“Be Ready To Be Blamed for Everything”: How Latvia Introduced Its Currency
Author: Einars Repše

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Abstract

For the latest thinking about the international financial system, monetary policy, economic development, poverty reduction, and other critical issues, subscribe to Finance & Development (F&D). This lively quarterly magazine brings you in-depth analyses of these and other subjects by the IMF’s own staff as well as by prominent international experts. Articles are written for lay readers who want to enrich their understanding of the workings of the global economy and the policies and activities of the IMF.

A new currency must be loved and trusted. Inspiring that love and trust—difficult to achieve, and very easy to destroy—requires that a central bank have full control over monetary decisions in order to build credibility and confidence in the monetary system.

With that idea in mind, my “short guide to introducing a currency” would include this set of “model recommendations”:

• liberalize your markets (foreign exchange and others):

• set up an independent central bank;

• introduce your currency;

• adjust your financial system to market principles:

• introduce floating exchange rates;

• follow a tight or extremely tight monetary policy; and

• be ready to be blamed for everything.

How were these recommendations applied in Latvia? We started by lifting all restrictions on holding and dealing in foreign currencies, and we freed prices. Then we set up an independent central bank, its most important feature is its autonomy: no one can influence or overrule its decisions because the governing body is protected from political influences. Appointed by parliament for six years, the members cannot be dismissed and are not permitted to engage in any other financial activities, private or governmental.

Having secured the Bank of Latvia’s independence, we introduced our own currency as smoothly as possible, avoiding any disruptive changes. The Russian ruble remained legal tender and was not confiscated, and the payments system remained the same. We realized that any confiscatory measures would only damage the reputations of the Bank, the currency, and the country.

We then adjusted our financial system to the principles of a market economy, liberalizing interest rates and cash withdrawal procedures. Since we had not fixed our exchange rate, we had to make sure that our monetary policy was an appropriate one to protect the value of our currency. We pursued a tight monetary policy, which led to an increase in the value of our currency.

We learned—despite our successes—to be ready to be blamed for everything. The Bank of Latvia was criticized severely initially, but now even our opponents agree that our policies have worked.

Now let me explain why and how the Latvian currency was introduced. The beginning of 1992 saw a severe shortage of Russian ruble bank notes. To combat that shortage, the Latvian ruble was introduced on May 7, 1992, as the Litvian equivalent of the Russian ruble bank note. Although it was declared equal in value to the Russian ruble, many people did not believe that the new money could be as successful as the “good old” Russian ruble. To prove them wrong, we pursued three major policies:

• All salaries and wages were paid out only in new Latvian bank notes, which instantly became impossible to ignore.

• The banks were instructed to convert unlimited amounts of Latvian rubles into Russian rubles.

• We set up a Russian ruble stabilization fund for conversion purposes.

These policies worked. As soon as the Latvian ruble was introduced, it was accepted as legal tender, even at a flea market. 1 tested it myself. Our actions relieved us of the shortage of bank notes and established Latvia’s monetary independence. The new currency enabled us to monitor our monetary situation, since we could now count the bank notes in circulation. Soon we began to notice an increasingly positive payments imbalance with the ruble zone, both in cash and bank transfers. Money flowed toward Latvia, bidding up the value of the Latvian currency relative to the Russian ruble.

To formalize our shift away from the ruble zone, we discontinued the fixed 1:1 exchange rate against the Russian ruble, introducing a freely floating exchange rate instead. Then, on July 20, 1992, we opened separate bank accounts with each of the “republics” of the former ruble zone and introduced separate exchange rates against each of these currencies. Only when our ties with the Russian currency were severed did real stabilization become possible.

Our idea was to stabilize the Latvian ruble first and only then to switch over to the lats, our permanent national currency. We decided to begin switching over to the lats in March 1993, allowing the new currency to coexist alongside the Latvian ruble. One lats was introduced as equal to 200 Latvian rubles. Again we made the transition as smoothly as possible, substituting one bank note for another and adjusting the price scale.

From June 28, 1993, all contracts and prices were redenominated in lati, and the posting of prices in foreign currency was forbidden. Finally, after October 18, 1993, Latvian rubles were no longer legal tender, but the Bank of Latvia continued to exchange Latvian ruble notes into lati at the original conversion rate.

Our main achievements since the introduction of our own currency have been a significant decline in the inflation rate and a stable exchange market. On average, inflation has been reduced from about 20 percent in July 1992 to about 0.5 percent per month over April-September 1993. Following the initial depreciation, the nominal exchange rate for the Latvian ruble—and later the lats—has strengthened significantly against convertible currencies, with the rate currently at about US$1= Ls 0.61. At the same time, we have been able to reduce gradually the refinancing rate charged by the Bank of Latvia from 10 percent per month at the beginning of 1993 to 2.25 percent in October 1993.

The text is based on a speech given by Einars Repse in Stockholm, Sweden, April 1993.

EINARS REPSE

Finance & Development, December 1993
Author: International Monetary Fund. External Relations Dept.