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Lithuania: IMF Puzzled By Reports Of Death Of Currency Board

Washington, 4 February 1997 (RFE/RL) - An official at the International Monetary Fund (IMF) in Washington says the IMF is puzzled by a rush of news reports and rumors that Lithuania is planning to scrap its currency board in the next few weeks.

Speaking on condition of anonymity, the official said "we don't know why the speculation is growing like this -- it's just snowballing."

Lithuania is one of only four countries in the world to have currency boards. Estonia is another. Latvia does not formally have a currency board, but has pegged its currency to the IMF's SDR (special drawing rights), which has the same effect.

When the current Lithuanian government swept to power last November, it included in its agenda a plan to abandon the currency board "gradually" but not before September, 1997. Prime Minister Gediminas Vagnorius said after the election that the "litas exchange rate will not become floating in the next 12 months."

When Parliament approved the government's economic program before the end of the year, it included the proposal to eventually end the peg of the litas to the dollar, the basis of the currency board. A currency board is a form of Central Bank which sets a fixed exchange rate of the currency against another major currency. It also limits the issuance of the local currency to the amount of hard foreign currency the country holds in its reserves.

IMF officials, who had originally advised Lithuania to adopt a currency board, made it a condition for Vilnius' three-year EFF (Extended Fund Facility) loan of around $188 million approved in October, 1994. The loan, which runs until October, has around $58 million remaining to be drawn.

That is why IMF officials say they were surprised last week when a number of stories surfaced, including one in the London "Financial Times," that the Vilnius government would end the currency board soon and replace it with a "crawling peg."

The crawling peg, which is used by Poland and Hungary, fixes the currency to a major one like the dollar, but pre-announces small monthly devaluations.

Economists say the crawling peg allows an economy to adjust to a more competitive exchange rate without unleashing the inflationary pressures associated with a large or unexpected revaluation.

One IMF official told our economics correspondent that "to our knowledge, that is not part of the plan. The government of Lithuania has been telling us they will not scrap the board until after the end of the EFF, in October, 1997."

Some private economists think it may be time for a change. Germany's Deutsche Bank, in an analysis issued last summer, praised the effects of the currency boards in the Baltic states.

"All three countries can boast a considerable reduction of inflation, rising productivity, progress with privatization and the reorientation of trade flows from East to West," said the bank's assessment. It added that for "economic reasons, no major changes are expected in this area of policy."

Now, however, a senior economist at the bank, Oliver Fratzscher, says conditions are changing. He points to a real appreciation of the litas against the U.S. dollar over the last 18 months and a corresponding foreign trade deficit. The formal exchange rate remains four litas to the dollar.

Fratzscher argues that the currency board has outlived its usefulness now that it has helped stabilize economic fundamentals.

The case is different in Bulgaria, he says, where the IMF has proposed a currency board to try to salvage the rapidly deteriorating economy. It is "absolutely vital" there, he says, as do others. A foreign debt trader in London told the "Financial Times": "Bulgaria needs a currency board to restore its battered reputation and reassure investors it will not default on its foreign debt."

But in the case of Lithuania, he said, "it is more of a constraint than a benefit after it has served its initial purpose."

IMF officials don't necessarily disagree with these analyses, but say it is too early for Lithuania to abandon something that it adopted less than three years ago and which has done so much good for the country's economy.

Estonia adopted its currency board two years before Lithuania, but private financial analysts say it would probably follow Lithuania's lead within six months to a year. Latvia would probably also ease its tie to the SDR if the other two countries act.