Rule of the Ruble

by JEFFREY D. SACHS

CAMBRIDGE, Mass. -- Here we go again. In its seventh straight year of ministering to the Russian economy, the International Monetary Fund is about to begin another "emergency bailout." Just five months ago, the I.M.F. pronounced the Russian economy on its way to recovery, declaring that "Russian economic reform is entering a less dramatic phase."

Now the Russian stock market is collapsing and the currency is under attack, despite a temporary lull in trading on Tuesday and Wednesday. The I.M.F. has promised to speed another $670 million in loans and is being called on by the Clinton Administration and the markets to provide much more. The Administration has also renewed its call to Congress to allocate more money for the I.M.F. itself.

The fund continues to fail in its economic advice. The bailout loans are unfair and ineffective. If we need a new global financial architecture, as Treasury Secretary Robert Rubin has urged, then we need a new architect as well, a thoroughly revamped I.M.F.

Understand the logic of the bailouts first. In the past three years, under I.M.F. auspices, Russia has been borrowing short-term funds from abroad to keep a corrupt and mismanaged Government afloat. The fund stood by as the Government squandered tens of billions of dollars by transferring state-owned oil and gas companies to cronies at cut-rate prices. At the same time, the Russian Government borrowed from foreign speculators at interest rates of 20 percent or more, and often much higher. The sky-high interest rates compensated the investors for the risk that the ruble might lose value against the dollar or that the Government might default.

Suddenly, foreign investors have called in these loans. They are spooked by several things, including the Asian crisis, the fall in the price of oil (a principal Russian export) and labor unrest. Suddenly, the ruble is about to lose value. In short, the risk that was long implicit in Russia's high interest rates is about to be realized.

The financial community in Moscow is understandably in a panic. The I.M.F. and the United States have been called in to save the ruble. This would insure that the earlier loans are repaid and that the ruble keeps its value long enough for speculators to get their money out without large losses. Therefore, the name of the game is to defend the exchange rate at any cost. Predictably, the I.M.F. has cheered as Russia raised short-term interest rates to a crippling 150 percent a year to try to keep the investors from running. But the ruble probably can't be saved at this point -- too much short-term money is fleeing the scene. True, the crisis that could follow a steep ruble devaluation might indeed be severe. But an I.M.F.-led bailout will likely do Russia more harm than good.

The problem is that the I.M.F. has become the Typhoid Mary of emerging markets, spreading recessions in country after country. The I.M.F. lends its client governments money to repay foreign investors, with the condition that the government also jack up interest rates, cut the flow of credits to the banking system and close weak banks. The measures are intended to restore investors' confidence. Instead, they kill the economies and further undermine confidence.

It would be much more sensible to keep interest rates moderate and let the economies continue to grow. True, currencies would lose value and speculators would lose their bets. But both borrowers and lenders would be more cautious in the future. The rare case for exceptional monetary tightness occurs when economies are suffering from exceedingly high inflation.

The I.M.F. orthodoxy has been put to the test in Asia in the past nine months. The fund gave us specific predictions about what would happen when it attempted its Asian rescue. It told us in its August 1997 rescue plan for Thailand that the economy would grow by 3.5 percent in 1998. It told us in October that Indonesia would grow by 3 percent. In December, it predicted Korean 1998 growth of 2.5 percent. The I.M.F.'s own bad advice destroyed its own forecasts. Every few weeks it has had to renegotiate its Asian programs, sharply downgrading the growth forecasts. It now predicts that Korea will shrink by 1 percent or more, Thailand by 5.5 percent or more and Indonesia by a staggering 10 percent or more.

In emerging markets all over the world, the drama is repeated. Investors who chased high short-term interest rates with short-term loans in recent years are calling in their loans. In just about every case, the I.M.F. is urging a heroic defense of the currency through draconian interest rate increases, sometimes backed by bailouts, sometimes not. The monetary medicine is now being applied with I.M.F. moral support in Brazil and South Africa, and with I.M.F. financial support in other parts of Africa, in Russia and throughout Asia.

The Administration and other financial observers should ask why the I.M.F. can't come close to its own targets. They should ask why many economies under its care continue to stagnate or collapse for years. And they should insist that the I.M.F.'s free run of the international financial system be brought to an end.

Jeffrey D. Sachs is the director of the Harvard Institute for International Development. From December 1991 to January 1994, he was an economic adviser to the Russian Government.

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