In our opinion, despite a seeming symmetry of situations, characterized by a decline or growth of oil prices, with regard to inflation and exchange rate fluctua tions for population and their impact over economic growth, monetary and credit policy trends should be significantly different in the above situations.
Basing on certain assumptions28, one can demonstrate that in the situation, when the energy sources prices in the external market are high, the most effective policy for Russia would be moderate (restrained) rates of rouble exchange policy in real terms with rather low inflation. In fact, this is a policy of one way inflation tar geting (with regard to restricted volume of foreign currency inflow and growing re serves with nominal exchange rate kept up at the same level), i.e., maintaining the upper limit of yearly growth rates of prices preferably decreasing from year to year). The RF Central Bank policy in the external market depends on its capacity for sterilization of emission, resulting from maintaining the stable nominal exchange rate to ensure required real rouble rate growth in the situation of effective inflation.
In the situation of downgrading energy sources prices, the effective measure of monetary and credit policy would be gradual, but rather fast decrease of nominal rouble rate to the values, ensuring the equilibrium balance of current account op erations.
The situations with both, high and low prices for energy sources were observed within the past decades in the world market. High prices, noted in the late 1970 s and the beginning of 1980 s served for the stabilization of socialist regime, while an ex plicit downfall of the world prices in 1985–1988 s was a major factor of budget crisis, which has caused the breakdown of the Soviet Union29. A similar downfall of the world prices for energy sources played a significant role in development of financial crisis of 1998 in Russia.
A case study of the 1998 financial crisis can be reviewed as an example of un favorable prices for energy sources in the external market.
Basing on zero volatility of capital flows balance and exports from Russia at the real exchange rate and imports volatility with the real exchange rate accounting to 0.8–0.9, one can assess the rate, at which import will reach the volume, enough to cover the excessive foreign currency supply in the market (matching accumulated external reserves). Those simple assumptions help to define, that the nominal exchange rate to maintain the equilibrium trade balance (in case of a single rouble re valuation) made RUR 16–18 for USD 1 as of the end of 2006.
Se for ref.: Clark P.B., Logue D.E., Sweeney R.J. (1977). The Effects of Exchange Rate Adjust ments. Washington, D.C.: U.S.; Morley S.A. (1992). On the Effect of Devaluation During Stabilization Programs in LDCs // The Review of Economics and Statistics. Vol. 74. Issue 1 (Feb., 1992). P. 21–etc.
For detail of the financial and budget crisis mechanism in the USSR at the end of 1980s, see “The Empire Breakdown. Lessons for Modern Russia”, E.T. Gaydar. – М.: ROSSPEN, 2006.
Section Monetary and budgetary spheres The basic grounds for financial crisis, happened in summer 1998, can be categorized as fundamental factors and external shocks30. The fundamental factors that caused the crisis were created by the national policy of financial stabilization, pursued by the country, characterized by rigid monetary and soft budgetary meas ures. Quasi fixed exchange rate of foreign currency under conditions of high infla tion brought up the growth of real rouble rate, extended imports and deterioration of balance of payments. High level of budget deficit (5–8 per cent of GDP in 1995– 1998) caused the high rates of government debt growth. By the year of 1998 the total debt burden accounted to nearly 50 per cent of GDP. That indicator is not so high as it is, but the domestic debt was made in the form of short term “GKO” (state treasury bills), and the amount required monthly only for redemption of the issued GKO, have reached 10–15 per cent of monthly GDP by the first half year of 1998.
The situation was aggravated by the external shocks: downgrading of the world market prices for energy sources, outflow of short term capital investments from the financial markets of developing countries and transition economies, which made the financial crisis inevitable31. The crisis, which has reached its peak in Au gust 1998, was characterized by the stock market downfall, banks’ collapse and deficiency of external resources. Measures were taken on introduction of a flexible rouble exchange rate, three month moratorium on redemption of the Russian banks’ external debts and mandatory restructuring of GKO OFZ liabilities. Three fold rouble devaluation took place, and inflation rate jumped up to nearly 40 per cent in September 1998.
The government, headed by the Prime Minister Mr. Е. Primakov, despite populist approaches, was pursuing a restrained monetary and credit policy, which allowed to stabilize the situation be the end of the year. A vast scale rouble de valuation, which brought up the national currency exchange rate to the level of 1994, has ensured equilibrium of external trade balance and served as a basic fac tor of economic growth, started at the end of 1998. Nevertheless, reviewing the background of transfer to the economic growth in Russia, one should not forget the successful developments, achieved by 1997 in the sphere of financial institutions:
liberalization of economy, privatization, monetary and budget stabilization and finalization of economic stagnation of transitional decay32. An important role played also the commenced growth of oil prices in the world market.
Rouble devaluation acted as a measure of social support to the domestic pro ducers, which has reduced the competition of the imported goods and stimulated Economy of Transitional Period. Outline of Economic Policy in Post Communist Russia. 1998– 2002. – М.: Delo, 2003, PP. 29–86.
Materials of Scientific Conference “Financial Crisis: Background and Consequences”. – Series “Research Works”, No. 18Р. – М.: IET, 2000.
Economy of Transitional Period. Outline of Economic Policy in Post Communist Russia 1998– 2002. – М.: Delo, 2003, PP. 114–128; R. Entov, O. Lugovoy, E. Astafyeva, V. Bessonov, I. Vosko boynikov, M. Turuntseva, D. Nekipelov “Factors of Economic Growth of the Russian Economy” – Se ries “Research Works”, No. 70Р, М.: IET, 2004.
RUSSIAN ECONOMY IN trends and outlooks national production33. All other conditions being equal, devaluation has increased relative price of imported goods, shifting the economy to the equilibrium balance, characterized by lower welfare level with a reduced share of imported goods in the total consumption volume. The aggregate effect of lower consumption level for domestic and imported goods in the background of relative prices dynamics was formed under the influence of import restructuring and income factors (together with income dynamics, based on the changes in the structure of relative prices, a noticeable impact on the demand was provided by reduction of income, caused by the crisis).
The effect of restructuring significantly differed as per economic sectors, de pending on volatility of consumption, preference in favor of imported goods, ca pacity for prompt regulation of import volume and extension of domestic produc tion. One can assume that rouble devaluation in 1998 caused a transfer to consumption of competitive domestic goods (with no return to preference of im ported commodities), which was kept up in the consequent years in the back ground of rouble strengthening in real terms. Russian economy, with its technolo gies and labor sources, was capable to produce a wide assortment of goods, the demand for which was almost totally covered by import. One should note, that against a considerable share of natural resources in the total export volume and fa vorable situation in the external market, the real exchange rate provides an insig nificant impact on the exports, and restructuring is observed primarily in the do mestic market. The experience of the 1998th has demonstrated that an intensive import consumption restructuring was taking place in the background of a sharp downfall of real exchange rate.
Therefore, basing on the Russian experience of economic development after the financial crisis of 1998, we come to conclusion, that in the conditions of aggra vated external market situation, the reaction of financial authorities should be dif ferent from the policy, pursued in favorable market conditions. Herewith we will demonstrate, that under favorable trading conditions there is no reason to use the nominal exchange rate for trading balance compensation., firstly, due to desirabil ity to maintain a decreased real exchange rate, and secondly, to avoid excessive reaction of the nominal exchange rate to the external shocks.
In line with the analysis of the effect of import restructuring, the assessment of exchange rate upward/downward trends should take into account, that those trends have other consequences, including import restructuring due to the changes in relative prices and real income of consumers, variable rates of external debt services, different export revenues, changes in the bank interest rates, de pending on the currency of deposits, etc. Among basic negative impacts of na tional currency devaluation one should mention accelerated inflation, caused by higher prices for imported goods, lower level of welfare of the individuals, who O. Dynnikova. “Macroeconomic Perspective of Rouble Strengthening and Foreign Currency Policy // Instruments of Macroeconomic Policy for Russia” – М, 2000; O. Dynnikova “Is a Weak Ruble a Key Factor of Economic Growth // Banking Business. – 2002. No. 1. P. Kadochnikov, S. Sinelnikov Murylev, S. Chetverikov “Imports Restructuring in the Russian Federation in1998–2002”, М., 2003.
Section Monetary and budgetary spheres keep their savings in national currency; pessimistic expectations of further rouble exchange rate downgrading on the part of both, domestic and external investors, which might provoke extended demand for foreign currency and capital outflow from the country.
Moreover, one should take into regard that devaluation could be blocked by political measures, taken by high rank officials, whose career is brought up at risk in that situation. Whereas in the period of financial crisis the state of external re serves could not restrain a transfer to the floating currency rate, in the situation of considerable currency reserves, accumulated during favorable external market conditions, financial authorities can for some time maintain (or prevent from down fall) the nominal exchange rate of national currency. Nevertheless, it should be pointed out, that vast scale sales of foreign currency, arranged by the Central Bank (for the purpose of gradual devaluation or maintenance of stable rate of national currency, rather than an abrupt downfall), leads to reduction of the monetary base, followed by relevant depression tendencies in the economy, caused by the mone tary supply deficiency, and to the crisis of financial system in general.
In view of the above considerations, one can come to conclusion that in unfa vorable conditions of external trade a reasonable policy would be an accelerated downgrading of rouble nominal exchange rate (with due regard to political restric tions and a “margin”, serving as a reserve for its growth under the conditions of fur ther cyclic growth of prices for energy carriers. Political feasibility of such model can be ensured by gradual and predictable rate of devaluation (in case that rate is denounced in advance) with the help of foreign currency interventions, made by the Central Bank to support the rouble rate, gradually decreased in the course of time.
The situation with high energy sources prices is observed currently in the Russian market, where there is a tendency to rouble strengthening, which can be beneficial to equilibrium of payment balance. However, the Central Bank is restraining this process with the help of foreign currency interventions, increasing foreign currency reserves and money supply as a result. Whereas there are no ef fective mechanisms of sterilization of interventions, implemented by the Central Bank, the inflation is restraining the process of rouble strengthening in real terms.
Equilibrium of current account operations could have been reached by strengthening of nominal rouble rate in case the Central Bank would have canceled or reduced the interventions to the amount, insufficient for maintenance of a stable nominal exchange rate. The above options of the simple model of equilibrium of current account operations provide similar results in the background of dynamics of exchange rate in real terms, though detailed analysis reveals a noticeable differ ence between those options.
In case the nominal exchange rate is used as an instrument of adaptation to the new economic situation, is hindered by the excessive reaction of exchange rate to external changes, as well as potential negative pressure on rouble rate on the RUSSIAN ECONOMY IN trends and outlooks part of external participants of foreign currency market34. As a result, in the back ground of floating RUR exchange rate dynamics of the external trade markets can lead to immediate drastic changes in relative prices and competitive capacity of domestic producers, exceeding the values, required for equilibrium.
If the Central Bank restrains the nominal exchange rate volatility with the help of foreign currency interventions, the trend of real exchange rate to shift to equilib rium can be implemented gradually. In this case high competitive potential of economy involves high growth rates in the periods, when the real exchange rate is getting close to equilibrium. As a result, one can expect that when the real ex change rate comes up to equilibrium value, the economy will reach the peak level (in terms of GDP share per capita). In its turn, it will form an additional demand for transactions with real cash balances, resulting in the background of low inflation to the reduced equilibrium of real exchange rate, than in case of immediate nominal devaluation.
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