WASHINGTON (Reuters) — An internal watchdog sharply criticised the International Monetary Fund yesterday for failures in its core duty of foreign exchange market surveillance, but the IMF said that steps were being taken.The report by the Independent Evaluation Office, which examined the IMF's scrutiny of its member countries' foreign exchange regimes between 1999 and 2005, found "the IMF was simply not as effective as it needs to be on both its analysis and advice, and in its dialogue with member countries".

Global imbalances posed by the yawning US trade and current account deficits partly have been fuelled by controversial foreign exchange policies that keep the Chinese yuan and other regional Asian currencies artificially cheap against the dollar to boost exports.

The IMF has repeatedly warned these imbalances are a grave risk to the global economy, but is under pressure to be more outspoken when it judges currencies have moved significantly out of line.

Much of the IMF's comment is delivered via regular economic health assessments of national economies, but the report found much to fault with the impact of these efforts.

It said the reasons for the failure were "many and complex", citing a lack of understanding of the IMF's forex surveillance mission, lack of cooperation from member countries and a failure by IMF management and its executive board to provide adequate direction and incentives.

It also found some countries had a strong sense that the process was not even-handed, and that there was a lack of communication between the IMF and some of its members.

"Unless the shortcomings are successfully addressed in the period ahead, and as the number of countries looking elsewhere for policy advice and support continues to grow, there could be serious implications for the ability of the IMF to discharge its responsibilities in the future," the report found.

IMF first deputy managing director John Lipsky said he welcomed the constructive criticism. But he disputed some of the report's conclusions, and said steps had been taken since the end of its examination period in 2005 to remedy the problems it had identified.

"The period covered by the report cuts off in 2005. Since that time we have been hard at work on exactly those areas," Lipsky told a press briefing on the report's findings.

The IMF is trying to overhaul its forex surveillance activities as part of a medium term strategy, and Lipsky said that the report's findings were an important reminder of why progress on this sensitive topic was important.