A currency union is plausible as long as fiscal policy is coordinated

At the recent meeting in Astana between the leaders of Belarus, Kazakhstan and Russia, Vladimir Putin said that time had come for the three countries to think over a currency union. The Russian President in March commissioned the Bank of Russia and the Russian government to explore the viability and feasibility of establishing a currency union within the Eurasian Economic Union (EAEU).

First of all, any economic integration is supposed to follow a certain sequence of steps. Integration begins with a free-trade zone (FTZ), allowing for free trade on every, or almost every, commodity item between the member states. Such a FTZ has been in effect since 1992 within the CIS.

The second step is customs union, allowing for not only free trade of goods, but also the removal of customs border between the member states, the lowering of non-tariff barriers in trade and a common foreign trade policy with regard to third countries. Thereafter, a common market the can be created, allowing for free movement of labor force, capital, goods and services.

The next step of integration – economic union – involves a common macroeconomic policy. Not until then, simultaneously with the establishment of a common budget system or, at least, the real (not declarative) coordination of budget processes, will it be possible to introduce a common currency in the economic union. This will allow the already existing positive effects of integration – the release of extra resources following the removal of trade and economic limits – to be reinforced by reducing transaction currency costs and currency risk hedging costs in mutual trade and investment.

The EAEU member states have so far moved to the second stage of integration. The Customs Union does exist and function, the customs borders have been removed. The foreign trade policy is truly common with regard to the import tariff, but not sanitary permits and ban on imports (Russian tit-for-tat sanctions have been introduced unilaterally). Export duties are determined individually by each member state. There are many non-tariff barriers inside the Eurasian union, there is no common veterinary and phytosanitary inspection, as well as mutual recognition of certificates (which leads to trade wars like the Russian ban in December on imports of Belarus-made food products), etc.

With the "customs union" integration stage still being in progress, we have already proclaimed an economic union, although there is still a long way towards a coordinated macroeconomic policy. A necessary condition for the creation of a currency union – free movement of production factors, allowing economic systems to timely respond to market signal – hasn't been met yet. Furthermore, no respective provision is stipulated in the Treaty on the Eurasian Economic Union (there is only a declarative goal not backed by explicit mutual commitments by the parties thereto).
Setting the course towards a currency union in the short run would imply not following the logical sequence of economic integration.

From the technical viewpoint, there are specific approaches intended to assess countries' readiness for a currency union. The basic idea of the so-called theory of optimum currency areas (pioneered by Nobel Prize-winning economist Robert Mundell as early as the 1960s) is as follows: countries' readiness for a currency union is directly linked to how business cycles are synchronized in these countries. If economies are moving synchronically, then external shocks (for example, collapsing or plummeting global crude oil prices) and the common central bank's policy will have a similar effect on the internal economic processes in the member states.

Otherwise, some countries will imminently sustain losses from a currency union upon having given up on their national currency and transferred partly their sovereignty up to the supernational level, lost the devaluation as a tool to smooth external shocks and non-tax distribution of resources. It won't be possible to compensate for such losses until there is a common budget system in place, otherwise, they will have to be covered each time through "cadging" from union partners on a manual basis.

Countries' readiness for a currency union can be measured by the degree of synchronicity of the following macroeconomic characteristics: trade as a percent of GDP, loans to the private sector as a percent of the total volume of loans, monetization of GDP, volatility of the bilateral exchange rate, correlation of growth rates in money supply and growth in the consumer price index, etc.

Considering the foregoing, our estimates show that it is Moldova and Ukraine, not Armenia, Belarus and Kazakhstan, that are synchronized most with the Russian economy. It may sound odd, but it is Russia and Ukraine that saw most of the downturn in 2009 in the CIS member states, whereas Belarus and Kazakhstan showed a tiny growth of GDP. In 2014, the Russian ruble dynamics were nearest the dynamics of the Ukrainian hryvna not only among the CIS currencies, but also among the currencies of all emerging economies.

Drawing on the example of Greece and other South European countries, one can see how the lack of coordinated fiscal policy in the Eurozone may lead to dismal results. If a currency union member state can obtain cheap loans from the common central bank while running a soft, close to irresponsible, fiscal policy, this member state begins to rob its partners within the currency union. Financing budget deficit with cheap loans make you wealthier at the cost of other partners whose prices and wages grow slower than those in your country.

A full-fledged currency union is plausible to the extent that the fiscal policy is coordinated, and we see the budget process in Greece being put under control of the European Union. No similar supernational bodies have been established or planned within the EAEU; only a common financial megaregulator in Astana is planned to be created by 2025, it will be in charge of financial markets regulation, not the monetary policy. Therefore, the establishment of common currency is not yet exposed to high risks for all of the Eurasian union member states.

Aleksandr Knobel, Ph.D. in Economics, the Head of Foreign Trade Department.

The commentaries are based on Aleksand Knobel's article for RBC "Jumping the gun: whether or not the EAEU can become a currency union?".