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N 10

Balancing Foreign Currency Demand and Supply in 1999
(summary)*

Public Sector Capital Flows
Banking and Corporate Sector Capital Flows
Households
Balance of Goods and Services
Balance of Payments Deficit
Foreign Debt Restructuring
Foreign Currency Demand and Supply Balance

Exchange rate forecasts should be based both on the estimation of money supply growth and on the forecast of foreign currency flows. The balance between the supply and demand for foreign currency can be sustained only through changes in the official foreign exchange reserves since abstracting from changes in household cash dollar savings made before the period, foreign currency outflows are equal to foreign currency inflows for a certain period of time. Therefore a gap that occurs between capital inflows and outflows will be balanced by changes in the exchange rate.

Foreign Currency Demand and Supply Balance

hus, if the government manages to restructure 50% of foreign debt payments due next year and the level of capital outflows is low, then the gap in capital flows will be about $1 billion. This gap could be covered by a corresponding decrease in the Central Bank foreign reserves, and the Central Bank could continue to control the exchange rate. In this case changes in the exchange rate will be determined by internal factors, primarily money emission. If the government decides to print a substantial amount of money to finance excessive budget expenditures then the resulting inflation would lead households to lose their confidence in national currency and the capital outflows would increase, resulting in a ruble devaluation. In other words, under the optimistic scenario the government would have a chance to avoid hyperinflation but whether it would take advantage of this situation is unpredictable.

he pessimistic scenario (high level of capital outflows and insufficient level of foreign credits) implies that capital outflows will exceed capital inflows by over $11 billion. This means that the government will not be able to carry out its foreign obligations and Russia will be declared bankrupt. The same can be predicted for banks and corporations. The foreign debt default will lead to an improvement in the balance of payments and a decrease in the federal budget deficit but also to the isolation of Russia from international financial society. But the most dangerous consequence of Russia's bankruptcy is that the consequent devaluation of the ruble will lead households to lose their confidence in the ruble and government economic policy as a whole. That in turn will lead to either a sharp increase in demand for foreign currency from households and substantial ruble devaluation or strict government control over foreign exchange policy including the restriction of foreign currency sales and purchases by households.

Foreign currency inflow/outflow balance and key monetary indicators for 1999