By Patricia A. Wertman, specialist in international trade and finance, CRS Economics Division

A currency stabilization fund has been proposed to ease Russia's transition to a market economy and its integration into the world economy. Currency stabilization funds buy and sell currency in support of a particular foreign exchange rate. They are used to counter short-term currency volatility that is not justified by underlying economic fundamentals. Currency stabilization funds may be used by countries that already have a fully convertible currency such as the United States, or by countries instituting convertibility.

Convertibility: Advantages and Disadvantages

Convertibility has advantages and risks. There are at least two major potential advantages for Russia: by linking domestic prices to world market prices, it would help to establish a domestic pricing system; and it would facilitate trade and investment.

Convertibility may also have a major disadvantage: if macroeconomic stabilization is not adequate, it may result in substantial "capital flight," which overtly signals a lack of confidence in government policies and deprives the economy of needed investment finds. Capital flight can deplete the fund. Indeed, not using a stabilization fund is a measure of successful currency stabilization.

Currency Stabilization

Russia lacks international reserves of its own that it might use for currency stabilization, so Russia's stabilization fund will be created from $6.0 billion loaned to Russia by the International Monetary Fund. The IMF will, in turn, obtain the necessary funds, including $1.5 billion from the United States, by borrowing from the major industrial countries under a set of medium-term credit lines established in 1962, the so-called General Arrangements to Borrow (GAB).

Two meaningful "hurdles" are likely to determine the timing of the activation of the GAB for Russia. One is the negotiation of an IMF standby credit involving macroeconomic conditionality. Ruble stabilization will require a well-controlled monetary policy, including realistic interest rates and control over excess credit creation. Conditions of cooperation must be established between the Russian central bank and the central banks of those republics that are likely to remain in the ruble zone. Replacement of the ruble by Ukraine, Belarus, Kazakhstan, Uzbekistan, and the three Baltic republics, all of which are already planning to issue their own currencies, must also be negotiated. Russia's budget deficit must also be brought under better control to avoid rapid inflation.

The other major hurdle for establishment of the ruble stabilization fund is determination of a realistic exchange rate for the ruble. Beginning July 1, the Russian ruble will become convertible on current account with a single exchange rate (the current amount of a country's balance of international payments is the net balance arising from exports and imports of goods and services, together with unilateral transfers). The ruble will be allowed to "float"--that is, its price will be determined by market supply and demand. Eventually, the ruble will be fixed to the dollar, with a range of fluctuation of +/- 7.5%. The government hopes to peg the rate at Rbs 80 per U.S. dollar, up from its July 2 auction rate of about Rbs 135 per dollar. In dollar value terms, this represents a drastic appreciation of nearly 70 percent. The course to ruble convertibility thus is not likely to be smooth.