If we act now to save the rouble, we will be helping ourselves too

FED BY THE ASIAN contagion, investors are beginning to run from the rouble. But a devaluation would be disastrous for Russia's new reform government. The West must act, and quickly.

Russia is not like Thailand or Malaysia. Last year it had a balance of payments surplus and, after the fall in the oil price, the deficit this year will be under 2 per cent of GDP. Tax collection is better than in the first part of last year, and the budget deficit has been halved. The new reform government established before Easter is better than its predecessor.

So why the crisis? There are of course some Russia-specific features. Wages arrears are still bad and have led to serious strikes, followed by promises of extra spending. At the same time the oil price fall was bad for tax receipts. All this fuelled fears of higher budget deficits. But these fears have proved wrong in the past and are even less plausible now.

There is much wrong with the Russian economy. It is over-regulated, the mafia has a strangle hold, and barter is pervasive. But these issues are irrelevant to today's issue, which is whether the rouble is overvalued.

The rouble has been well managed for the last three years and this has brought important stability to Russia. Despite complications from parts of industry, Russia has achieved export earnings sufficient to pay for its needs. And inflation has come down to single figures.

So, without the Asian debacle, there would be no crisis now in Russia. But, of course, if investors start worrying about whether other investors will run, they start running themselves. Thus fear of devaluation becomes self-fulfilling, and it may become impossible for a country to defend its exchange rate unaided - even when devaluation is not justified by economic fundamentals.

A devaluation in Russia would be as catastrophic for Mr Yeltsin as the devaluation in Britain was for John Major. The greatest achievement of the reformers has been to bring low inflation and financial stability. If they cannot even do that they will lose all credibility.

That would open the way to major left wing gains in the parliamentary elections in late 1999, and make it most unlikely that any reformists could be elected in the year 2000. Not only would this be very bad for the life of Russian citizens; it would also be bad for the citizens of western countries, who need a peaceful and co-operative Russia in order to preserve a peaceful world order.

A devaluation in Russia would also spell danger for other emerging economies. The next country to be picked off could be Brazil, it could be Hong Kong. The world financial community therefore has a huge interest in drawing the line in Moscow and preventing the collapse there, which could have a further domino effect.

The basic problem for Russia is that the foreign exchange reserves of the central bank are not sufficient to meet the demand for dollars that could arise, especially if there is massive selling of the Russian rouble treasury bills held by foreign investors.

In order to prevent them selling, everyone must know that the Russian government has sufficient dollars at its disposal to meet any wave of selling to buy up any amount of roubles that investors wanted to dump in the market at the current exchange rate. If investors knew this, there would be no reason for them to want to dump their roubles now in fear of a worse exchange rate later.

The G7 nations need to put together a stabilisation fund of at least $10bn which would be available for the Russian government. This is not money given to Russia, this is money that would be available as a loan facility. The sooner it is provided, the less likely it is to be needed. Indeed, if Western support was unequivocal the loan might never be drawn down because it would not need to be used. The measure of its success would be how little it was used.

It would not be necessary or right for the G7 countries to provide money for the government to spend in its budget. That is the role of the IMF, and it is important that the IMF reaffirm its commitment to paying for the steady delivery of the extended fund facility it has made available to Russia.

Time is very short because, as we know, speculative attacks can develop very quickly; and interest rates in Russia are already very high with 80 per cent per annum being paid on roubles (as compared with 11 per cent per annum being paid on the government's dollar debts). Such a differential, of course, only makes sense if people expect a devaluation and it is crucial that the West acts in the next few days to make clear that Russia cannot be forced to devalue. That would have enormously beneficial effects, both in Russia and in the rest of the world.

Russia would be saved from the chaos that would follow from a devaluation. A devaluation there would lead to an immediate increase in inflation, and even worse, to bank failures. And bank failures would lead to bankruptcies of enterprise. Unemployment would rise on a massive scale, as it has in Indonesia.

Social peace could not be guaranteed. By contrast, if the fear of devaluation were to be removed, interest rates would come down and the economic recovery would begin.

The rest of the world, too, would heave a sigh of relief that the international community had shown its ability to act - not after a devaluation, as in Asia, but before.

The world financial system is now under considerably greater threat than at any time since the early Eighties. The introduction of the euro may add to further turbulence and volatility in the world's major exchange rates, and it would be heartening to see the international community able to take charge of the situation beginning in Russia. Nobody should want exchange rate changes that are not justified by economic fundamentals. They distort the structure of economies and create unemployment. Ultimately they can undermine the public faith in markets and in free trade. We would all then lose. Now is an opportunity for the G7 to show that they can strike before the horse has bolted. Let us hope that in the next few days it's members have the courage and wisdom to do so.

Richard Layard is Director of the Centre for Economic Performance at the LSE and is a former adviser to the Russian government.