Russian Currency Crisis

Brian Billick Davin Costa Manuel Davila Tom Degnan Tom Lacny

Russian Currency Crisis

Currency Crisis
Speculative attack on a countrys currency that can result in a forced devaluation and possible debt default Russia 1998: led to the devaluation of the ruble and the default on public & private debt

 Declining productivity, an artificially high fixed exchange rate between the ruble and foreign currencies to avoid public turmoil, and a chronic fiscal deficit were the reasons that led to the crisis. The economic cost of the first war in Chechnya (1994-1996), estimated at $5.5 billion (not including the rebuilding of the ruined Chechen economy), also contributed to the crisis. When the East Asian financial crisis broke out in 1997, prices for Russia's two most valuable sources of capital flows, energy and metals, plummeted. Given Russias fragile economy, the rapid decline in the value of those two capital sources resulted in an economic chaos in the country where GDP per capita fell, unemployment soared, and global investors liquidated their Russian assets

 In an effort to prop up the currency and stem the flight of capital, in June 1998 Kiriyenko hiked GKO (governments bonds) interest rates to 150%. The situation was worsened by irregular internal debt payments. Despite government efforts, the debts on wages continued to grow, especially in the remote regions. By 1 August 1998 there were approximately $12.5 billion in debt owed to Russian workers. On 17 August 1998 Russia employed a "floating peg" policy toward ruble. IMF refused to grant loan as Russia had not checked its fiscal deficit. On 13 August 1998, the Russian stock, bond, and currency markets collapsed as a result of fears from investors that the government would devalue the ruble, default on domestic debt, or both. Annual yields on the ruble denominated bonds were more than 200%. The stock market was down 65%. From January to August 1998 the stock market had lost more than 75 percent of its value.

History: Optimism
April 1996
Russian officials began negotiations to reschedule payment of foreign debt inherited from the former Soviet Union = major step toward restoring investor confidence Appeared to be a turning point for economic stability
Trade surplus moving toward a balance Improving relations with the West
IMF & World Bank prepared to provide expanded assistance

Inflation had fallen from 131% in 1995 to 11% in 1997 Output was recovering Oil (45% of Russias exports) selling at a high $23 per barrel

History: Problems
Summer 1997: S-E Asian Crisis
Pacific Rim countries experience currency crisis Soon after, the ruble comes under speculative attack
CBR defends currency, but loses nearly $6 billion in foreignexchange reserves

December 1997
Prices of oil & nonferrous metal (2/3 of Russias earnings) begin to drop In1998 real GDP declined 4.9%

History: Problems
February 1998
Russian government submits new tax code with fewer yet more efficient taxes Crucial parts intended to increase federal revenue ignored Russia fails to reach agreements for additional IMF funding

March 1998
President Yeltsin abruptly fires entire government Conflict between the government & CBR shake investor confidence

May 1998
With reporters in the room, CBR chair warns government ministers of debt crisis within 3 years Oversensitivity from Asian currency crisis lead investors to assume impending devaluation of the ruble

History: Problems
May 1998
Government bond yields had swelled to 47% Commercial banks & firms had less cash to keep them afloat Federal governments initiative to collect more taxes in cash lowered banks and firms liquidity Oil priced dropped to $11 per barrel

August 13, 1998

Annual yields on ruble-denominated bonds were at 200+% Russian stock, bond, & currency markets collapsed as a result of investor fears that the government would devalue the ruble, default on domestic debt, or both Stock market closed for 35 minutes as prices plummeted

History: Aftermath
From January to August the stock market lost more than 75% of its value On August 17, the government floated the exchange rate, defaulted on its domestic debt, halted payment on rubledenominated debt, and declared a 90-day moratorium on payment by commercial banks to foreign creditors

Interest Rates
During the summer of 1998, the Russian economy was primed for the onset of a currency crisis
In an attempt to avert the crisis, the Central Bank of Russia intervened by decreasing the growth of the money supply & twice increasing the lending rate to banks (raising it from 30% to 150%)

Interest Rates
The rise in interest rates had 2 effects:
First, it exacerbated Russias revenue problems
Debt grew rapidly as interest payments mounted This put pressure on the exchange rate because investors feared that Russia would devalue to finance its non-denominated debt

Second, high government debt prevented firms from obtaining loans for new capital and increasing the interest rate did not increase the supply of lending capital available to firms
At the same time, foreign reserves held by the CBR were so low that the government could no longer defend the currency by buying rubles

Inflation in Russia
Optimism before Crisis
Inflation had fallen from 131% in 1995 to 22% in 1996 to 11% in 1997 Promising relations with West (World Bank and IMF aid) Output recovering slightly

Inflation in Russia
Pessimistic Signs
In May 1998 the Central Bank of Russia (CBR) is forced to defend the ruble with $1 billion
Russian oil and gas tycoons begin to advocate for a devaluation of the ruble to increase the value of their exports affected by the decrease in oil prices. The lending rate is boosted to 150% by the CBR. August 13th 1998 IMF approves emergency aid packages which raises the fears of devaluation by investors weakening the stock, bond and currency markets.

GDP of Russia

Graph take from http://www.balticdata.info/russia/economics/macro_economics/russia_macro_economics_russia_GNP_GDP_summary.htm

GDP Decline
There were numerous factors attributing to the decline in the GDP between the 3rd quarter in 1997 and the 4th quarter of 1998:
The high government debt that Russia had to deal with following the collapse of the Soviet Union, and the doubt that investors had to the ability of the Russian government to be able to pay back their debt and not default The decreasing oil prices also contributed to the deficiencies in GDP growth as it lowered output this is due to the fact that Russia had to cutback on its production of natural resources in order to maintain a level of profit in the production of coal, oil, and natural gas Furthermore, the Asian crisis caused speculation that like the Thai Baht, the Ruble was also severely overvalued. The Central Bank of Russia tried to defend the Ruble in the late fall, and on November 11, 1997, the CBR loses $6 billion Finally, the impending short-term debt that Russia owed to other foreign countries in 1998 caused the sharp decrease in GDP in 1998.

Foreign Investments in Russia: before the currency crisis

Investor fears and worries severely weakens the Russian money markets (stock, currency, bond) this forces Russia to devalue the ruble, and default on some risk, lowering prices and GDP further in 1998 and 1999.

Chart taken from - http://www.nes.ru/english/research/pdf/1999/Strebul.pdf

GDP of Russia

Graph take from - http://research.stlouisfed.org/publications/review/02/11/ChiodoOwyang.pdf

GDP Growth
Russias GDP resurged following the currency crisis:
Renewed consumer spending is helping raise domestic production of consumer goods, increasing competition and therefore boosting quality, and affecting company behavior. The middle class (an estimated 1.16 million people out of a total population of 9.3 million) account for 60-70 percent of all consumer spending in the capital http://www.cdi.org/russia/johnson/5485-8.cfm A survey of the Moscow middle class (1,000 people aged 18 to 54 were questioned), conducted in July 2001 by ComCon, a Moscow market research firm, found that the middle class (an estimated 1.16 million people out of a total population of 9.3 million) account for 60-70 percent of all consumer spending in the capital. - http://www.cdi.org/russia/johnson/5485-8.cfm

Money Supply
M2: One measure of the
money supply that includes M1, plus savings and small time deposits, overnight repos at commercial banks, and noninstitutional money market accounts.

CPI: Consumer Price Index.

An inflationary indicator that measures the change in the cost of a fixed basket of products and services

Change in Annual Rate

Fragile Financial Systems

The inability of banks and other financial institutions to cover their obligations when confidence falls and investors make panic withdrawals can lead to their collapse. This fragility is an intrinsic characteristic of banking systems and will be heightened when banks hold assets in local currency while having liabilities in dollars (the socalled mismatch problem). Fears of a crisis, which lead to depreciation of the currency can then leave banks and corporations unable to cover their liabilities and result in a self-fulfilling prophecy of financial collapse.

Trade Balances During the Russian Default of 98

Implications of Trade Balance

Expect to see a general increase in trade deficit during a monetary crisis. This, coupled with government deficit, can raise interest rates and slow investment/growth. Exports have exceeded imports, even during the 1998 crisis. BOP closely approached zero, however, and saw a sharp decline. TD was never >5% and was not expected to fall in that magnitude, so TD was never a strong issue with Russia in 1998. Russias high BOP showed it could historically repay its debt, something which looks good to outsiders.