The Ruble Area: A Breaking of Old Ties?

SlNCE the dissolution of the Soviet Union, most of the former member states have retained the ruble as their national currency but have followed independent monetary policies. Such a combination is not sustainable. With mounting disarray in the ruble area, each state must now quickly adopt either a common monetary policy or a separate national currency.


SlNCE the dissolution of the Soviet Union, most of the former member states have retained the ruble as their national currency but have followed independent monetary policies. Such a combination is not sustainable. With mounting disarray in the ruble area, each state must now quickly adopt either a common monetary policy or a separate national currency.


Over the past year, Estonia, Latvia, Lithuania, and Ukraine have left the ruble area and launched currencies of their own. Azerbaijan, Kyrgyzstan, and Moldova say they intend to follow suit, and several other states are considering doing the same. This is the culmination of many months of disarray in the ruble area, following the demise of the single Soviet monetary authority. First, credit policies had begun to diverge in different parts of the former USSR. Then states started to issue their own “coupons” or parallel currencies, and, in the wake of a wave of payments restrictions, rubles in different states began to trade at different exchange rates—effectively putting an end to the ruble zone as a single currency area, or monetary union (Table 1).

Table 1

Currencies in the states of the former USSR, April 1993

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Source: National central banks of the states of the former USSR.

This situation cannot continue if the remaining ruble area states hope to avoid hyperinflation, implement credible adjustment programs, and establish market economies. Each state must now decide whether it wants to remain in the ruble area and attempt to establish a common monetary policy, or pursue an independent monetary policy under a separate national currency. This article looks at the options open to them, as well as the forces that led to the current dilemma.

How the system unraveled

In the closing days of the USSR, the old Gosbank system was replaced by a more decentralized system in which the main branch of the Gosbank in each of the newly independent states was transformed into a central (or national) bank. Initially, the room for maneuver for the new central banks was limited in that the Central Bank of Russia (CBR) took over the sole power of issuing ruble currency, since all the printing presses were located in Russia. But the non-Russian central banks quickly discovered that they could determine their own rates of domestic credit expansion by borrowing from the CBR, by creating new commercial bank reserves, and, in some cases, by issuing parallel currencies or “coupons.”

Thus, not surprisingly, as 1992 wore on, monetary policies and inflation rates began to diverge in different parts of the ruble area as national credit policies accommodated varying degrees of price liberalization, different levels of budget deficits, and diverse trade imbalances. Without a single monetary authority to coordinate national policies, no individual state had an incentive to clamp down on credit expansion; quite the reverse: each state had an incentive to maximize its claim on ruble area resources by expanding credit at a faster rate than the area average.

In the early months of 1992, the overall monetary policy stance in the ruble area remained more or less under control, since Russia—which by sheer weight tended to exert the dominant monetary influence in the ruble area—maintained a relatively restrained overall monetary policy. As a result, following a surge of prices at the time of the price liberalization in January, retail price inflation in the ruble area fell sharply in the second quarter. For example, Russian consumer price inflation fell from 27 percent a month in February to 7 percent in July. As the year progressed, however, all ruble area states tended to ease their monetary policies. The easing was most pronounced in some of the fuel-importing states—notably Ukraine—which attempted to postpone the need for adjustment by expanding credit.

Much of the monetary easing through the second half of 1992 was motivated by policy choices concerning extensive subsidies to enterprises. These subsidies were reflected in large government budget deficits, financed by central bank credit, and in direct subsidized credits to ailing state enterprises. In Russia, the finance rate of the CBR was left at 80 percent (well below the rate of inflation), domestic bank financing of the fiscal deficit averaged around 9 percent of GDP over the second half of the year, and a large share of CBR credit to banks was directed to specific sectors at heavily subsidized interest rates. But there is no question that a further major cause was the basic imbalance between resource-rich Russia and the other states, together with the way in which this imbalance was financed.

Under central planning, administered prices had been set in such a way that imbalances in the measured value of interstate trade were small. Also, no constraints were placed on cross-border payments or financing. However, when price liberalization began in early 1992, including a staggered but substantial rise in fuel prices toward world market levels, the terms of trade turned sharply in Russia’s favor and against the non-Russian states that are net energy importers. For the first time, the non-Russian states had to take heed of their payments imbalances, becoming dependent on financing from surplus trading partners. They were ill-equipped to cope: besides the financing problems created by the escalating cost of energy imports, they had to contend with the inadequacies of the payments mechanism that had been bequeathed by the Soviet system (see “Energizing Trade of the States of the Former USSR,” by Constantine Michalopoulos and David Tarr, Finance & Development, March 1993).

Russia stepped into the breach by financing the spending of deficit states through the provision of automatic credit to their correspondent accounts at the CBR. However, this extension of credit from Russia to the other states allowed them to continue their expansionary domestic credit policies while at the same time weakening Russia’s own monetary policy stance. In this way, the worsening trade imbalances were a further factor contributing to the general easing of monetary conditions in the ruble area in the second half of the year. Reflecting this easing, the monthly rate of increase in Russian consumer prices rose from 7 percent in July to 25-30 percent in October-December, and has remained in this range. In the Moscow foreign exchange market, the nominal value of the ruble fell from an average of 125 per dollar in June to 415 in December and more than 600 in March 1993.

Making matters worse was the acute shortage of currency, which gave rise to serious difficulties in paying salaries and pensions. This stemmed from an inability to print banknotes fast enough to keep up with inflation, along with a growing use of cash by households and businesses to try to circumvent major technical problems with the payments system. Some states felt the pinch more than others. For example, Russia’s share of rubles issued by the CBR rose from 64 percent in December 1991 to 77 percent in June 1992, while the shares of Belarus and Georgia dropped from more than 3 percent to about l½ percent, and the shares of Ukraine and the Baltic states fell even more sharply.

To mitigate the cash shortage, Ukraine, followed by many other states (Azerbaijan, Belarus, Latvia, Lithuania, and Moldova) began to issue coupons that were allowed to circulate in parallel with ruble currency. In some cases, the coupons were declared sole legal tender for certain transactions, such as purchases in state stores or transactions in border areas, in attempts to restrict the export of goods to neighboring states that were liberalizing prices at a relatively rapid pace. Even after the CBR began issuing large denomination ruble banknotes in the third quarter, and essentially eliminated the currency shortage by late 1992, the use of coupons continued unabated. On July 1, 1992, Russia attempted to stem the flow of credit to the other states—and hence insulate itself from the actions of the other central banks in the ruble area—by changing the technical arrangements for interstate payments. The CBR imposed limits on the amount of credit it would provide through the bilateral correspondent accounts—no longer would it automatically finance in full the incipient payments imbalances. However, while the limits temporarily dampened the financing available to some states, overall credit expansion to the other central banks remained substantial, as many states succeeded in negotiating extensions to the limits.

The deficit states have tried to cope with the credit limits primarily by rationing then-importers’ access to Russian rubles—that is, by restricting import payments for nonessential items. Governments have also attempted to enhance earnings of Russian rubles by insisting on pre-payment for exports and, more recently, by allowing the relative scarcity of Russian rubles to be reflected in premia vis-à-vis non-Russian (noncash) rubles. Since the deposit rubles issued by banks in various states have begun to trade at exchange rates that differ from par, they are increasingly regarded as de facto different currencies.

Markets for national noncash rubles have developed outside the ruble area and are also emerging within the ruble area, although progress in the latter case has been complicated by the continuing circulation of a common cash ruble that, in principle, remains exchangeable at par for deposit rubles. For example, in Latvia on April 5, 1993, ruble claims on Belarus and Moldova were traded at discounts of 19 percent and 6 percent, respectively, relative to ruble claims on Russia. In Belarus, March auctions in Russian deposit rubles were indicating a 24 percent discount on Belarussian deposit rubles.

Ending the disarray

Where does this leave the newly independent states? Certainly, as long as the present situation continues, ruble area states have every incentive to act as “free riders”—trying to expand credit faster than their neighbors. For if they do, they will have the wherewithal to outbid their trading partners and claim a larger share of the shrinking ruble area output. If, instead, they try to pursue a conservative credit policy, they will unavoidably continue to import inflation from the rest of the ruble area, while exchanging domestic goods and services for claims of uncertain value on the other ruble area states. To insulate themselves from this process, they would then be tempted to impose additional trade and payments restrictions of the type already imposed by Russia.

Moreover, it is highly doubtful that the present situation can continue. The spontaneous disintegration of the ruble area into an unsatisfactory set of semi-independent currencies suggests that a common currency area cannot be sustained in the present uncoordinated policy environment. If hyperinflation and a trade war are to be avoided, each country must decide between two alternatives: (1) remain in a single currency area and return to a common monetary policy; or (2) introduce a separate currency and allow exchange rate adjustments to insulate it from its neighbors’ inflation. There do not appear to be any other viable choices.

A unified monetary policy. For the first option to work, countries would have to agree on credible mechanisms for carrying out a common monetary policy. Credit emission would have to be determined by a single authority empowered to impose strict limits on credit expansion by individual central banks and for the area as a whole. A single ruble currency would circulate throughout the area, with distinct national cash rubles acceptable only if their quantities were regulated so as to ensure a fixed exchange rate against the ruble. Foreign exchange systems, central bank finance rates, and commercial bank reserve requirements would need to be harmonized across the board. Moreover, a degree of coordination between fiscal policies would be necessary to ensure that budgetary targets were consistent with the credit ceilings.

The cooperative solution. All of the requirements listed above seemed possible at the time of the break-up of the USSR. Plans were drafted to reconstitute the seceding central banks into a Banking Union—a fully cooperative system modeled on the US Federal Reserve. But in the end, the attempt foundered in a dispute over how many votes each country should receive when it came to setting monetary policy.

Efforts to re-establish a unified monetary stance continued throughout 1992. These included an initiative by the IMF staff to promote multilateral monetary policy coordination (discussed at a May conference of central banks in Tashkent), several bilateral agreements negotiated subsequently on Russia’s initiative, and the Bishkek agreement in October, which called for the establishment of an Interstate Bank (ISB). The ISB was subsequently founded at the heads of state summit in Minsk in January 1993 with most ruble area states plus Ukraine as members. However, in recognition of continuing difficulties in agreeing on monetary policy, the bank’s role was restricted (essentially) to multilateral clearance and settlement of payments between member central banks. While the ISB may recommend measures to improve policy coordination among the member banks, it will have no responsibility for ruble area monetary policy.

The Russian solution. Increasingly—since effective multilateral cooperation is proving impossible—the smaller states are beginning to see the option of remaining within the ruble area as a bilateral arrangement to hitch their monetary policy wagon to Russia’s. Such a course would mean accepting Russian interest rates and inflation and agreeing on domestic credit policy with the CBR: national central banks would effectively become branches of the CBR. To achieve monetary and price stability, it would then be a matter of waiting for Russia to tighten its monetary policy. For some states, the option of a bilateral agreement is seen to offer the prospect of improved terms for energy and credit contracts with Russia. However, the monetary policy aspects currently appear unattractive to most of the states. It would be difficult politically for them to surrender monetary policy authority to Russia, and recent experience—in Estonia and Latvia, as well as in Russia—has shown that Russian monetary policy does not necessarily provide a better anchor than would their own currencies.

Separate currencies. In this environment, many central banks now see the second option as the only sure path to monetary stability. Formally adopting an independent currency would delink the issuing central bank from the CBR and give it control of its own inflation performance. But to achieve stability, each state would have to accompany the move to a separate currency with a stringent anti-inflation monetary stance, and allow its exchange rate to adjust vis-à-vis the ruble. In particular, countries that leave the ruble area would no longer have leeway for unrestricted financing of budget deficits and troubled enterprises.

To date, the three Baltic states, Kyrgyzstan, and Ukraine have chosen the separate currency option. The Estonian kroon was introduced on June 20 and pegged to the deutsche mark in a currency board arrangement. The Latvian ruble, already in circulation as a supplementary currency, was declared the sole legal tender in Latvia on July 20, and was floated against other currencies, including the ruble. On October 1, Lithuania declared that previously issued coupons (the talonas) would become the sole legal tender pending the introduction of a new currency, the litas; the talonas is also floating. On November 12, Ukraine declared that the coupon (under the new name of karbovanets) would be the sole legal tender and would be exchanged for US dollars on the basis of competitive bidding among commercial banks. The karbovanets eventually will be replaced by a national currency, the hryvnia. Finally, on May 3, 1993, Kyrgyzstan’s Parliament voted to introduce the som as sole legal tender; it will also float.

Three of the four countries that left the ruble area in 1992 have used their independence to stabilize. The Baltic states have chosen to adopt the firm policies required to reduce inflation relative to ruble area inflation. Latvia, for example, reduced inflation to less than 3 percent per month by the end of 1992, compared to 25-30 percent per month in the ruble area states (Table 2). As a consequence, the new currencies of the Baltic states have appreciated against the ruble. Ukraine, on the other hand, has chosen to inflate at a faster rate, on average, than the ruble area, with the result that the karbovanets had lost two thirds of its value relative to the ruble by April 1993.

Table 2

Low interest rates, high inflation

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Sources: Government officials of the states of the former USSR and IMF staff estimates.

Includes the effect on inflation of price liberalization and the elimination of the monetary overhang.

n.a.: not available.

As for the states remaining in the ruble area, some of them (such as Azerbaijan and Moldova) have recently announced their intention to introduce separate currencies. In the case of Azerbaijan, the manat, introduced as a parallel currency in August last year, will become the sole legal tender. Several others are making preparations for a possible departure from the area, in some cases including arrangements to print their new currencies. However, these countries are still holding off making their final decisions.

The states see the decision to leave the ruble area as hinging on a number of factors in addition to the issues of ruble area stability and monetary independence. The desire for a distinct national symbol tends to favor a separate currency, while the wish to maintain existing interstate arrangements on trade, credit, and energy pricing favors the ruble area option (at least as a transitory solution). States fear that interstate balance of payments financing would be less automatic in a currency regime separate from that of Russia. Further, a number of states have been concerned that departure from the ruble area would cause a sharp increase in the cost of oil imports from Russia. While such worries are tending to become less relevant as the price of Russian energy moves steadily towards world levels, the prospect of improved economic relations within the ruble area continues to delay final decisions on the separate currency question.

For states that do adopt the separate currency option, it is important that they ensure the orderly introduction of their new currency (and the orderly withdrawal of ruble currency) in a way that minimizes disruptions to themselves and to their neighbors. Moreover, they must not underestimate the efforts required to create the institutions and acquire the expertise for conducting independent monetary and exchange rate policies and managing international reserves. They must also face decisions about their exchange regime—whether to allow the new currency to float or to peg the exchange rate, and if so, to what currency or group of currencies—and the rules governing the new currency’s convertibility into foreign exchange (see “The Experience with Floating Rates” in this issue).

Other problems to solve

The resolution of the ruble area’s monetary arrangements will not solve all of the financial problems that have plagued the former Soviet states in 1992. In 1993, whether or not a state chooses to remain in the ruble area, it will need to address the fundamental problems of inflation and growing payments imbalances. Monetary policy—with support from fiscal policy—should be squarely directed at containing inflationary pressures, which have reached unprecedented proportions. No state will achieve monetary stability until it puts a cap on the unrestrained credit to enterprises that was widely observed during 1992. To do so will require the imposition of hard budget constraints on enterprises and a rethinking of the methods used to control central bank credit emission. Certainly, the practice of allocating subsidized directed credit must be curtailed.

For most states, 1993 will also be a year of painful balance of payments adjustment. The payments restrictions of the latter part of 1992 signalled that Russia will no longer automatically accommodate trade imbalances with the other states. Thus, as Russian energy prices approach world levels, most states will be required to make major savings in their net usage of energy and foreign exchange in order to contain their foreign borrowing within manageable proportions.