Don’t Devalue the Ruble
By Anders Aslund

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 that it has too large a short-term government debt in comparison with international reserves. The critical issue is that about $25 billion of treasury bills are held by Russian commercial banks and foreign investors, while the international reserves hover at around $15 billion.

First, the government needed to stop all new borrowing through treasury bills, and it has been doing so since 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 GDP last year, but it will be less than 5 percent of GDP this year. This is exactly what the International Monetary Fund (IMF) requires. For next year the IMF and the Russian government seem to agree that a budget deficit of 2.5 percent of GDP should be alright. After having stopped the fiscal bleeding, the Russian government now needs to refinance its short-term debt, reducing those interest rates to 20-25 percent a year.

There are three possible sources of financing for the next month: the IMF, the World Bank, and Eurobonds. The release of proposed supplementary reserve facility (SRF), of $10 billion-$15 billion from the IMF does not look very likely. This is because the SRF is supposed to last a maximum of three years and Russia needs medium-term financing. Moreover, the IMF is short of funds.

A more realistic and sensible package would consist of a mixed strategy. First, the IMF could extend its current extended fund facility (EFF) 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 that they implement 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 entirely 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 privatization projects—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 the 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 any kind of significant foreign investment, however, Russia must undertake a number of fundamental reforms:

· First, a tax reform leading to a comprehensible tax system and reasonable and stable tax rates must be adopted. 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 norm in both large and small Russian enterprises, must be stopped and the culpable parties must be penalized.

· Third, the government must show that it favors a level playing field by doing away with all privileges for the biggest companies. This means permanently abolishing tax offsets and forcing large enterprises, such as Gazprom, to pay their taxes.

What would the effects of devaluation be? Two years ago Bulgaria provided a striking parallel. Too large a budget deficit and too little international financing forced it to devalue. Panic struck. People sold their leva for dollars. The exchange rate plummeted by around 98 percent within a year. Similarly, a Russian devaluation would undermine what little remaining confidence there was in the ruble, and the exchange rate would drop by 80 to 90 percent.

The leva 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. GDP fell by around 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.

One difference from Russia is that Bulgaria was ruled by old communists. In Russia the reformers in government would probably be blamed, and the spectre of populism and nationalism could rise up. Whoever rules during a devaluation is bound to lose power. And the crisis would not stop in Russia. Ukraine and Kazakhstan, at least, would be forced to devalue, facing the same economic devastation, followed by changes in political regimes.

Anders Aslund is a senior associate at the Carnegie Endowment for International Peace. He contributed this comment to The Moscow Times on July 7, 1998.