simple cases where the "free" marketplace
to which it implicitly refers as a benchmark for
comparison is easily identifiable. For example,
if a firm receives a government loan at an interest
rate that is lower than the rate charged by private
banks in the country of the firm, a benefit will
have been conferred upon the recipient firm. However,
this definition becomes less certain when the
"free" marketplace is not easily identifiable.
In fact, in the case of the Chinese fixed exchange
rate system, it seems that the free marketplace
is not only difficult to identify, but is simply
non existent. There is no currency exchange market
in China or elsewhere for the Yuan where its value
is determined by the interaction of the forces
of supply and demand.
One could say however that the free
market value of the Yuan is the value that would
prevail if China had a free exchange rate system
reflecting the economic forces behind its balance
of payments. Since the free marketplace alluded
to in the WTO case law definition of benefit is
not rigorously defined, and since this case law
definition could evolve, this view has some merit.
Although it is unlikely that a WTO panel would
adopt it, one cannot say with certainty that the
benefit criterion is an insurmountable legal obstacle
to challenging the Chinese fixed exchange rate
system as a subsidy. Of course, a convincing economic
demonstration that the Yuan is currently grossly
undervalued would be necessary, since without
this demonstration there is no question of finding
a benefit.
With regard to the governmental "financial
contribution," the clearest case would be a sum
of money granted by a government to an industry.
But the WTO Subsidies Agreement specifies clearly
that a governmental financial contribution exists
not only when it provides outright financial assistance,
but also in other various cases. More precisely,
according to Article 1 of the SCM Agreement, such
a contribution exists if a government practice
involves a direct or a potential transfer of funds
(e.g., grants, loans, equity infusions and loan
guarantees) and when a government provides goods
or services other than general infrastructure,
or purchases goods. It exists also when government
revenue that is otherwise due is foregone or not
collected (e.g., fiscal incentives such as tax
credits) or when a government makes payments to
a funding mechanism or entrusts or directs a private
body to grant financial contributions which would
normally be vested in the government. Finally,
any form of income or price support for producers
is also a financial contribution.
At first glance, it does not seem
that the Chinese "undervalued" fixed exchange
rate system could fit in one of these categories.
However, it is possible that the provision or
the conversion of foreign currency at a fixed
rate could be perceived as equivalent to a service
given by the Chinese government or by bodies entrusted
by it. Since this system would most likely be
challenged as a de facto export subsidy, one may
look at the Illustrative List
[4] of prohibited export subsidies
annexed to the SCM Agreement in order to find
any mention of exchange rates. Item (j) of this
List identifies as a prohibited export subsidy
any governmental "exchange risk programmes [provided]
at premium rates which are inadequate to cover
the long-term operating costs and losses of the
programmes." Since the Chinese fixed exchange
rate system is not an exchange risk program and
since it is difficult to speak in an economically
meaningful sense of "costs and losses" of this
system for the Chinese government, it does not
seem that the United Stated could successfully
invoke Item (j) of the Illustrative List of prohibited
export subsidies.
Challenging China's fixed exchange
rate as a subsidy in the WTO would not be easy.
Nevertheless, it might be possible in this case
to satisfy all three of the WTO criteria for an
actionable subsidy (namely, specificity, governmental
financial contribution and benefit).
Of course, there could be other legal
avenues for challenging the Chinese system in
the WTO. For example, Article XV, paragraph 4
of the General Agreement on Tariffs and Trade
(GATT 1994) might be invoked. It bars signatories
from using "exchange rate action" to
"frustrate" the intent of the Agreement.
About the Author:
Marc Benitah is Professor of International Law,
University of Quebec. Professor Benitah has recently
published at Kluwer Law International a comprehensive
book on the law of subsidies entitled "The
Law of Subsidies under the GATT/WTO System."
[1] International Trade Daily Highlights,
September 25, 2003.
In the original version of this Insight, an item
was missing in the list of cases where there is
a governmental financial contribution. According
to Article 1 of the SCM Agreement, there is also
a financial contribution when "a government
provides goods or services other than general
infrastructure, or purchases goods." In this
light, the original conclusion that it does not
seem that the Chinese "undervalued"
fixed exchange rate system could fit in one of
the categories describing a financial contribution
may be too categorical. Indeed, one cannot reject
the hypothesis that the provision or the conversion
of foreign currency at a fixed rate could be perceived
as equivalent to a service given by the Chinese
government or by bodies entrusted by it.
The general conclusion remains that challenging
China's fixed exchange rate as a subsidy in the
WTO would not be easy. Nevertheless, it might
be possible in this case to satisfy all three
of the WTO criteria for an actionable subsidy
(namely, specificity, governmental financial contribution
and benefit).
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