Source: Carnegie
Don't Devalue Ruble
The Moscow Times, Tuesday, July 7, 1998
Devaluation is not needed because the ruble is not overvalued. Whoever rules during a devaluation is bound to lose power. The ruble has been under severe pressure for over a month. Ever more people are saying that devaluation is inevitable or even good. Neither, however, is true. Russia can avoid devaluation, and it must try to do so.
Devaluation is not necessary because the ruble is not overvalued. Last year, Russia had a huge trade surplus of $20 billion, and it has had similar trade surpluses for years. Falling oil and commodity prices have diminished the trade surplus, but it is still large. Russia's position is excellent in comparison with other transition countries. Virtually all have large trade and current account deficits, and a few have current account deficits exceeding 20 percent of GDP. Russia's most immediate problem is too large a short-term government debt in comparison with international reserves. The critical issue is about $25 billion of treasury bills held by Russian commercial banks and foreign investors, while the international reserves hover around $15 billion.
The government first needed to stop all new borrowing through treasury bills, and it has done so from the beginning of 1998. Next, the government had to get the budget deficit under control, and it has done so as well. The budget deficit was 8 percent of gross domestic product last year but it will be less than 5 percent of GDP this year. This is exactly what the International Monetary Fund demands. For next year, the IMF and the Russian government seem to agree that a budget deficit of 2.5 percent of GDP should be right.
After having stopped the fiscal bleeding, the Russian government now needs to refinance its short-term debt, reducing those interest rates from 60 percent to 80 percent a year to 20 percent to 25 percent a year.
For the next month, there are three possible sources of financing: the IMF, the World Bank and Eurobonds. The proposed supplementary reserve facility, or SRF, of $10 billion to $15 billion from the IMF does not look very likely. The SRF is supposed to last a maximum of three years, while Russia needs medium-term financing. Moreover, the IMF is short of funds.
Therefore, a more realistic and sensible package would consist of a mixture. First, the IMF could extend its current extended fund facility, or EFF, with up to $5 billion. Second, the World Bank could provide an additional $5 billion in so-called adjustment loans that are paid to the government on condition of certain structural reforms. Finally, Russia could raise a few billion dollars in eurobonds. Such a package would be sufficient to reinforce Russia's international reserves and salvage the ruble exchange rate. It is perfectly possible to conclude such an agreement and even make a first IMF disbursement within a month.
With such a package in place, and after the immediate financial crisis is over, Russia could raise a lot of private investments within the next six months. The current crisis is a good reason to speed up remaining privatizations, and quite a few have been prepared. A large number of foreign investments could be forthcoming in booming industries, such as food processing and car manufacturing. Russia received foreign direct investments of $6 billion in 1997, and that was only a beginning.
At present, Russian stock prices have fallen by 75 percent from their peak last October. On the one hand, it shows how deep the crisis is. On the other, it indicates that Russia possesses very attractive assets that are available on a functioning market. In a recovery, Russia's equity market could easily attract $20 billion within a year. In order to get significant foreign investment of any kind, however, Russia must undertake a number of fundamental reforms. First of all, a tax reform leading to a comprehensible tax system and reasonable stable tax rates must be adopted. A tax reform is needed to impede capital flight and promote enterprise restructuring. Second, property rights must be secured. In particular, the aggressive theft of the property of minority owners, which has become the rule in both large and small Russian enterprises, must be stopped and penalized. Third, the government must show that it favors a level playing field by doing away with all privileges for the biggest companies for good. This means permanent abolition of tax offsets and that large enterprises such as Gazprom will be forced to pay their taxes.
What would the effects of devaluation be? Bulgaria two years ago provides a striking parallel. Too large a budget deficit and too little international financing forced it to devalue. Panic struck. Everybody sold their leva for dollars. The exchange rate plummeted by no less than 98 percent within a year. Similarly, a Russian devaluation would undermine what little remaining confidence there is in the ruble, and the exchange rate would drop by 80 percent to 90 percent. The devaluation made the foreign debt service more expensive, and the velocity of money rose, causing Bulgarian inflation to skyrocket to 600 percent. Most banks went bankrupt, and the money economy was devastated. The GDP fell by no less than 10 percent in 1997, and the impoverished people took to the streets in the tens of thousands, forcing early elections, which ousted the ruling party.
The only difference from Russia is that Bulgaria was ruled
by old communists. In Russia, the reformers in government would probably be
blamed, and the specter of populism and nationalism could open up. Whoever rules
during a devaluation is bound to lose power. The crisis would not stop in Russia.
At least, Ukraine and Kazakhstan would be forced to devalue, facing the same
economic devastation, followed by changes of political regimes.
© copyright The Moscow Times 1998