Ruble, “Altyn” or Euro? Effects of de-dollarization or adopting a single currency in the EAEU.

_ Yuri Kofner, junior economist, MIWI – Institute for Market Integration and Economic Policy. Munich, 3 July 2020.

Beginning from 2018, the staff of the Eurasian Economic Commission (EEC) and near-EEC experts have intensified their search for ways to increase existing and to create new economic benefits from the Eurasian Economic Union and the Eurasian integration process. By the next EAEU heads-of-state summit, which is planned for Autumn 2020, the member states intend to consider and preferably adopt the “EAEU Development Strategy until 2025”.

Dollarization of the EAEU economies

Along with industrial cooperation, the creation of supranational Eurasian companies, joint customs inspection and export facilitation, one of the more often-mentioned ideas is the proposal to de-dollarize the economies of the Union member states, e.g. in a report by economists of the Eurasian Development Bank.

Box 1. Benefits and drawbacks of dollarization Dollarization is when the economic agents of a country begin to use global reserve currencies, predominantly the USD and the EUR, as a medium of exchange or a legal tender alongside or in place of the domestic currency. Dollarization normally occurs when the local currency is too volatile and has begun to lose its usefulness as a medium of exchange for market transactions. Dollarization can have both benefits and costs. It typically results in enhanced monetary and economic stability, but necessarily involves loss of economic autonomy in monetary policy and may also increase transaction costs.

According to IMF data, in 2019, the USD made up 60.9 percent of the world’s official foreign exchange reserves, the EUR – 20.5 percent. Over the past twenty years the USD’s share declined by ca. 10 p.p., that of the EUR remained relatively unchanged.

Over the past decade, the average dollarization of loans issued to individuals and legal entities of the EAEU member states has decreased by about 10 percentage points. However, in 2019, it still amounted to 27.3 percent in simple average terms or to 20.8 percent in the sum average (Tab 1.).

Table 1. Dollarization of loans in the EAEU and its member states (2010-2019, in percent)

	2010	2011	2012	2013	2014	2015	2016	2017	2018	2019
ARM	58,5	58,0	52,2	48,0	49,3	53,9	57,7	54,0	48,0	44,4
BLR	30,3	37,2	53,1	48,0	47,5	55,7	55,6	51,3	48,0	47,5
KAZ	30,5	20,1	14,4	15,9	25,4	20,2	21,1	12,3	12,7	8,0
KGZ	47,6	52,5	55,2	55,0	56,1	50,3	38,4	34,0	32,6	28,4
RUS	11,7	9,2	7,7	10,7	11,6	10,8	7,7	7,8	8,8	8,3
EAEU simple average	35,7	35,4	36,5	35,5	38,0	38,2	36,1	31,9	30,0	27,3
EAEU sum average	30,2	35,2	48,0	44,5	45,0	51,0	29,0	25,5	24,2	20,8

Source: EEC Statistics Department and author’s calculations.

The dollarization of assets of individuals and legal entities decreased even more during the study period – by about 15 percentage points. Nevertheless, it is still higher than the debt dollarization and in 2019 amounted to 41.6 percent in simple average terms or 28.8 percent in the sum average (Tab. 2).

 Table 2. Dollarization of deposits in the EAEU and its member states (2010-2019, in percent)

	2010	2011	2012	2013	2014	2015	2016	2017	2018	2019
ARM	65,4	62,0	66,4	62,5	68,1	69,0	64,4	59,4	56,8	46,9
BLR	51,4	64,9	61,1	62,2	71,7	74,2	69,9	66,7	64,3	60,3
KAZ	34,9	31,4	29,8	37,4	55,5	69,0	54,6	47,7	48,4	43,1
KGZ	50,0	48,1	45,0	47,3	54,5	63,7	48,9	45,3	41,0	35,3
RUS	22,9	21,3	20,1	21,1	32,1	36,3	29,1	25,6	25,5	22,3
EAEU simple average	44,9	45,5	44,5	46,1	56,4	62,4	53,4	48,9	47,2	41,6
EAEU sum average	43,2	56,0	54,4	56,1	66,2	70,0	38,5	33,3	32,8	28,8

Source: EEC Statistics Department and author’s calculations.

Between 2013 and 2019 the share of USD and EUR in cross-country payments for intra-EAEU goods and services trade declined also by 11.6 percentage points, but still made up 26 percent by the end of the period (28.6 percent on average over the study period). It is noteworthy that the RUB is the predominant currency used for intra-union trade: between 2013 and 2019 its role increased from 61.8 to 72.4 percent (70.2 percent on average). The share of the national currencies of the other member states is negligent at 1.3 percent on average (Tab. 3).

Table 3. Currency structure of payments for export and import of goods and services between EAEU member states (2013-2019, in percent)

	2013	2014	2015	2016	2017	2018	2019
AMD	0,1	0,1	0,1	0,1	0,1	0,1	0,1
BYR	0,4	0,3	0,5	0,4	0,4	0,3	0,3
KZT	0,4	0,5	1,1	0,7	0,9	0,7	1
KGS	0	0	0	0	0	0,1	0,1
RUB	61,8	67,4	68	74,1	74,9	72,7	72,4
USD	30,8	26,3	25	19,3	18,3	19,2	19,4
EUR	6,8	5,2	5,1	5,2	5,2	6,8	6,6
Other currencies	0,2	0,2	0,2	0,2	0,2	0,1	0,1

Source: EEC Statistics Department.

The USD and EUR share in the EAEU’s foreign trade is still high: in 2019 it constituted 81.2 percent of export revenues and 64.6 percent of import payments for goods and services trade of the union with all countries of the world (Tab. 4).

Table 4. Currency structure of the EAEU member states of export revenues and import payments for goods and services with all countries of the world (2019, in percent) _a

	EAEU	BLR	KAZ	KGZ	RUS
Export revenues
RUB	16,5	34,4	9,7	23,4	15,2
USD	60,6	28,9	87,3	69,8	61,9
EUR	20,6	34,4	2,4	3	20,6
Other foreign currencies	1,9	0,6	0,6	1	2,1
Import payments
RUB	31,6	48,4	25,7	13,3	30,7
USD	36,5	22,3	57	80	35
EUR	28,1	27,9	15,6	4	30
Other foreign currencies	3,6	0,7	1,7	0,2	4,2

Source: EEC Statistics Department. _a No data available for Armenia.

As we see, albeit a declining trend, dollarization in USD and EUR terms is still relatively high in intra- and especially in extra-EAEU trade. Although dollarization can produce some benefits, such as greater macroeconomic stability, it reduces the effectiveness of national monetary policies and can increase transaction costs in trade between the union member states.

Three scenarios: De-dollarization, “Altyn”, Euro

For this reason, the aims of this paper are: Firstly, to estimate the potential effects of full de-dollarization of payments for intra-EAEU goods trade. The relevance and potential advantages of such a policy goal were described in the section above.

In addition, the author would also like to conduct two thought experiments and evaluate the potential economic effects from two rather hypothetical scenarios:

Secondly, from the introduction of a single Eurasian currency in the EAEU with its own supranational emission centre. From the very beginning, the Eurasian integration project has been compared with the European Union and its achievements, including, of course, the Euro. In this regard, on various informational occasions, the domestic media regularly discussed the possibility of introducing a single currency in the EAEU and its precursors – the EurAsEC and the Eurasian customs union. And even as far back as in 2003, Kazakhstan’s first president Nursultan Nazarbayev and the main ideological driver behind modern Eurasian integration, voiced the idea of a Eurasian currency union and proposed to call the potential single currency “Altyn” (Turkic for “gold”).

As an important precondition for a potential monetary union, during the first five years of the EAEU’s existence, its member states managed to achieve certain successes in the field of macroeconomic convergence, for example, by bringing the price growth rates closer to a common level of 4 percent.[1] The member states also meet a part of the traditional requirements for an optimum currency area (OCA) suggested by (Mundell 1961), e.g. labor mobility and a similar business cycle.

Box 2. “Astana” criteria Macroeconomic convergence is a very important condition for deeper economic integration. According to the EAEU Treaty, signed in 2014 in Astana (now Nursultan), the member states must conduct a “coordinated” exchange rate policy (Article 64), as well as an agreed macroeconomic policy with the following convergence criteria (Articles 62, 63), akin to the Maastricht criteria in the EU: ·         the annual deficit of the consolidated budget of a state-controlled sector shall not exceed 3% of GPD; ·         the government debt shall not exceed 50% of GDP; ·         the inflation rate (consumer price index) per annum shall exceed the inflation rate in the member state with the lowest value by not more than 5%.

Nevertheless, there is a consensus among economists that the creation of a monetary union and the introduction of a single currency in the EAEU would be premature and not advisable, since the negative economic outcomes would likely exceed the few positive ones. Among the reasons:

1. In terms of socio-economic development and macroeconomic convergence the EAEU appears as a “two-tier” economic integration bloc. On the one hand, the initiating countries – Belarus, Kazakhstan and Russia, form a healthier “core”, where the macroeconomic convergence between them is quite noticeable. On the other hand, the newer and smaller member states – Armenia and Kyrgyzstan, lag behind this “core” in terms of both the level and the speed of convergence. In the medium-run, one can hardly expect a change in this trend.
2. Between 2014 and 2018 all member states in different years missed the Astana convergence criteria in inflation, budget deficit and government debt.
3. There is a long-time imbalance in mutual goods trade within the Eurasian Economic Union, where the Russian Federation acts as a net exporter and the other member states as net importers. As the eurozone and TARGET-2 experience has shown, such asymmetries create a lot of pressure on exchange rates, productivity and the functioning of a potential Eurasian clearing system.
4. Although the creation of a common capital market is planned for 2025, so far progress in that direction has been limited. Integration work has only just begun and real progress in harmonizing national regulations and policies will be crucial.
5. Along with the lack of a common financial market, the process of creating supranational integration institutions has not yet reached the level necessary to even think about a common currency. A supranational sanctions mechanism, which could make the national monetary and fiscal policies adhere to the convergence and stability criteria, as it – arguably more or less – functions in the EU, does not exist in the EAEU, nor is it planned, nor is it likely that the introduction of such a mechanism will be achieved in the near future. Indeed, it is planned to set up a supranational financial regulator by 2025, but already experts anticipate that the central banks and member states are not ready to transfer to it enough powers necessary for more than mere symbolic functions.

Thirdly, the author would like to estimate the potential effects of an even less likely scenario: namely from the adoption of the Euro and the entry of the EAEU member states into the eurozone.

Despite the fact that the idea of a common economic space between the EU and the EAEU has many supporters in business, scientific and political circles on both sides, due to the Ukrainian crisis and the rupture in West-Russia relations, it is hardly realistic in the medium term. At least until the resolution of the aforementioned serious political differences.

Nonetheless the EAEU is already autonomously adopting European technical regulations and standards, which is an important basis for potential economic rapprochement in the future. And eminent economists such as (Felbermayr et al. 2017), (Spartak 2020) and the IIASA research group, have shown that the establishment of a free trade area “from Lisbon to Vladivostok” would entail significant positive trade and welfare effects to both parties.

One of the last and extreme steps of such hypothetical interregional integration could be the adoption of the EUR as a single currency for the EAEU member states.[2]

Here, the author would like to emphasize once again that this is an extremely counter-factual thought experiment, because even assuming the implausible political will to take such a step, the adoption of the EUR would certainly not take place overnight. Such an event would be preceded by 10–20 years of strict criteria fulfilment: low inflation, tight control budget expenditure and government debt, currency pegging, restrictions on exports, technological processes, CO2 emissions, labour regulations, human rights, etc.

Methodology

The aim of this study is to estimate the trade and welfare effects of three counterfactual scenarios in and from intra-EAEU goods trade only: 1. the complete de-dollarization of payments; 2. the introduction of a single Eurasian currency; 3. the adoption of the EUR.

It is important to note here that this analysis is limited and does not consider potential effects in the monetary or fiscal spheres. Inspired by a recent publication by (Felbermayr and Steininger 2020), the author would like to evaluate the potential trade and welfare effects exclusively from the point of view of a possible reduction in transaction costs in mutual goods trade between the union member states. And whereas Felbermayr and Steininger employed a gravity model, the author uses a less sophisticated multi-sector partial equilibrium model designed by (Francois and Hall 2002).

Due to the plurality of variables, it is quite difficult, or rather laborious, to determine the average foreign exchange transaction costs for import and export operations in mutual goods trade between the EAEU member states.

However, on the basis of consultations with relevant experts from the financial department of the Eurasian Economic Commission (EEC) and from the Eurasian Fund for Stabilization and Development (EFSR), the author was able to determine: First, that the currency exchange transaction costs, understood as the interbank buying-selling spreads between currencies in intra-EAEU goods trade, average from 0.2 to 2 percent depending on the volume and on the currencies of the transaction.

Secondly, there is no unanimity regarding the possible effect of de-dollarization on transaction costs. On the one hand, the move in transactions from using hard reserve currencies – USD, EUR – to less liquid and more volatile national currencies may actually increase the cost of currency exchange due to higher risk premiums. On the other hand, de-dollarization would take out the additional cross-exchange, e.g. from “KZT – USD – RUB” to only “KZT – RUB”, which arguably would lower transaction costs.

Another limitation to this simulation is that it does not take into account likely changes in real exchange rates, domestic price levels and production costs (productivity) due to the various effects of either de-dollarization or the introduction of a single curreny.

In this regard, the first scenario – “de-dollarization” – is defined as a halving of transaction costs from 2 to 1 percent, but only for 28.6 percent of the intra-EAEU goods trade, which on average is still carried out with the help of USD and EUR.

The second scenario, i.e. the introduction of a single Eurasian currency “Altyn”, is defined as the complete nullification of currency exchange transaction costs for all intra-union goods trade.

The third scenario, the adoption of the EUR within the EAEU, is also defined as zeroing the currency exchange transaction costs, however, not only in the framework of intra-union goods trade, but also in bilateral trade between the EAEU and the EU.[3]

The simulation used in this paper is a 4×4 “Global Simulation Analysis of Industry-Level Trade Policy” model (GSIM) with four parties: 1. China, 2. the EAEU, 3. the EU and 4. the “rest of the world” (RoW). The simulation was repeated and summarized for 24 aggregated MTN product sectors. For the simulation in this paper the author used the following input data:

1. Bilateral trade data from 2018 for the four parties (EAEU, EU, China and the “rest of the world”) aggregated for 24 MTN product sectors from the WITS (UN COMTRADE)For the bilateral trade flows CIF recorded imports were preferred. Country effects were estimated by applying the share of each member state in intra-Union trade.

1. Aggregated simple most favored nation (MFN) ad-valorem import tariffs from 2018 were taken from (WTO 2019) and the WITS (UNCTAD TRAINS).
2. The AVEs of NTMs for intra- and extra-EAEU trade were taken from (Knobel et al. 2019), for China from (Niu 2018), for the EU were taken from (Berden et al. 2015), for the rest of the world from (Niu et al. 2018).
3. Average exchange rate transaction costs estimations based on the above-mentioned expert consultations.
4. Import elasticities were taken from (Ghodsi et al. 2016). The export supply (1.5) and substitution (5) elasticities were taken as constants across all sectors and regions.

Results

De-dollarization

The complete de-dollarization of the remaining 28.6 percent of intra-EAEU goods trade would increase total intra-EAEU goods trade by only 0.8 percent (USD 490 million) and the union’s combined GDP by only 0.01 percent (USD 230 million). Only Belarus and Kyrgyzstan would experience “noticeable” welfare effects of a 0.1 percent GDP increase each.

“Altyn”

The adoption of a single Eurasian currency would create more tangible yet still rather insignificant results: total intra-EAEU trade would increase by almost 6 percent (USD 3.4 billion), which would result in an annual increase of the EAEU’s gross domestic product by only almost 0.1 percent (USD 1.6 billion). Again, only Belarus and the Kyrgyz Republic would experience more pronounced welfare changes of 1 and 0.7 percent, respectively.

Euro

The decrease of transaction costs due to the adoption of the EUR by the five EAEU member states would increase total intra-Eurasian Union goods trade by 3.8 percent (USD 2.2 billion) and EU-EAEU trade by 4.4 percent (USD 14.1 billion). As a result, the Eurasian Economic Union’s GDP would be 0.32 percent higher each year (USD 5.6 billion), that of the European Union expectedly only 0.02 percent (USD 3 billion).

Table 5. Trade and welfare effects of de-dollarization or adoption of a single currency in intra-EAEU goods trade

	Intra-EAEU trade change	EAEU welfare change	EU-EAEU trade change	EU welfare change
De-dollarization	0.8 percent (USD 490 million)	0.01 percent (USD 230 million)	n/a	n/a
“Altyn”	5.9 percent (USD 3.4 billion)	0.09 percent (USD 1.6 billion)	n/a	n/a
Euro	3.8 percent (USD 2.2 billion)	0.32 percent (USD 5.6 billion)	EAEU export to EU: 4.4 percent (USD 9.4 billon)   EU export to EAEU: 4.4 percent (USD 4.7 billion)	0.02 percent (USD 3 billion)

 Source: Author’s estimations.

Conclusion

A phased de-dollarization of the rest of mutual goods trade in the EAEU as a policy goal would not require the sharp and fundamental restrictions in monetary and fiscal policy related to a potential currency union. At the same time, the above made simulation showed that the trade and economic effects of such an event would be rather marginal: only 0.01 percent additional GDP.

In regard to the advisability of the hypothetical adoption of a single currency in the EAEU, either a Eurasian one or the Euro, the short answer based on the simulation results would be that it would “not be worth it”, validating the previously mentioned consensus by economists. On the one hand, the welfare effects for the EAEU from lower currency exchange transaction costs in intra-union goods trade would range at best between 0.1 and 0.3 percent. Yet, they are likely to be outweighed by the expected negative effects of introducing a monetary union. Among them:

1. The loss of the ability to take proportionate and adequate measures to counter inflationary or deflationary trends (e.g. the latter was the case in Armenia in 2016) at the national level.
2. The fixation of exchange rates would lead to the need to compensate for the lack of a currency appreciation / depreciation mechanism by other mechanisms, especially though greater wage flexibility and mobility. As the Eurozone experience has shown, this can lead to a loss in national (labour) productivity and competitiveness. In case of the EAEU this could reinforce the already protracted current account asymmetries between Russia and the other member states. This is apart from the likelihood that pegging of volatile currencies could provoke large-scale speculations.
3. As the previous history and ongoing debate on the Eurozone shows, to ensure compliance with macroeconomic convergence criteria, (current account) debt repayment and the counteraction to economic shocks, the introduction of a fiscal transfer union, with all its problems and centrifugal potential, will become a tragic necessity. In case of the EAEU this would likely mean direct fiscal transfers from Russia to the other member states. In light of the rather minor trade and economic importance of these markets for the Russian Federation, Russian voters are unlikely to approve such a move. And following the recent integration rhetoric of Russian president Vladimir Putin, Moscow in return will demand deepening integration to such an extent, which the other union countries are unlikely to accept.

Yes, Belarus and Kyrgyzstan might benefit more significantly from the introduction of a single Eurasian currency in the form of an annual GDP gain between 0.7 and 1 percent. However, the above-mentioned drawbacks of lost monetary policy, enforced fiscal austerity, and productivity losses will make even these potential gains not worthwhile.

Finally, of course, it must be emphasized once again that, that within the limited nature of this paper, the potential trade-economic effects were studied in terms of reducing currency exchange transaction costs only in intra-union goods trade. In the future, it would be important to conduct a similar yet more comprehensive simulation using a gravity or DSGE model for all freedoms of movement provided under the common EAEU market: trade in goods, trade in services, investments and personal remittances / private money transfers. Concurrently, it would be worthwhile to estimate the feasibility of introducing a single currency in the EAEU from the point of view of the optimum currency area theory.

Notes:

[1] In this regard, since there is evidence for this trend to continue in 2021-2024 after the COVID-19 crunch, the author suggests that the central banks of the EAEU member states should consider the feasibility of a common inflation (price stability) target of 4 percent.

[2] Such a – purely hypothetical – scenario, can certainly not be considered as mutually equal integration, but rather as the incorporation of the EAEU countries into the common European market under the monetary, fiscal and standardization supremacy of Brussels.

[3] According to Eurostat, in 2018 only almost half of extra-EU exports and ca. one-third of extra-EU imports were payed in EUR. Therefore, it would be more correct to use for the present analysis trade between the EAEU and the 19 eurozone countries only. In this regard, it is important to accept the results of the third scenario as indicative rather than definite.