-----11 __ .-1 ________________________ 53875 Public Disclosure Authorized Transition and Macro-AdJustment Division • Country Economics Department • The World Bank .~------------------------~------------------------------------- The case of national currencies in the former Soviet Union Crov~lning the Estonian Kroon n Jun{~ 199~! Estonia carried out and hyperinflationary conditions on liberalization atthe startof1992. The a monetary reform to replace the the black markets. overall inflation rate, however, re­ I Soviet rublE with a new national mained high as a result ofcontinuing Public Disclosure Authorized currency, the krl)on (I::TOwn). In doing When Gosbank was disbanded at the rapid increases in the total ruble so, Estonia becEme the first country end of 1991 (together with the Soviet money supply throughout the former of the former S(lviet Union (FSU) to Union), the number of ruble issuers Soviet Union. achieve monet ary independence. fell to a "mere" fifteen, and the prob­ Estonia's example is important not lem of uncoordinated inflationary fi­ Viewed from Estonia's perspective, the only because se {era] other republics nance continued. The monetary over­ case for introducing a national cur­ plan to imrodu~e their own curren­ hang was eliminated by the rise in rency seemed overwhelming. Thegen­ cies, butahobecause Estonia adopted prices thatfollowed the Russian price eral view was that an independent a specific mondary mechanism-a currency board· ·-thElt is designed to make the kroon a stable and convert­ What's inside ... ible currency from the start. China's Party Congress Endorses "So· the understaffed, underfunded judicial infra­ Monetary Chs os cialist Market Economy" structure. (page 6) Public Disclosure Authorized Economic development should proceed with­ The background to Estonia's monetary Varlet,. ofBunprianTaxes (page 8) outbeing bogged down in an abstract debate reform is the monetary chaos that over what is socialist and what is capitalist, ReeearchUpdBte:ServicesB8BGrowth· emerged in the final years of the So­ announced the recent Party Congress in Promotina Sector in the FSU (page 9) viet Union. Duri 19 1990and 1991 each Beijing, replicating Deng's cat and mice alle­ of the republic~ of the Soviet Union gory: the color ofthe cat is not important as Quotation of the Month: "What Is The established a SE parate central bank, long as it catches mice. (page 4) Market Value ofAny1hinc in Russia operating alonrside the Soviet-wide alter All?" Euromoney Interview with Gosbank. By la:.e 1991 sixteen sepa­ Coastal Winds Blow Inward V":ae~rGeraah.enko.BeadoftheRussian rate central ban ks were issuing ruble Central Bank (page 10) credits with no overall coordination. In the next few years China's free trade Gosbank has taKen care of the Soviet zones are expectedto incorporate the entire Conference Diary (page 11) Union's huge bldget deficit (exceed­ coastal area and even some selected inland ing 20 perl~ent ofthe GNP), financing provinces. (page 5) Mneatones ofTransition (page 12) it through money creation. In addi­ tion, central bf.nks of the republics Legal Reform in Hungary World BankIIMF Acenda (page 13) Public Disclosure Authorized were financing their enterprises and governments. It all added up to hyper­ The streamlining ofHungary's legal system New Books and Working Paper8 inflation, s,ocialj st-style: the enormous to promote the private sector has made ma­ (page 14) monetary overhang, combined with jor headway, despite difficulties such as price contJ:ols, produced severe short­ clarifying property rights and coping with Selected Articles (page 16) ages in tr,e offidal supply networks The Wor1d Bank/CECTM nation required an independent cur­ duction o(new currencies in tl'te new reform-with its aim ofachievingthe rency; moreover, it was also thought states of the FSU. Cooperative ar­ immediate current account convert­ that monetary independence was rangements, in which several central ibility of the kroon-seemed vital in needed to escape from the continuing banks had the authority to issue view of the country's high trade de­ inflationary pressures and monetary rubles, were bound to be inflationary, pendence, its urgent need to develop instability in the rest ofthe FSU. The considering the strong political pres­ new exports in Western markets, and Estonians recognized that even if suresfor monetaryexpansionandthe its need to generate competition on Russia were to try to stabilize the institutional weaknesses oftherepub­ the domestic market. The Central ruble, other republics could under­ lican central banks. Russia 'mder~ Bank also aimed to insulate the mon­ mine it by continuing an easy mon­ stood that the only effective means of etary policy from intense lobbying etary policy oftheir own. In fact, do­ establishingcurrency stability was to pressures from industry and govern­ mestic credit expansion in Russia make the Russian Central Bank the ment. To achieve these goals, the Es­ remainedhigh,andpoliticalpressures sole entity authorizedto extend ruble toniangovernmentandCentral Bank for further credits to heavy industry credits. settled on the ideaof a currency board remained strong. (see box). The International Monetary Fund Inflation was not the only problem. (lMF) tried atfirst to delay the intro­ The kroon was to be introduced at a Trade was becoming bogged down by ductionof Estonia's currency, argu­ fixed exchange rate vis-a-vis the large delays in clearing payments ingthatthecountrywasnotyetready deutsche mark (DM), and with full between Estonian andRussian enter­ andthatthecurrency should beintro­ backing ofgold and foreign exchange prises. Moreover, an excess of bank duced late in 1992, or in 1993. As it reserves.All future emissions ofhigh. credits relative to currency notes in turned out Estonian authorities de­ powered money would have to be the ruble arealed to a severe shortage cidedto proceed on their own, in view backed by foreign exchange receipts ofcash in the first halfof 1992. Even of the urgency of the situation and of the Central Bank. In essence, the when enterprises had money in their with confidence that the monetary Central Bank would swear off domes­ bank accounts, they could not draw reform could be carried out quickly tic credit expansion; the kroon's mon­ on them to pay wages because of a and successfully. On the eve of the etary base would rise or fall only as shortage ofcash.As Russia controlled monetary conversion, the IMI!' pro­ the Central Bank bought or sold for­ the printing presses, and therefore vided them some last-minute techni­ eign exchange in returnfor kroons. To the distribution ofnotes,many repub­ cal support, and followed up with ne­ avoid an unnecessary trade collapse lics responded to the cash shortageby gotiations for a standby loan afterthe with the ruble zone, Estonia andRus­ issuingtheir own "coupon" moneys or monetary reform had taken place. sia agreed to maintain trade finane­ other money substitutes, thus adding ingin rubles, with a floating exchange to the chaotic monetary conditions. Smooth Conversion rate between the two currencies. Russia also hoped for the rapid intro- The Estonian strategy of monetary The monetary conversion was under­ taken duringJune 20-22, ata conver­ sion rate of 10 rubles per kroon for What is a currency board? bank balances, wages, prices, and A currency board's only purpose is to its expenses andto maintain its reserues other contracts. Residents could con­ issue notes (paper currency) and coins at the leuel set by law. vert up to 1,500 rubles into kroons at convertible on demand into a foreign the 10:1 rate, and rubles in excess of asset at a fixed rate ofuchange. The In an economy where capital {lows can that sum at a 50:1 rate. About 2.2 foreign asset can be a foreign currency, occur (any economy with a conuertible billionrublesin cash were exchanged, gold, or some other commodity, ora cur­ currency that has few barriers to for­ and these will be returned to Russia. rency or commodity basket. A currency eign investments), the balance oftr(lde board does not grant loans (except in does not impose any strict limits on a At the time of the conversion, the serving as a clearinghouse for bank currency board system'IJ ability to ex­ market exchange rate was about 75 checks) or accept deposits. As reserves it pandthe money supply. Instead, a more rubles per DM, or 7.5 kroon per DM. holds high-quality, interest-bearing se­ complex but still market-based form of Thenewfixed ratewassetata slightly curities, denominated in the foreign as­ limitation, based on people's estimates more depreciated rate, 8 kroon per set. Its reserves mustbe at least lOOper­ ofprofitability, applies. Hong Kong and DM. At this rate, the initial holdings cent ofits notes andcoins in circulation. Singapore experienced trade deficits for of Central Bank reserves, made up A currency board makes profits from the decades under their currency boCJtrd mostly of monetary gold held in the difference between the interest on the systems, yet their money supplies ex­ West since 1939, more than equalled securities that it holds and the expense panded all the while. of maintaining its notes and coins in the total stock of the broadly under­ circulation. It remits to the gouernment From related studiesby Steve H. Hanke stood kroon supply (M2). Thus, at the all profits beyond what it needs to pay and Kurt Schuler start, the entire money supply, not just the high-powered money (as in October 1992 --"--r'-~'II"-I ____------------------­ Transition some other currency board arrange­ property. There is a new attention to institutional bulwark (such as a cur­ ments), was backed by more than 100 financial reform, because banksand rency board arrangement) and by percent currency and gold reserves. other intermediaries must now sur­ sound fiscal policy. vive by their profitability rather than The post-conversion monetary policy through cheap credits from the Cen­ It is time to move rapidly to create guarantees theconvertibility ofkroon tral Bank.