The Estonian Currency Board Arrangement 1992-2010

222 Pages·2015·3.11 MB·English

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Layout and design Urmas Raidma
©Eesti Pank 2014
ISBN 978-9949-493-44-9
A Long Transition:
The Estonian Currency
Board Arrangement
1992-2010
Tallinn 2014
Eesti Pank

As editor of this book and one of its authors, I would like to thank every-
one who has contributed. The authors of chapters of the book – Kalev Kukk,
Andres Lipstok, Hilma Naaber, Erkki Raasuke, Märten Ross, Karsten Staehr
and Lenno Uusküla – and the following people who have done important work
for it:
Plamen Boudjakov of the Bulgarian central bank
Sigitas Siaudinis of the Lithuanian central bank
Helo Meigas of Swedbank
Marika Priske formerly of the Ministry of Economic Affairs and Communica-
tions, now of the Ministry of Social Affairs
Kadri Mats of the Ministry of Economic Affairs and Communications
Chair of the Estonian Employers Confederation Jüri Käo
And colleagues at Eesti Pank:
Aivar Kurrot
Janno Luurmees
Martti Randveer
Andres Saarniit
Evelin Tamla
Jaak Tõrs
Robin Hazlehurst
Kaja Kell
llmar Lepik
Editor and author
FOREWORD
This book is different from most similar ones as it tells a story that has fin-
ished. It is very rare in monetary and economic policy to find stories with a
clear beginning and end, but the story of the Estonian currency board is one
such, as it started with a monetary reform on 20 June 1992 and ended on 1
January 2011 when Estonia joined the euro area.
Such a framework provides a unique opportunity to describe a clearly defined
stage in the modern history of the economy. Although this book tells the story
of Estonia, it also gives a picture of the age as a whole, because although Esto-
nia is small and exceptional in some ways, most of the major events of the last
decade of the 20th century and the early years of the 21st appear here in one
way or another.
This is particularly true of the main processes of the period in Central and
Eastern Europe as the economy changed from a command economy to a mar-
ket economy. There was, and still is to some extent, a mix of very different eco-
nomic policy choices. Looking back more than twenty years later we can say
that there was no single and only route through these processes and towards
the living standards of the ‘old’ member states of the European Union. There
were better and worse choices in the short term but no one country from Cen-
tral and Eastern Europe stood out as much more successful than the others.
This period is made more interesting by its coincidence with changes in the
global economy. Globalisation became a torrent, the role of emerging markets
increased, financial markets were liberated, and information and communi-
cations technology advanced. With the great changes came great crises, in
the form of the Great Recession and the subsequent European debt crisis. The
changes they caused have not yet ended and they will be considered in greater
depth in the future.
6
This book concentrates on the changes of 1990–2010 looking through the
prism of monetary policy, which in Estonia’s case meant the monetary policy
based on the fixed exchange rate. As a broader perspective is needed, the book
covers the modern history of Estonia’s economy in a wider sense, at least where
it concerns the general logic of development, the essential features of economic
policy and the main macroeconomic indicators such as GDP growth, inflation
and employment or unemployment.
The small size of the country sets its own limits. A country the size of Esto-
nia is not able to have a fully free choice among all the possible doctrines of
monetary policy and so this is a study of a small and open economy in transi-
tion, where the distinctive feature of Estonia, the currency board arrangement,
takes centre stage and the story unfolds in several acts with two crises in the
Asian and Russian crisis and the later Great Recession.
Another distinctive feature is that the policy-makers and the people of Estonia
travelled a path in twenty years that normally takes many times longer, start-
ing from essentially zero with hyperinflation and an economy collapsing out
of the break-up of the Soviet Union, and finally arriving at accession to the
European Union and the euro area. This required a new financial system to
be built and to evolve, and needed new markets to be created such as the secu-
rities market and the credit market. Furthermore, the global crisis required a
section of the road to be travelled twice for the pre-crisis level of wealth to be
regained, and so it is clear that this was an exciting and challenging time.
I hope that you will enjoy reading this book.
Ardo Hansson
Governor of Eesti Pank
7
1. THE ROAD TO MONETARY REFORM 1989–1992
Kalev Kukk
1.1. THE WIDER ECONOMIC BACKGROUND
The tensions that had been rising in ideology and domestic policy from the end
of the 1980s in the Soviet Union and other communist bloc countries passed
into the economy at the turn of the decade. This led to both a rapid worsening
of imbalances and a sharp drop in output. This was not a classical cyclical
crisis, but rather a systemic or transitional crisis as an economic system that
could no longer be sustained collapsed. Clearly a new system based on free
market principles would take time to develop and could not replace the old
system immediately. There was a set of key circumstances that can explain the
rapid collapse of the economic system of the USSR.
Firstly, the Soviet planned economy was a system that was obsessed with
indicators for physical production volumes, and it was unable to cope with
declining production of natural resources. In 1986–1987, the first serious
signs appeared of the inevitable crash that was going to hit the economy, which
had by then been pushed to extremes. In 1989 production of natural resources
in the USSR generally fell to around the level of 1986 (see Table 1.1.).
Table 1.1. Production of natural resources in the Soviet Union, 1985–1990
1985 1986 1987 1988 1989 1990
Oil (million tonnes) 595 615 624 624 607 571
Coal (million tonnes) 726 751 760 772 740 703
Iron ore (million tonnes) 248 250 251 250 241 236
Mineral fertilisers – calculated for 100% active
33.2 34.7 36.3 37.1 34.3 31.7
ingredient content (millions of tonnes)
Timber (million cubic metres) 98 102 103 105 101 92
Raw cotton (million tonnes) 8.8 8.2 8.1 8.7 8.6 8.3
Source: Narodnoye khozyaistvo SSSR v 1990 g. 1991, 397–472.
Secondly, the liberalisation of management of the economy under perestroika
was primarily observed in the commonly-owned economy in an increasing
unwillingness to take responsibility. Administrative fear, which had been the
main driving force of the Soviet economic system, started to dissipate. It ulti-
mately became clear that efforts to carry out reforms of something that could
not be reformed were doomed to failure, because any attempt to support and
8
stabilise the economy of Estonia or the USSR from the centre through reforms
ended up destabilising it. There was a fall in 1989 in the growth rate of the
Soviet Union’s gross national product (GNP) to 1.9% and in gross national
income (GNI) to 2.5%, which the ideological perception of the time saw as
unprecedented1. Indeed the earlier growth in national income was replaced by
a decline in Azerbaijan, Georgia, Kazakhstan, Tajikistan and Turkmenistan.
In 1990 the GNP of the USSR fell by 2.3% and the national income by 4.0%, and
the only Soviet republics where national income appears not to have declined
were Estonia, Turkmenistan and Uzbekistan (Narodnoye khozyaistvo USSR in
1990. 1991, 12).
Thirdly the Soviet economy was inherently destructive of capital by its very
nature. New investments were no longer enough to compensate for the depre-
ciation of existing production capacity and this led to an unavoidable decline
in output. The so-called people’s capital that didn’t belong to anyone and had
already been invested once was not supposed to grow by itself. The principle
followed was that the state made investments and the state received the income
from them.
The imbalances were further worsened by the dead-end policies of the central
bank and the government of the USSR, which led to sharp rises in the budget
deficit and in internal debt. As a result the consolidated budget deficit of the
USSR climbed from 1.8% of GNP in 1985 to 9.2% in 1988, while internal debt
grew from 18.2% of GNP to 35.6%, increasing further to 56.6% in 1990 (see
Table 1.2.). This in turn aggravated the conditions that triggered hyperinfla-
tion in subsequent years.
Table 1.2. Some Budget and Monetary Policy Indicators in the Soviet Union in
1985–1990
1985 1986 1987 1988 1989 1990
Consolidated budget deficit (billion roubles) 13.9 45.5 52.5 80.6 80.7 41.4
- as % of GNP 1.8 5.7 6.4 9.2 8.6 4.1
Internal debt (end of year, billion roubles) 141.6 161.7 219.6 311.8 398.6 566.1
- as % of GNP 18.2 20.3 26.6 35.6 43.1 56.6
External debt in convertible cur-
18.3 22.5 26.1 34.1 43.8 43.8
rency (billion USD)*
Cash in circulation (billion roubles) 70.5 74.8 80.6 91.6 109.5 136.1
Sources: Narodnoye khozyaistvo USSR in 1990. 1991, pp 5–28; * Ǻslund 1996, p 71.
1 The terms GNP and GNI are here used as they were in the Soviet Union, so they are not the
same as those concepts in the market economy.
9
In the second half of the 1980s economic reform had become a major topic
of discussion, and this was expressed in Estonia in the concept of economic
self-sufficiency, under the name of Self-Management for Estonia. The wider
debate can be considered to have started when the Tartu newspaper Edasi pub-
lished a short article by Siim Kallas, Tiit Made, Edgar Savisaar and Mikk Titma
on 26 September 1987 headed Proposal: Self-Management for the Whole of the
Estonian Soviet Republic (Kallas et al, 1987). Several reform plans were drawn
up in the next couple of years that then became the Principles of Economic
Autonomy of the Estonian SSR passed by the Supreme Soviet of the Estonian
Soviet Republic on 18 May 1989.
The economic reforms that started in Estonia in the late 1980s under the ban-
ner of self-management cannot be considered as truly market-based reforms.
Their greater concern was for institutional reorganisation, on which later eco-
nomic and social reforms could draw. One of the reforms saw Eesti Pank re-es-
tablished as the central bank of Estonia on 1 January 1990, though it acted in
a largely symbolic role until national independence was regained and primar-
ily functioned operationally as a commercial bank. Efforts were made to find
a new macroeconomic equilibrium based on free-market principles from the
end of 1990.
Ideas similar to the economic autonomy that appeared in the second half of
the 1980s could already have been perceived elsewhere, notably the Croatian
Spring of the early 1970s, and the socialist market economy idea proposed by
Ota Šik, one of the leaders of the Prague Spring and later a Professor of Eco-
nomics at the University of St Gallen.
In 1990 a recession started in Estonia. Estimates by the European Bank for
Reconstruction and Development (EBRD) put the fall in GDP at 6.5% (EBRD
2012)2. This was mainly caused by ever-increasing difficulties in obtaining raw
materials and increasing payment problems for companies. As export oppor-
tunities opened up, it became clear that the products made so far were uncom-
petitive on foreign markets and the output intended for the domestic markets
of the USSR could not be sold in the West.
Under the circumstances, it is understandable that Western economic experts
gave highly pessimistic assessments of the ability of Estonia, Latvia and
2 The State Statistics Committee of the USSR put growth in national income in Estonia at 1.1%
(Narodnoye khozyaistvo SSSR v 1990. 1991, 12).
10