# I. Problems with Exchange Rate Conversion

This section reviews the Idnd of exchange rate conversion practices<sup>that normally suffice</sup> for Bank purposes. Conversion by the official ruble-dollar<sup>rate is judged to "egregiously'</sup> overstate FSU's per capita income; and while precedents exist for<sup>using staff estimates to deal</sup> with such problems, the ad hoc approach that has been used elsewhere<sup>seems inad3quate in the</sup> present context. A more refined procedure, referred to as the Synthetic<sup>Atlas-type Conversion</sup> Factor (SACF) is recommended in Section II. The SACF shows<sup>promise beyond the FSU and</sup> conforms with the announced intention of the Bank staff<sup>to explore uses of purchasing power</sup> pareties (PPPs). Its application to other CMEA economies is detailed<sup>in Section HI.</sup>

# a. Background

There are still significant gaps in our understanding of<sup>the accounting and administrative</sup> underpinnings to the formal structure of FSU exchange rates. In CMEA economies,<sup>the official</sup> rate is said to have been a simple anachronism, not unlike the gold parities<sup>of the old par value</sup> system of the West; and a clear overstatement of the value of CMEA<sup>currencies. By</sup> conventional exchange rate methods, then, it is usually considered to<sup>be the upper limit of</sup> plausible estimates. For the FSU, however, it seems to have had<sup>meaning since it was adjusted</sup> annually against a basket of Western currencies; it appreciated against<sup>the dollar in 1986 and</sup> then remained largely unchanged through 1991.

The commercial rate was as artificial as the so-called official rate<sup>that was the only</sup> acknowledged rate until late 1990. Where the official rate of<sup>0.59 rubles per dollar is almost</sup> certainly an egregious over-valuation (yielding per capita income<sup>of $6180), a rate of almost</sup> exactly three times that (the commercial rate was pegged at 1.76 rubles<sup>per dollar in November</sup> 1990 and moved thereafter in tandem with the official rate) may<sup>be just as egregiously under-</sup> valued (yielding a per capita income of only $2070).

The FSU's commercial rate only came into existence in November<sup>1990; it was said to</sup> have been set at a level estimated to ensure that local currency proceeds<sup>would be at least as</sup> high as domestic wholesale prices, for 90 percent of exports (see IMO,<sup>World Bank, OECD and</sup> EBRD 1991, p. 426). This could be viewed as a depreciation, relative<sup>to the erstwhile official</sup> rate, of 300 per cent. Presumably, the rate was more than high<sup>enough, perhaps much more</sup> than high enough, to achieve that result for the bulk of exports.<sup>6That can be easily read to</sup> mean that it undervalued the ruble. The alternative is to argue that<sup>the commercial rate was</sup> more a formal acknowledgment of schemes previously in place to achieve the same result. in terms of foreign trade price differentials (FTDs), which require some explanation<sup>(given below).</sup> 6Analysis of the most detailed file available on PTDs, providing separate information by partner country and S-digit CMEA trade classification, suggests that a rate about twice the<sup>official rate would have satisfied the 90 percent criterion</sup> specified.

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