The Coming Ruble Meltdown

STEVE H. HANKE AND ALAN WALTERS

September 22, 1992|By STEVE H. HANKE and ALAN WALTERS

Russia has a long history of manufacturing and distorting economic data. Now the International Monetary Fund is lending a fig leaf of respectability to that age-old Russian exercise.

This, of course, is standard IMF fare. The Wall Street Journal, noting that the IMF ''has become one of [Boris] Yeltsin's biggest cheerleaders,'' recalls that ''Often, the IMF has lavished praise upon a nation's reform process only to concede later that things went awry.''

Thus Richard Erb, the IMF's deputy managing director, traveled to Moscow last month and gave the Yeltsin government's economic program a clean bill of health -- just as the ruble was taking another nosedive, plunging 18 percent against the dollar in just one week.

As the IMF and World Bank gather in Washington for this week's semi-annual meeting, nameless bureaucrats at the IMF are telling us that Russia will need only another $18 billion in foreign aid next year to grease the skids of transition. Before the U.S. taxpayers underwrite that largess, they should reflect on the monetary mess in Russia. Contrary to the IMF's bland optimism, Russia faces a ruble Chernobyl that would create significant economic instability and leave many political casualties.

To understand why, we must look at the state of Russian industry and its connection to that country's credit system -- particularly to the central bank, which serves as the economy's ultimate credit pump. Russian industry is made up of a number of huge state-owned enterprises -- at least 80 percent of them insolvent. To keep the them afloat and postpone the needed massive shake-out and restructuring, a sea of credit is required. Not surprisingly, we observe the creation of just such a credit sea.

To avoid cutting output and firing workers, the state-owned enterprises have been supplying each other with interest-free credits. These credits have been piling up rapidly, and the total now exceeds all the rubles in circulation. In addition, the enterprises have established commercial banks -- now comprising 80 percent of Russia's 2,000 commercial banks. The banks' primary purpose is to extend cheap credit to their founders. Interest rates charged are less than inflation, so real interest costs are negative.

The state enterprises also obtain subsidies and credits directly from the Russian government, accounting for a huge and growing state budget deficit. If that weren't enough, the central banks in the republics of the former Soviet Union, although they can't print ruble notes, can issue ruble credits, and they have been doing so, particularly in the Ukraine.

At the end of the day, all the issuers of credit must knock on the Russian central bank's door and request a ruble bail-out. They must sing the same song: ''Give us rubles or we will go broke.''

The Russian central bank will not be able to avert a ruble Chernobyl. Afterward, lacking credibility, it will have great difficulty producing a sound, convertible ruble.

Not that Russia has ever had much monetary credibility. Its governments have issued currency since 1768. The ruble was fully convertible, however, for only 35 of those 224 years, ending in 1914.

Early last year, the central bank continued to undermine its credibility when it repudiated its own 50- and 100-ruble notes. Most people had time to exchange their high-denomination bills for an equivalent amount in smaller denominations, but some 10 to 12 billion rubles were confiscated by officials on the theory that possession of big banknotes was evidence that the money had been obtained through ''speculation'' and other illegal means.

Since then, the government has announced various schemes to prop up the ruble, but none have been implemented. Many observers believe that Russia's entry into the IMF will solve its credibility problem. That is a false hope. To appreciate that, let us look at Yugoslavia, where despite IMF membership since 1945, responsible behavior, credibility and sound money have proved as elusive as the Holy Grail.

In December 1989, well before the current civil war, Yugoslavia's monthly inflation rate was 50 percent, its annual one 2,720 DTC percent. Armed with an IMF stabilization plan, Yugoslavia introduced a currency reform establishing a ''hard'' exchange rate of seven dinars to the German mark. To maintain the peg under conditions of low credibility, real (excluding inflation) lending rates had to be pushed up to a yearly rate of about 40 percent. Inflation came down during 1990, but with Yugoslav interest rates much higher than those in Germany, the dinar became grossly overvalued relative to the German mark, plunging Yugoslavia into a deep depression.

Eventually, Yugoslavia had to give up on the hard peg and pump massive amounts of credit into its industrial dinosaurs and the commercial banks that those enterprises owned. Now the official exchange rate is 1,200 dinars per mark, and on the black market about 1,500. The government fears that by the end of this year inflation may climb to 100,000 percent or more. Of course, civil war doesn't help an economy, but Yugoslavia's fate was already sealed by ill-advised IMF reforms.

Russia's fate in the monetary sphere is also sealed. A ruble meltdown is assured. Let's hope that Russia can avoid a bloody civil war.

Steve H. Hanke is a professor of applied economics at the Johns Hopkins University. Sir Alan Walters, former personal economic adviser to Margaret Thatcher, is vice chairman of AIG Trading in Washington.

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