China's Fixed Exchange Rate for the Yuan: Could the United States Challenge It in the WTO as a Subsidy?
October 04, 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." 
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." 
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. 
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  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."
 International Trade Daily Highlights, September 25, 2003.
 Merco Press, Sunday, October 19, 2003, at http://www.mercopress.com/Detalle.asp?NUM=2728 .
 Report of the WTO Appellate Body, Canada - Measures Affecting the Export of Civilian Aircraft, WT/DS70/AB/R, para. 157, (1999).
 Available at http://www.wto.org/english/docs_e/legal_e/24-scm_03_e.htm#annI
By Marc Benitah
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).