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. Last Updated: 07/27/2016

EDITORIAL: Devaluation Won't Work For Russia

The fundamental issue in the financial crisis of the past few weeks has been the frantic battle by the government and the Central Bank to defend the current value of the ruble. A massive austerity program and stratospheric interest rates have been employed to keep the currency stable.

Some, however, question whether it is worth the effort. Edwin Dolan of the American Institute of Business and Economics, in an article in Thursday's paper titled "A Case for Devaluation," argued that it was not.

His arguments, echoed in the Russian press, run something like this: The current value of the ruble is arbitrary. A cheaper ruble would protect Russian manufacturers from imports and boost the ruble earnings of exporters.

Moreover, the high interest rates that the Central Bank is using to convince investors to keep their money in rubles are destroying the economy. Because fear of a devaluation is one of the main risks facing Russian financial markets, the argument goes, why not just get it over and done with? Devaluation was not a disaster for Mexico in 1995. Why is Russia different?

In fact, the circumstances here are quite different and devaluation would be very bad news.

In the short term, the process of devaluation would likely be no less traumatic than the current battle to stabilize the currency, probably more so, and a devaluation would require higher, not lower, interest rates.

If the Central Bank cracked and allowed a devaluation, it would create panic among investors and, when inflation inevitably jumped, this panic could easily spread to the general population. Interest rates would have to be hiked sharply to try to hold in capital.

In the longer term, a devaluation would destroy the credibility of the Central Bank, which has staked its reputation on a stable currency. If the bank proves incapable of managing a fairly predictable exchange rate, markets will once again start to view Russia as a country with a high currency-risk. All loans and transactions here will factor in that uncertainty.

Those who approve of a devaluation misunderstand the nature of Russia's problems, which are not external but internal. Russia's foreign trade balance is in surplus and its balance of payments is more or less neutral. Devaluation may have some marginal positive effect on the trade balance, but that would be more than wiped out by the huge rise in debt-service costs to Russian banks and the state, which both owe dollars.

The way to keep investors in the country is to cut the deficit to avoid a debt default. A devaluation will not solve that one.