Russian_Crisis_1998

Reconstructing Russian Rubles Abstract: The writing consists of an in depth analysis of the Russian Crisis in 1998 and provides its scholarly knowledge in the simplest form of structure making use of graphs and diagrams. This paper discusses pre and post crisis events; it explores the key causes and consequences of the crisis and discusses federal response to the economic downturn. The introduction provides readers with a brief idea about the crisis and the latter looks into important events, facts and figures that circulated and lead to the crisis. It then provides a summary of what were the consequences, and what may have caused it. The paper concludes with critical analysis and my opinions on the whole situation. Just when Russia’s global outlook was strengthening following the collapse of the Soviet Union in the early 1990s, the country was struck by not only one of the worst currency crisis it has seen, but also one of the most complicated one. ‘A currency crisis can be defined as a speculative attack on a country’s currency that can result in a forced devaluation and possible debt default’ (Chiodo & Owyang. 2002:7). Russia borrowed billions of U.S Dollars after the collapse of the Soviet Union, to stabilize their economy. Between 1991 and 1997, the country privatized businesses to improve conditions, started negotiations between Paris and London clubs to repay back their outstanding long term debts to restore resident and non-residents investor confidence. Oil, Timber and Gold has been Russia’s largest export, and contributed massive figures to Russian exports. Although Russia should signs of economic recovery, there were other factors that interfered in its redevelopment. Alongside in 1997, the Asian crisis triggered in Thailand, had round spread effects all over Asia. So what is it that caused the most catastrophic Ruble (the Russian currency) crisis just when it showed signs of economic prosperity' How did the government react' Russia’s healthy position was reflected in many ways. It’s trade surplus movement to a balancing export and import figure, better western relations, International Monetary Fund (IMF) aids, a large fall in inflation rate from 131 percent in 1995 to 11 percent in 1997, recovery in national output, a healthy pegged exchange rate between 5 and 6 rubles per dollar, and high oil price of 23 dollar per barrel were all signs of a strengthening economy. Russia also generated foreign income through the sale of their federal loan bonds, Gosudarstvennoe Kratkosrochnoe Obyazatelstvo (GKO). But some factors however did float around the economy that proved to be problematic for Russia, the country’s real wages were really low, and more than half of its work force weren’t paid in full on time. The taxation system was another weakness in the economy, the nation which was at the time, under President Boris Yeltsin, had low tax income- both corporate and public tax (due to corruption), which caused huge sums of federal deficits as government spending were more than tax revenue. In November 1997, the Asian crisis was caused which started in Thailand, and slowly spread around the Pacific ring countries- Russia was also affected as investors stopped investing in the fear that Rubles may devalue. Oil prices started to fall, and the Russian Central Bank (CRB) raised interest rates to keep Investors interested. The events led to rising uncertainty as the whole situation started to get complicated. Rubles were under speculative attacks by investors. The CBR then spent 6 billion U.S Dollars on printing money to defend the Rubles. ‘Krugman’s first-generation model suggests that a government finances its deficit by printing money or depleting its reserves of foreign currency’ (Chiodo & Owyang. 2002:15). Boris Yeltsin fired Prime Minister Viktor Chernomyrdin and his cabinet, and hired 35 year old Energy Minister Sergei Kiriyenko as the new Prime Minister and ordered him to create a new governing body. Russia realized the necessity to start collecting tax, and so it did, while at the same time requested for more financial support from the IMF, and Russian banks started borrowing from foreign markets to bring in the dollar currency as price of oil continued to fall (Oil, Timber and Gold were Russia’s two third of hard currency earnings). During these incidents, the only positive aspect was the economic growth of 0.8 at the end of year 1997. Source: http://theinflationist.com As the year 1998 progressed towards the 2nd quarter, investors had totally lost confidence in Rubles, while the CBR input another 1 billion U.S Dollars defending the Rubles. ‘However, by May 27, demand for bonds had plummeted so much that yields were more than 50 percent and the government failed to sell our enough bonds at its weekly auction to refinance the debt coming due’ (Chiodo & Owyang. 2002:13). CBR’s constant effort on getting the economy under control by printing and injecting more money was not enough. Oil prices had gone down to a staggering 11 U.S Dollars per barrel from 23 U.S Dollars per barrel, and the CBR had pushed up the interest rates to 150 percent as demands for GKO bonds were at its lowest. Russia’s overall debt to date (i.e. in August 1998) was estimated to be at around 160 billion U.S Dollars. IMF granted 4.8 billion U.S Dollars to Russia as an emergency aid package on 20th of July 1998, but it was not enough and on 13th August, 1998, Russian stocks, bonds and currency became weaker and prices hit lowest points- 4 days later the Russian government was forced to devalue the Rubles, default on their debts and even declared a moratorium of 90 days on all payments to foreign creditors. Kiriyenko and his governing body were fired immediately and Yeltsin tried to bring Chernomyrdin back to the Prime Ministry position. Over time the stock market lost up to 75 percent of its value, 39 percent of it in just May 1998. The government finally declared to freely float its exchange rate against U.S Dollars. One of main causes for the Russian Ruble crisis was the exchange rate and the peg, instead of letting it float, the government ended up spending billions of U.S Dollars to protect Rubles, which was a waste. Even the fiscal policies had a lot of faults, barely any or no tax revenues were generated what so ever, and at the same time the rise in interest rates by CRM was pressurizing the exchange rate. Another main cause was associated to the timing of the events- which can be stated as just bad luck, those are, timing of the spread of the Asian crisis, loss of 39 percent of stock market value as interest rates went up, timing of the drop in oil prices. According to me, Moral Hazard also plays a major role in the study, that is, the tendency to take excessive risk that one is insured against- Russian officials carried on adding pressure to them, as they felt secured by federal forces circulating around the economy. Russian federal reserves were low, and reckless behaviour mounted to more debts. Even printing money was not much of help. I strongly believe that the Russian president contributed to the crisis, along with the new cabinet of ministers. Boris Yeltsin, was heard to have attended foreign meetings in a drunken state, and did not show much concern on redeveloping the country back to prosperity. Such behaviour from the president of the biggest country in the world is quite unacceptable, especially under dire economic circumstances. A lot of the consequences are mentioned above, but there were other points that were not directly looked at. The crisis caused a significant damage in the Russian Political structure, breaking it not once, but twice, which causes havoc in the countries, especially when it’s facing an economic situation as described. Low Federal Reserve and inability to pay wages caused worker protests, demonstrations and riots. Banks were not bailed out by government and thus bankrupt and followed to closure, examples of big commercial bank names include, Inkombank, Oneximbank and Tokobank. Prices for Russian commodities, food items shot up by nearly 100% and imports were expensive too- citizens started stocking up, leaving low stock levels or even zero stock at shop shelves. The society was also struck; there was increased tension with in public. A new group of government body was chosen by new Prime Minister Promokov. Other neighbouring countries were severely affected by the Ruble crisis, as the multiplier effect spread round Asia and even East Europe. Belarus accounts for up to 60 percent of its export to Russia, and with the 1998 crisis, its Balance of Payment figures were negatively affected. Cheap Russian commodities were injected into Kazakhstan killing local Kazakh industries. Even Moldova, who sold 85 percent of their wine, brandy, canned goods and tobacco to Russia, suffered a 5 percent decline in GDP. Ukraine was one of other affected nations as Hryvnia (Ukrainian currency) devaluated by 60% and prices in the country rose. Newly developing European nations such as Estonia, Lithuania and Latvia suffered recession due to a heavy decline on their exports too to Russia. Countries like United States and other borrowers had a lot of money frozen in the Russian economy as they were not paid back to the date of the crisis, it would have affected their future economic plans as respected economies were not paid back the borrowed money from Russia. After these very economically devastating events, Russia’s road to recovery was rather speedy and surprising. The quick recovery was due to healthy increase in oil prices during 1999-2000. It aided Russia and it led to a large trade surplus as Oil was a massive export. Domestic industries benefited as they started producing more, since the devaluation made imported goods more expensive, and the economy became more productive and relied less on imports. Russia’s economy was quite old fashioned in 1999, and a lot of transactions were will under the barter system and non-monetary instruments of exchange- recovering from a currency crisis, it is a fortunate to have been operating under the barter system as the financial situation did not have much of an impact on many producers. Russian PM Promokov new governing body was also a reason behind the recovery of the economy, as he promised and paid back wages to the labour markets that were not paid- this injected more cash into the economy and it aided the demand and supplies to rise, simultaneously, the industry having producing more and importing less. The fact that Russian industries were producing more also encouraged less unemployment, which contributed to a healthy economic reformation. Social and Political force and pressures were also maintained under control after Promokovs became the Prime Minister. ‘The economic crisis of 1998 became a result of certain decisions, the official believes, although bad luck was also involved. Mr. Gilman said that even world’s biggest men of genius would have faced difficulties if they had attempted to solve Russia’s problems in the 1990s.’ (Anonymous. 2008) - Gilman was the Russian IMF representative. I strongly believe that bad luck and time is a major function in the crisis, but Russian activities and the Moral Hazard intensified their economic situation even more. Today, Russia as a country stands to be one of the strongest country (in terms of political success, capital strength, army and even economical position) in the world, and is a part of the BRIC countries (Brazil, Russia, India, China)- the upcoming major forces of the world, ‘the big four’ as many call it. I support the fact, that if the Ruble crisis never happened, Russia would have currently been the most dominant nation of the world, and have been contributed to and involved in major worldwide activities. ‘The official described the default of 1998 as the price which Russia had to pay to evolve from its old system to the new globalized economy’ (Anonymous. 2008).   | Jan. | Feb. | Mar. | Apr. | May | June | July | Aug. | Sep. | Oct. | Nov. | Dec. | Interbank Rate1 | 24.1 | 30.3 | 25.9 | 29.5 | 47.6 | 56.1 | 58.8 | 45.3 | 139.7 | 84.9 | 36.7 | 27.8 | GKO Yield of the Bank of Russia obligations2 | 29.4 | 26.4 | 22.2 | 25.0 | 43.9 | 51.3 | 58.0 | 84.2 | — | — | — | — | OBRYield of the Bank of Russia obligations5 | — | — | — | — | — | — | — | — | 80.1 | 54.9 | 40.8 | 48.1 | Deposit Rate3 | 11.6 | 12.2 | 11.2 | 11.0 | 12.9 | 14.0 | 15.1 | 17.5 | 23.8 | 27.3 | 22.3 | 25.7 | Loan Rate4 | 29.8 | 30.4 | 38.3 | 38.8 | 40.4 | 48.0 | 44.9 | 48.6 | 46.8 | 49.0 | 44.8 | 41.7 | Source: http://www.cbr.ru | References: 1. Chiodo, A.J and Owyang, M.T. (2002). A Case study of Currency Crisis: The Russian Default of 1998. Available at: http://research.stlouisfed.org/publications/review/02/11/ChiodoOwyang.pdf. [Accessed 11/12/2010] 2. Schidt, R. (2009). The 1998 Russian Financial Crisis. Part 1: Course of events. Available at: http://stockbreakthroughs.com/2009/03/08/the-1998-russian-financial-crisis/. [Accessed 11/12/2010] 3. Pinto, Brian. and Ulatov, Sergei.(May 2010). Financial Globalization and the Russian Crisis of 1998. Available at SSRN: http://ssrn.com/abstract=1610009 [Accessed 10/12/2010] 4. Dell'Ariccia, Giovanni, Schnabel, Isabel and Zettelmeyer, Jeromin.(October 2002) Moral Hazard and International Crisis Lending: A Test. IMF Working Paper, Vol. , pp. 1-55, 2002. Available at SSRN: http://ssrn.com/abstract=880258 [Accessed 9/12/2010] 5. Pastor, G. and Damjanovic, Tatiana. (October 2001). The Russian Financial Crisis and its Consequences for Central Asia. IMF Working Paper, Vol., pp. 1-42, 2001. Available at SSRN: http://ssrn.com/abstract=880206 [Accessed 10/12/2010] 6. Anonymous. (2008). Russia's financial crisis of 1998 plotted by IMF. Available at: http://english.pravda.ru/history/19-08-2008/106148-financial_crisis-0/. [Accessed 13/12/2010] 7. Eiteman, D.K, Stonehill, A.I and Moffett, M.H (2010). Multinational Business Finance. 12th ed. U.S.A: Pearson Education Inc. 8. Anonymous. (1999). Interest Rates in 1998. Available at: http://www.cbr.ru/eng/statistics/credit_statistics/print.asp'file=interest_rates_98_e.htm. [Accessed 13/12/2010] 9. Anonymous. (2010). Russian Default 1998 | Ruble Crisis | Russian Financial Crisis - Analysis. Available at: http://theinflationist.com/sovereign-default/russian-collapse-ruble-currency-crisis. [Accessed 13/12/2010]