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Bank System Stabilization

Category: Bank Management

Stabilization entails two elements: creating a stable and convertible currency, and reducing budget deficits and accumulated debts.

Most Centrally Planned Economies (CPE’s) suffered from a large monetary overhang, i.e. the productive capacities of the economies were not sufficient for the amount of money kept by households and firms. This hidden inflation threatens to become open inflation once markets and prices are liberalized (see 2.1.2). Transition countries have to cope with this problem in order to create a stable currency that allows economic agents to rationally decide on their consumption, saving and investment decisions. Otherwise, the co-ordination of economic activity via a system of markets cannot function efficiently. In addition to this, countries must — in the medium run — have convertible currencies. Otherwise, their economy cannot be integrated in the global exchange of goods and services and the international flow of capital.

The performance of various CIS countries in regard to monetary stabilization is highly diverging. Russia has managed to reduce yearly inflation of the Ruble from more than 1000% in 1992/1993 to 20% in 1996. It depends crucially on whether or not the government will be able to control the budget deficit whether the battle against inflation in Russia can be won. In any case, it is a good signal that citizens of many CIS countries, whose currencies are losing ground quickly, are already considering the Ruble a safeguard against inflation in their country. Unfortunately, CIS governments are reluctant to co-ordinate their anti-inflationary efforts and it is hence uncertain to what extent other countries will be able to stabilize their currencies, or whether the Ruble may play the role of a regional hard currency.

The reduction of governments’ budgets is the second important element of stabilization. If the state controls large parts of an economy, the private sector will be paralyzed, since governments may be inclined to levy taxes, or finance budget deficits by printing additional money. In both cases, the ultimate consequence is inflation. While budget cuts are hence necessary, they may be painful. Subsidization of unprofitable industries must be stopped or at least reduced, which leads to unemployment. Since CIS countries have no social security system and enterprises provide many social services, budgetary stabilization may create social tensions. It must even be feared that the practice of subsidizing loss-making firms could even increase when firms are more and more subject to competitive pressure due to other reforms, for instance, liberalization. The severe effects of subsidization on banking practices are discussed in detail in Section 2.2.

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