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Belarusian Review


The Exchange Rate Policy for Belarus

What model of exchange rate policy (ERP) is the most acceptable for Belarus? The answer to this question has remained a hot discussion in recent years.

Surprisingly, only one option of ERP reform has been discussed: to adopt the currency of another country. However, this scenario is considered as the most radical one, and for that reason it has been most rarely implemented by countries over the course of the 20th century. This option brings a threat of ultimate financial dependency.
In order to find out the most suitable ERP for Belarus, it is important to analyze all options, as well as to study successful experience of the countries, which went through similar problems.
Baltic states are the most successful republics of the former Soviet Union in regard of adoption a stable currency, inflation decrease and attraction of foreign investments. All three states (Lithuania, Latvia and Estonia) have been effectively implementing same ERP model - Currency Board policy.
This policy can be the most important part of alternative program for successful modernization of Belarusian economy.


Belarus is looking for an optimal ERP model. That model should provide the country with a stable currency and be an effective tool to challenge high inflation. That model must be an important part of the program aimed at large - scale economic reforms.
It is curious that only one of them limits the discussion about various possible ERP models: adoption the currency of another country i.e. Russia. This approach is curious for the following reasons:

(i) This is the most radical and potentially the most dangerous option for economic independency of Belarus has been discussed.
(ii) Russian ruble has been selected in the capacity of an ?anchor? currency. That currency is far from being the most stable even on the former Soviet Union territory.
(iii) For some reason they successful experience of neighboring countries, which managed to overcome problems similar to current Belarusian ones, and introduced the most stable national currencies in the region, has been ignored.

Meanwhile there is a wide choice of exchange-rate policies is available to choose from ranging from completely fixed to freely floating, with number of options in between. Which policy a country chooses must depend on its circumstances at the time; on what exchange ? rate arrangements other countries are using, and on the long-run goals of economic policy.
In case of inflation to be the most acute problem for a country?s economy, (the inflation level in Belarus is the highest in Europe and the Index of Soft Budget Constraints is the lowest ("softest") among CIS countries) and when a state is in need of a stable currency to implement social and economic reforms the following ERP models are used:

(i) Currency Board,
(ii) Currency Union,
(iii) The adoption of the currency of another country.
A Currency Board is a form of hard peg that requires each unit of country?s currency to be backed by an equal amount of reserve currency. Linking a weak currency to a stronger currency can be a useful anti-inflation device to gain monetary credibility.
The two major disadvantages of Currency Board systems are:

Firstly, that credit for entrepreneurs to invest is not elastic to needs of trade (because it depends on the availability of a reserve currency).
Secondary, if the reserve currency appreciates in value, so too does the currency that linked to it. This can cause problems of competitiveness with other trading partners, and damage exports.
Another form of hard peg is a Currency Union where countries decide to adopt a common currency, so that by definition exchange rates between member countries of the Union disappear. Countries may decide to enter a Currency Union if they feel that multiple currencies, exchange rate volatility, and uncertainty are seriously damaging trade, and the costs. The conditions for an optimal currency area in which the benefits to the members exceed the costs are that (i) economic cycles should be synchronized and economic shocks symmetrical so that a single monetary policy is suitable for all members, (ii) labour and capital are freely mobile, (iii) fiscal transfer mechanisms exist to help disadvantaged regions, (vi) multiple currencies are seriously damaging trade.
It is never easy to know whether the benefits will exceed the costs, and decisions are often taken on political as well as economic grounds.
The francophone countries of West Africa are part of a currency union that uses the French Franc as the common currency, and the largest Currency Union in the world was formed by twelve countries of the European Union, using Euro as its common currency.
Another form of hard peg is to simply adopt the currency of another country. As far as monetary and exchange rate policy is concerned, the country becomes an adjunct to the country issuing the currency. This is a last resort for countries unable to manage their own affairs. In recent years, Ecuador and El Salvador have dollarised.

The analysis of the aforementioned types of ERP shows that Currency Board policy is the most acceptable option for Belarus in its current economic situation. The following arguments to support that option are:

(i) So far, Belarus and Russia did not create an optional currency area. It is universally recognized that both countries still do not have common markets for goods, labour and capital. There are no influential social institutions, which are able to guarantee stable economic relations between either of the states. That is why the Currency Union with Russia does not seem to be the best option for Belarus at this stage of the country economic development.
(ii) Russian economic and political systems are still very volatile and vulnerable. That is why adoption of the Russian currency cannot guarantee a stable financial development of Belarus in a long-term outlook. Ironically, even Russian companies prefer US dollars to Russian rubles in dealing with Belarus contracts.
(iii) Currency Board policy was successfully implemented in 1990?s in Lithuania, Latvia and Estonia. It was those three states, which, while being in similar economic conditions compared to today?s Belarus, were able to introduce the most stable currencies in the region and reach the lowest inflation. They were able to attract substantial foreign investments and implement the most consistent reforms.

International experience in utilization Currency Board policy shows that it was introduced in times of a serious crisis when other, more merciful techniques of currency policy, did not work out. Countries, which implemented that policy in the 20th century, can be divided into two groups:

(i) Countries, which introduced that policy in a legislative level: Hong-Kong, Argentina, Estonia, Lithuania, Bulgaria.
(ii) Countries which used the main principles of that policy: Taiwan, Latvia, Singapore

Successful implementation of Currency Board policy in Belarus will require the state to make tougher the entire financial and economic policy. That policy excludes possibility of large accumulation of internal state debt, as well as large-scale support of commercial banks. It is necessary to determine a stable reserve currency. Will it be a Euro, US dollar or Russian Ruble anyway?
Perhaps, it is better to start implementation of that policy with a rather "mild" Latvian variant followed by shift towards more "strict" Estonian variant.
Implementation of Currency Board policy can be a key factor of the program of large-scale economic reforms, which is a real alternative to today?s unilateral strategy under discussion.

Siarhei Krycheuski has a PhD in Economics from the Belarus State Economic University, and an MBA in International Business from Pace University. Formerly an economist with the World Bank, he is currently a visiting lecturer at the Export Trade and Training Institute in Toronto.

This article appeared in
Belarusian Review, Vol. 15, No 4
Copyright 2003 Belarusian Review
All rights reserved.

Siarhiej Kryceuski

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