At the start of the economic transition, key reform-oriented policy makers in the Russian government sought to get market price mechanisms working as quickly as possible. These reformists argued that price liberalization and policies designed to bring about macroeconomic stabilization could be expected to impose some economic hardship for a period of time, but that it was better to live with temporary difficulties than to be burdened by distorted prices and unsound policies that might endure for years or even decades. This pro-reform perspective became known as "shock therapy." The reformists took their inspiration in large measure from Western monetarist doctrines that maintained that
|Exchange rates: Russia|
|rubles per US$1|
|Note: The post-January 1, 1998 ruble is equal to 1,000 of the pre-January 1, 1998 rubles.|
|SOURCE: CIA World Factbook 2001 [ONLINE].|
sound monetary policy should be the basis of a govern-ment's economic programs.
The Russian post- communist economic transition thus started with prices being rapidly liberated from artificially low levels. This led to a rapid rise in prices for many basic commodities. It also led quickly to an immediate burst of inflation. The pent-up demand for consumer goods that had been suppressed during the period of Soviet central planning gave additional impetus to inflation as consumers rushed to buy previously unavailable goods, thereby bidding up prices. Early in the transition, inflation averaged over 1,000 percent per year in Russia. As inflation ate away at the value of the ruble, the amount of money necessary to buy a loaf of bread, for instance, appeared to grow inordinately large. While the size of the numbers on a country's currency should be arbitrary—that is, no one should care if the cost of a loaf of bread is 1 ruble or 1,000 rubles—what matters is what proportion this represents of a person's income. The fact that it had become necessary in Russia to hand over large amounts of rubles to buy simple, everyday necessities was psychologically unnerving for the public. To address this problem, on 1 January 1998 Russia "rede-nominated" its ruble, introducing new bills with 3 fewer zeros than pre-1998 rubles.
Redenomination is a process by which a country's money is reissued but assigned a different number. The Russian bank authorities simply decided to remove the "excess" 3 zeroes after the numbers on the face of the currency. For instance, a 1,000 ruble note was reissued as a 1 ruble note. At the same time, Russia re-introduced the traditional coin, the kopek, valued at 1/100th of a ruble.
These redenomination measures were primarily for convenience. They were designed to have no technical effect on the value of the currency. However, they did have an effect on the public. These measures tended to contribute to the erosion in public confidence in the currency and an increase in the use of foreign currencies, particularly the dollar, as an alternative to saving.
Russia has undertaken a number of different approaches to exchange rate policy. These included establishing a "currency corridor" in 1995 and a "crawling band" mechanism from 1995 to 1997. For the most part, these measures were viewed as part of an effort to establish a more "natural" ruble-to-foreign currency rate. From 1994 until 1998, falling inflation, slow money supply growth, and the effective functioning of Russia's ruble-dollar mechanisms contributed to a period of relative ruble stability. In January 1998, with the ruble trading at just over 6 to the dollar, Russia replaced the crawling band mechanism with a more freely floating but still semi-managed ruble. The exchange rate policy allowed the ruble to fluctuate within 15 percent around a central exchange rate, which Russia intended to maintain at between 6.1 and 6.2 rubles to the U.S. dollar between 1998 and 2000. In July 1998, the ruble was trading at R6.2 to the U.S. dollar. In August of 1998, Russia widened the band within which the ruble was allowed to fluctuate, resulting in an unofficial but real devaluation of the ruble. In total, the ruble lost 71 percent of its value in 1998, closing the year at R20.65 to the dollar. The ruble fell to R25 and lower to the dollar in April 1999, mildly appreciated in value through early summer, but began to decline again at the height of summer. The ruble ended 1999 at R27 to the dollar.
The monetary authority in the former Soviet Union was the Soviet Central Bank. The Soviet Central Bank functioned as an investment mechanism to achieve social objectives, not as a bank in the Western sense of provider of specific financial services. Soviet practice emphasized financial stability and the assignment of prices not on the basis of relationships of scarcity (that is, supply and demand) but on the basis of social criteria. Prices were established at levels that the government thought would achieve the most social good. Typically, necessities such as bread and housing were extraordinarily cheap to the consumer while luxuries, such as cars and foreign vacations were extremely high or unavailable altogether. Prices of foreign goods were established indirectly through the exchange rate that was stipulated by the Central Bank for foreign currencies. When the transition started, price liberalization implied that buyers and sellers should be able to establish their own agreed-upon prices. New laws were passed to allow the functioning of private banks, but initially these banks did not have provisions for inter-bank settlement of accounts. Consequently, the private banks begin to function less as banks and more as investment funds.
Spurred on by the potential gains of the initial waves of privatization of state enterprises between 1993 and 1995, these private banks in fact offered few financial services but served mainly as holding companies for large investors and conglomerates. The unevenness of supply and demand in the transitional markets created opportunities for great profit-taking and great risk-taking. This led to a serious problem of capital flight. As investors and speculators captured gains from buying and selling, they sought to park their earnings in stable investments. For the most part, this meant foreign currencies, particularly the American dollar. For a period of time in 1992 and 1993, Western currencies were in popular use in Russia and were preferred to the ruble. Massive amounts of money moved out of the Russian economy to Europe and America. To address this problem of capital flight, the government imposed a series of frequently changing regulations on the financial services industry between 1993 and 1994. In 1994, the Central Bank imposed new currency controls, requiring all exchanges of foreign currency to go through licensed currency traders who were closely regulated by the government.
After the financial markets collapsed in 1998, the Russian central bank, aided by increased technical assistance from the international financial institutions and Western countries, developed a considerable amount of autonomy from the Russian government. This allowed the central banking authorities to resist the attempts of the government to call upon the bank's assets to solve short-term problems or address the demands of important political constituencies. Gradually, the role of the Russian Central Bank came to resemble that of most market economies, a role in which the bank functions as a neutral and independent manager of financial functions, not as a personal banker to the government or government officials.