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. Last Updated: 07/27/2016

The Strong Ruble Way to a Weaker Economy

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Last week the euro broke through its record high against the dollar, which was established in 2004, and there is some consensus that the next milestone value for the common European currency will be $1.40. Since early 2006, the dollar has fallen not only against major internationally traded currencies, but also against those of a large number of developing and, in particular, resource-based economies.

The ruble has been no exception and has steadily risen over the same period, climbing in value from 27.9 rubles to the dollar to 25.7 rubles -- a gain of almost 8 percent. There is really nothing unusual about this movement, as it has been underpinned by a steady inflow of foreign currency generated by rising world oil prices and the associated jump in export revenues. That the Central Bank, which has often cited the prevention of excess ruble appreciation as one of its goals, has apparently chosen to put more effort into slowing inflation has come as more of a surprise. Instead of printing rubles to soak up excess foreign currency flowing into the country, and thus fueling inflation, the bank has chosen instead to let the ruble's value climb.

Russia today is a country that relies heavily on imports for an enormous range of basic consumer goods -- from vehicles and luxury products to construction materials, home appliances, and foodstuffs. But the origin of these products differs greatly depending on the type and quality of what is being imported. The major portion of dollar-denominated imports comes -- as is the case for many other countries -- from Asian nations, predominantly from China. Production costs in these countries are so low that it seems next to impossible to manage trade flows through exchange-rate mechanisms. According to statistics from the State Customs Committee, Chinese imports into the country were up a staggering 82 percent in the first two months of this year over the same period in 2006, largely on the back of a 298 percent jump in imports from Hong Kong.

As significant as this growth is, China still accounts only for around 10.9 percent of Russian imports, while the European Union's share is relatively stable at about 40 percent. Imports of European goods, furthermore, are more sensitive to exchange-rate fluctuations as a result of carrying higher price tags.

The latest trade developments between Russia and Europe have been even more disturbing than those arising to the east. In recent months, Russian exports to the EU have fallen by 2.5 percent, while imports were up up 44.7 percent. Russia's trade surplus with the EU was cut by 25 percent over the first two months of 2007 alone. Taking all this into consideration, a significant increase in the strength of the ruble against the euro looks like a real necessity. Only four years ago, in early 2003 -- at the exact same time that world oil prices really began to climb -- the dollar hit a historic high of 31.88 rubles. At that time the dollar was hovering around parity with the euro. A simple calculation shows that, had the ruble/dollar rate remained steady, the relative value of the euro today would be over 43 rubles, or 25 percent higher then the actual figure. The lower value of the ruble would act as a powerful brake on a catastrophic rise in European imports to the Russian market.

What has happened instead can hardly be considered the result of a sound economic agenda. During this same four-year period, the dollar's value fell from 31.88 to 25.69 rubles, losing 24 percent of its value, while the euro appreciated from 31.65 to 35.06 rubles, gaining a mere 10.8 percent. Both those moves look like a well-orchestrated import-promoting policy making the Chinese and Asian goods cheaper but not countering supply of high-priced European goods. It seems to me that the best, and quite possibly the only way to have managed the exchange rate between 2003 and 2007 would have been to peg the ruble to the dollar and then let it trace its way downward along with the greenback against the currencies used by Russia's main trading partners.

Why then, you may ask, have matters taken the direction they have? One of the basic foundations of the strong ruble policy lies in the government's obsession with inflation. Since 2002, the official inflation rate has registered a modest decrease -- from 15.2 to 8.9 percent -- but imports rose by 270 percent, climbing to $164.7 billion in 2006. If current trends continue, this will reach $240 billion in 2007, thus halving Russia's overall trade surplus in the space of one year. By 2009, according to analysts, Russia will become a net importer of goods and services, assuming that new developments in global politics don't take oil above the $100-per-barrel level. But why should unrealistic inflation targets be the only ones the Russian economy is required to meet?

The major inflationary pressure today doesn't come from loose monetary policy, but from the lack of competition generated by state policies aimed at the consolidation of state-owned and only partly privatized enterprises into big corporations enjoying complete control over the domestic market. They are only able to remain competitive by compensating for their inefficiency with higher prices. A good example can be found in the recent merger between RusAl, SUAL and the Swiss trader Glencore, where Russian antitrust authorities have allowed the united entity to set its domestic prices 5 percent above those at the London Metals Exchange. Even if the ruble falls there will be no significant rise in inflationary pressures.

If the Russian government really wants to improve the competitiveness of those industries oriented toward selling their products on the domestic market, it needs to devalue the ruble. This would present some technical problems, as the Central Bank is committed to following its free market approach to exchange rates established in the early 1990s.

But now is a good time to rethink this policy as there is relatively little ruble-denominated debt on the market and large corporations used to borrowing in dollars or euros sell a significant enough portion of their products for hard currency. It makes particular sense to do this now, before Russia enters the WTO, as membership in the trade club will make it much more complicated to regulate monetary policy while still following the rules. Looking back to the European experience of 1970s and 1980s, it is clear that the regular devaluations of national currencies served to increase competitiveness in their economies.

Talking about a strong ruble but letting the currency lose value isn't actually too tough to do. The U.S. Treasury steadfastly maintained that there is no contradiction between its avowed strong dollar policy and the slide in the currency's value between 2003 and 2007. As the ruble continues to grow in strength, the position of the economy will continue to weaken. And another ruble crisis won't be enough to save the economy from the current currency disaster.

Vladislav Inozemtsev is a professor of economics, director of the Moscow-based Center for Post-Industrial Studies and editor of the Russian edition of Le Monde Diplomatique.