The Ruble as a Global Reserve Currency? No!
Op-ed in the Moscow Times
© Moscow Times
Do you remember the Kremlin hubris of the summer of 2008? Forget it! The ruble cannot possibly become a reserve currency for the next half-century. To become a major financial center, Moscow needs many years of serious reforms not even contemplated today.
In June 2008, Prime Minister Vladimir Putin proclaimed, "We have no crisis." Also President Dmitry Medvedev thought that Russia would escape the crisis and said, "Russia has not yet carried out a number of reforms...and has thereby managed to avoid some serious mistakes."
Medvedev's speech to the St. Petersburg International Economic Forum on June 7, 2008, marked the peak of hubris. "We have set ourselves the not very easy goal of setting Russia on an innovative development track and becoming one of the world's five biggest economies by 2020," he said. "The transformation of Moscow into a powerful financial center and the transformation of the ruble into one of the leading regional reserve currencies are the key ingredients to ensure the competitiveness of our financial system." Dreams can be useful if they help people doing the right things, but these mirages were a pure distraction.
If few Russian businessmen desire ruble bonds, why should foreigners embrace them?
Crises offer solid reality tests. This year, the Russian government predicts a GDP slump of an astounding 8.5 percent. Medvedev acknowledged the poor performance of the Russian economy in his web article of September 10, in which he asked, "Should we drag ourselves also into the future with a primitive economy based on raw materials and endemic corruption?" After one year, not one single reform has been accomplished, although crises usually render necessary reforms politically possible.
Berkeley professor Barry Eichengreen is the foremost researcher of reserve currencies and his conclusions are unequivocal. In the last two centuries, the world has seen three significant reserve currencies. The pound sterling dominated in the 19th century. In the course of half a century, the US dollar gradually overtook sterling. In the last decade, the euro has emerged with 27 percent of global currency reserves, while the dollar still holds two-thirds. Sterling and yen account for 3 to 4 percent each, leaving less than 1 percent for other currencies.
The real question is whether the dollar will disqualify itself as a reserve currency and give way to the euro, or possibly the Chinese renminbi in a few decades. But the ruble hardly complies with any of the arduous demands for a reserve currency, having become convertible as late as July 2006.
First, a reserve currency must be characterized by low inflation and macroeconomic stability, but Russia has had persistent double-digit inflation. A reserve currency should preferably have a stable or rising exchange rate. At least, it should be freely floating. Yet the ruble exchange rate policy remains erratic.
Second, only the world's biggest economies can produce a global reserve currency. Both the US economy and the eurozone are still 10 times larger than the Russian economy, which comprises just 2 to 2.5 percent of global GDP. Even the Chinese economy is about three times larger than Russia's at current exchange rates.
Third, a reserve currency country must have great financial depth, which is skin-deep in Russia. Its market capitalization is only a few percent of the U.S. level, and the free float is minimal because of the dominance of state ownership. The ruble bond market barely exists. The Russian banking system is politicized and therefore dysfunctional, with a handful of state banks holding almost half of all banking assets.
Fourth, a good regulatory framework and strong rule of law must prevail. Russia has plenty of good financial legislation from the 1990s, but serious lapses persist, such as a poor bankruptcy law, which facilitates corporate raiding. Worse, the courts are politicized, which undermines property rights to the benefit of vested interests. Worst, however, is that security agencies are allowed to carry out arbitrary interventions and confiscate large corporations to the benefit of related private interests.
Russia ranks 147 on the Transparency International Corruption Perception Index and 120 in the World Bank Doing Business Index of some 180 countries. Doing Business rates Russia at 161 with regard to ease to trade across borders. Who would voluntarily transfer money for safekeeping into such an unsafe country?
A fifth criterion of a reserve currency is what economists call network externalities, which include various international uses, for example, for pricing, invoicing, or transactions outside the country. But the ruble is not used for any purpose outside of Russia. The hyperinflationary ruble zone that collapsed in 1993 remains a bitter memory. Repeated Russian attempts to revive it have only aroused bad blood.
Businessmen in neighboring countries prefer to launch their initial public offerings on the stock exchanges in London, Frankfurt, or Warsaw while all abhor Moscow. So do Russian businessmen, who predominantly favor London. If a state cannot attract its own businessmen to its stock markets, it has a serious reputation problem. If few Russian businessmen desire ruble bonds, why should foreigners embrace them? No country has pegged its currency to the ruble because it is too unstable and poorly managed.
Finally, the power of incumbency of a reserve currency is as great as inertia is monumental. My boss Fred Bergsten has pointed out that the dollar survived even three years of double-digit inflation around 1980 as the dominant reserve currency because it had no competition.
Today, the euro has become a realistic alternative to the dollar, and the renminbi might eventually do so, if China changes many policies. But the ruble is disqualified on all accounts. No preconditions exist for it to become a reserve currency.
Nor would it be beneficial for Russia if the ruble became a reserve currency, because higher demand for the ruble would drive up its exchange rates and reduce Russia's competitiveness. For such reasons, Japan, Germany, and Switzerland have actively opposed their currencies being used in national reserves, and the European Union remains skeptical.
Thus, to make the ruble a reserve currency is no priority for Russia. Nor is it possible or even beneficial. This topic is little but mythmaking for dedicated Kremlin bureaucrats. Russia needs to focus on control of its pervasive corruption and harmful state companies as well as the curtailment of corporate raiding. But real debates are less pleasant.