Sens. Marco Rubio (R-Fla.) and Ted Cruz (R-Texas) are certainly right to take President Obama and Germany’s Chancellor Angela Merkel to task for not adopting a very much tougher line towards Russia for its many actions to destabilize Ukraine. Since continued weakness from the West would only invite more aggressive behavior from Vladimir Putin’s Russia not only towards Ukraine but also towards Russia’s near neighbors.
However, the senators’ proposal that the U.S. Treasury should work with the International Monetary Fund to help Ukraine set up a currency board to stabilize its currency would seem to be wide of the mark. For not only would such a proposal require very large-scale international financial support that would put the U.S. taxpayer at risk. It is also far from clear that in Ukraine’s present circumstances the setting up of a currency board would be in the country’s best interest.
In the senators’ view, Ukraine’s move to a currency board would have many advantages. It would help Ukraine’s money become as stable and as reliable as the world’s dominant economies currencies. This currency stability would ripple throughout the economy as foreign investors would have confidence that the Ukrainian currency was not in a death spiral. At the same time, it would hold out the attractive prospect that Moscow would immediately face the dismaying reality that Ukraine’s money was suddenly far more dependable than is its own currency.
While the establishment of a Ukrainian currency board has seeming appeal, it is far from clear that this is a viable option for Ukraine right now. Since for a currency board to be credible, the Ukrainian currency would need to be backed by ample international reserves. More serious yet, for a currency board to be credible, it would require an effective Ukrainian government that would be able to abide by the basic requirements of a currency board. In particular, the Ukrainian government would need to maintain the soundest of public finances that would allow the government to operate without recourse to central bank financing.
The sad reality is that Ukraine does not have anywhere near the required amount of international reserves to back a currency board. Indeed, according to the IMF, Ukraine’s international reserve holdings presently amount to a paltry US$20 billion, or less than three months’ import payments. This would imply that if a currency board were to be set up, Ukraine would need a multiple of the US$27 billion that is presently on offer from the IMF and the major G-7 economies. Do Rubio and Cruz really want to place both the U.S. and the international taxpayer on the hook for such large sums of money particularly with a Ukrainian government that has the poorest of track records in terms of both corruption and of IMF program implementation?
Of greater concern still is the fact that Ukraine’s presently very poor public finances would not provide support for a currency board. According to the IMF, Ukraine’s general government is currently running a budget deficit equivalent to around 8 ½ percent of GDP. Under a currency board, which precludes central bank financing to the government, such a deficit would need to be virtually eliminated in a short period of time. With the Ukrainian economy already deeply in recession such a policy course of action would be both economically and politically very risky. Since, in the near term at least, even more radical deficit reduction than is presently being proposed under the IMF program would drive the country more deeply into recession.
Yet another reason to question Ukraine’s early move to a currency board is the country’s need for a competitive exchange rate. As many countries in the European periphery are discovering, tying oneself to a strong currency like the Euro can be very costly. This is particularly the case at a time when one might need a weaker currency to boost exports both as an offset to much needed budget tightening and as a means to narrow the current account deficit.
In sum, one can empathize with Rubio and Cruz calling for stronger sanctions against Russia and for more financial support for Ukraine. However, before going down the currency board route, one would hope that they would give more thought to both the potential exposure of the U.S. taxpayer and to the question as to whether a currency board would best serve the Ukrainian people’s interest.
Lachman is a resident fellow at the American Enterprise Institute, a conservative think tank.