Real Exchange Rate Misalignment: Prelude to Crisis?

in the foreign exchange market and depletion of reserves led to a sudden devaluation and under-
valuation of the Ruble. At the beginning of August the overvaluation was about 21%. When the
Ruble floated there was a sharp decline resulting in a 21% undervaluation. The average
overvaluation of the Ruble of 10% in the pre-crisis period was 150% higher than the average
undervaluation of 4% in the post-crisis period.

In Poland there were several changes in the foreign exchange regime to increase the
flexibility of the exchange rate during the mid-1990s. First, the band around central parity was
widened from 0.5% to 2% in March 1995. Then there was a revaluation of 6% at the end of
1995 and a widening of the band to 7% in May 1996, 10% in February 1998 and 15% in March
1999. Finally in April 2000 a full float was introduced.³⁵ As the band widened the greater
flexibility of the nominal exchange rate appeared to reduce the degree of misalignment. The
greatest misalignment was in 1995 just prior to the revaluation, and in late 1999 just prior to the
introduction of the free float. While our methodology is quite different our results for Poland
also corroborate the claims of Dufrenot and Egert (2005) and Lommatzsch and Tober (2005) that
the real appreciations in transition economies were equilibrating movements with
macrofundamentals and productivity gains being important determinants of those movements.

If we take movements in the real zloty exchange rate, which could more readily
equilibrate via both nominal exchange rate changes and foreign and domestic price level changes
as a benchmark, the maximum overvaluation of the Ruble, 21%, was 250% higher than the
maximum overvaluation of the zloty, 6%. The maximum undervaluation of the Ruble, 21%, was
more than 100% higher than the maximum undervaluation of the zloty, 10%. We see that if the
nominal rate is fixed or heavily managed, as in Russia at that time, without proper foresight and
stabilization programs, then significant misalignments are likely outcomes. Further, if the
³⁵ See Orlowski (2000) for additional details.

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