A multilateral payments union has been proposed as an intermediate solution to the problems associated with introducing independent currencies in the republics of the former Soviet Union. Splitting the rouble zone into republican currency areas would lead to very high openness for most republics. Without monetary cooperation, the 4:1 ratio of inter-republic to external trade would make the republics' aggregate reserve demand five times greater than under a single currency; most would also face unsustainable balance-of-payments deficits as soon as Russia charged world market prices for energy. With such liquidity and solvency problems, a non-cooperative approach could lead to widespread bilateralism and a fall of inter-republic trade by up to 50%.

In Discussion Paper No. 654, Research Fellow Peter Bofinger and Daniel Gros consider an internal fixed exchange rate system modelled on the EMS as a possible solution to these difficulties. Such a system could be pegged to Western currencies via the Russian currency. It would reduce reserve demands as the republics' mutual intervention obligations made their currencies relatively close substitutes. Russia would inevitably dominate the system, however, which the other republics would accept (ignoring political considerations) only if they expected Russia to pursue a stable macroeconomic policy, without which a fixed exchange rate system would nullify their own attempts to achieve stability.

Bofinger and Gros then consider the role of a multilateral payments union if the republics instead pegged their currencies to the ecu without internal fixed exchange rates. Its main function would then be the multilateral clearing of inter- republican trade; by providing limited credit facilities it could also reduce the precautionary demand for reserves and allow members to maintain convertibility restrictions against non- members while enjoying de facto current account convertibility among themselves.

They find that persistent multilateral deficits are the main threat to the functioning of a payments union. In the case of the CIS, even individual quotas twice those of the post-war European Payments Union would be absorbed within one or two years if the deficit republics fail to reduce absorption rapidly after the transition to world market prices. Russia's overall surplus may be expected to decline very quickly, but its increased demand is unlikely to be concentrated on goods from the major deficit republics. A payments union should therefore be implemented only after all participating republics have adopted comprehensive stabilization policies. Since Russia would probably become the system's major creditor, an initial contribution of Western financial resources estimated at some $3-4 billion would be required to limit its burden and ensure its willingness to participate.

A Multilateral Payments Union for the Commonwealth of Independent States: Why and How?
Peter Bofinger and Daniel Gros

Discussion Paper No. 654, May 1992 (IM)