A Service of Leibniz-Informationszentrum econstor Wirtschaft Leibniz Information Centre Make Your Publications Visible. zbw for Economics Schmieding, Holger Working Paper — Digitized Version No need for a monetary halfway house: Lessons from the European Payments Union for post-Soviet currency arrangements Kieler Diskussionsbeiträge, No. 189 Provided in Cooperation with: Kiel Institute for the World Economy (IfW) Suggested Citation: Schmieding, Holger (1992) : No need for a monetary halfway house: Lessons from the European Payments Union for post-Soviet currency arrangements, Kieler Diskussionsbeiträge, No. 189, ISBN 3894560282, Institut für Weltwirtschaft (IfW), Kiel This Version is available at: http://hdl.handle.net/10419/48095 Standard-Nutzungsbedingungen: Terms of use: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Documents in EconStor may be saved and copied for your Zwecken und zum Privatgebrauch gespeichert und kopiert werden. personal and scholarly purposes. 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Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, If the documents have been made available under an Open gelten abweichend von diesen Nutzungsbedingungen die in der dort Content Licence (especially Creative Commons Licences), you genannten Lizenz gewährten Nutzungsrechte. may exercise further usage rights as specified in the indicated licence. www.econstor.eu KIELER DISKUSSIONSBEITRAGE KIEL DISCUSSION PAPERS No Need for a Monetary Halfway House Lessons from the European Payments Union for Post-Soviet Currency Arrangements by Holger Schmieding L CONTENTS The Soviet ruble has become the common currency for 14 independent states with their own policies on credit expansion and budget deficits. The built-in inflationary bias of the present arrangement can be redressed if the common ruble makes way for separate cur- rencies. However, if major successor states of the Soviet Union switch to their own monies, trade between the former Soviet republics may be further disrupted as long as the new currencies are not convertible for current transactions. The European Payments Union (EPU) of the 1950s is often presented as a model for the successor states of the Soviet Union with separate currencies. However, the EPU clear- ing mechanism and its facility for soft credits were mere second-best devices to mitigate the harm that was caused by the inconvertibility and the collective overvaluation of the West European currencies against the dollar. In the 1950s, a sufficient devaluation of West European currencies would have removed the rationale for restrictions on trade and payments and would thus have made the EPU obsolete. Today, the former Soviet repub- lics need not waste their time in a payments union, i.e. in a halfway house on the road to convertibility, unless they opted for a gross overvaluation of their currencies. In recent years, Poland, Hungary and Czechoslovakia have made their currencies conver- tible at least for most current transactions of their residents. This minimum convertibility has promoted their integration into the worldwide division of labour; it has been main- tained because exchange rate policy has not led to a sustained misalignment. Instead of copying Western Europe's post-war mistake, the post-Soviet republics should follow the example of the East-Central European countries and make their currencies convertible at realistic and sufficiently flexible exchange rates. Regardless of their currency arrangements, the successor states of the Soviet Union have to transform their banking systems and establish an efficient system to clear payments between banks. Technical help from abroad could promote this process. However, the states need no mechanism that discriminates between interstate payments and pay- ments between the states and third countries. Proponents of a special post-Soviet payments arrangement sometimes argue that such an institution would promote the cooperation between the successor states of the Soviet Union; it would thus be politically useful regardless of economic considerations. How- ever, the strained political relations between many post-Soviet countries suggest that the readiness for a reliable cooperation is limited. Hence, special arrangements that inflate rather than economize on the need for cooperation are likely to be unstable. INSTITUT FUR W E L T W I R T S C H A F T KIEL AUGUST 1992 ISSN 0455-0420 Contents I. Introduction 3 II. The General Rationale for a Payments Union 4 III. The Experience of the European Payments Union 5 1. The Overvaluation of West European Currencies 6 2. The Functions of the EPU 7 3. The Evolution of the EPU 9 4. Evaluation 11 a. Expansion of Trade 11 b. Trade Liberalisation and Currency Convertibility 11 IV. A Post-Soviet Payments Union? 12 1. Is Convertibility Infeasible? 13 2. The Examples of Poland, Hungary and Czechoslovakia 16 3. Are the Ex-Soviet Republics Special Cases? 19 V. A Mixed Payments Union? 21 VI. A Payments Mechanism for Convertible Currencies? 23 VII. The Politics of Payments Arrangements 24 VIII. Recommendations 26 Bibliography 27 Deutsche Bibliothek - Cataloguing-in-Publication Data Schmieding, Holger: No need for a monetary halfway house : lessons from the European Payments Union for post-soviet currency arrangements / by Holger Schmieding. Institut fur Weltwirtschaft Kiel. - Kiel : Inst. fur Weltwirtschaft, 1992 (Kiel discussion papers ; 189) ISBN 3-89456-028-2 NE: Kieler Diskussionsbeitrage © Institut fur Weltwirtschaft an der Universitat Kiel Postfach 43 09, D-2300 Kiel 1 Alle Rechte vorbehalten Ohne ausdruckliche Genehmigung ist es auch nicht gestattet, den Band oder Teile daraus auf photomechanischem Wege (Photokopie, Mikrokopie) zu vervielfaltigen Printed in Germany ISSN 0455 - 0420 Bibliothek des Institute fur Weltwirtschaft Km\ I. Introduction With the peaceful collapse of the Soviet empire and the concurrent dissolution of the Soviet central bank, the ruble turned into the common currency of 15 independent successor states with their own central banks. Only Estonia has so far cut the links to the ruble and introduced its own separate money. On the macro- economic level, even the most stability-oriented successor states are hard put to resist the temptation to join the inflation race and expand the central-bank-financed deficits of their state budgets and state firms be- yond any reasonable limits. Although the erosion of the ruble as a medium of exchange and store of value harms all its users, the biggest chunk of the inflation tax accrues to the republic which boosts the money supply most. On the microeconomic level, the old mechanism to guarantee, clear and settle ruble payments has vanished with the central Soviet institutions. The resulting uncertainties and delays are already con- tributing to the rapid decline in the division of labour within and among the independent successor states of the Soviet Union ("republics" for short). According to Russian estimates, Russian deliveries to other re- publics in January 1992, for instance, fell 25-30 per cent short of their January 1991 levels [IMF, 1992, p. 7]. The way to stop the competition for the ruble inflation tax is obvious: The common currency has to be abolished if an effective re-centralisation of monetary policy is impossible or politically undesirable. As soon as major successor states follow the Estonian example and replace the Soviet ruble by their own monies however, the microeconomic problem may become even far more acute. In the worst-case scenario, trade among the republics may shrink substantially in the absence of any new method to settle inter-repub- lican payments. If, for instance, each republic tried to balance bilateral trade flows at the lower side of the bilateral exports or imports, the volume of inter-republican trade would decline to 44 per cent of its previ- ous value.1 Even worse, such bilateral trade restrictions could induce a chain reaction of mutual retaliation and thus a further reduction in inter-republican exchanges [Dornbusch, 1992]. This would be all the more unfortunate as all successor states are heavily dependent on their mutual trade, the huge and oil-rich Russian Federation less so than the smaller republics. To avoid such a dismal outcome, various authors have proposed to establish a payments union among the ex-Soviet republics. Even the European Bank for Reconstruction and Development has joined the chorus. This paper examines whether the successor states of the Soviet Union should indeed enter into special payments arrangements. It assumes the likely case that major republics such as the Ukraine intro- duce their own monies. The paper is organised as follows. First, the general rationale for a payments union, the oft-cited ex- ample of the European Payments Union (EPU) of the 1950s and the arguments for and against a post-Soviet payments union along the lines of the EPU are analysed (Sections II, III and IV respectively). Thereafter, the possible rationale for a payments union among republics with very different degrees of third-money convertibility and for a payments mechanism for republics whose