Russian Currency
Crisis
Brian Billick
Davin Costa
Manuel Davila
Tom Degnan
Tom Lacny
Russian Currency Crisis
 Currency Crisis
– Speculative attack on a country’s 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
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
 Narrow band in place to keep exchange rate between 5
and 6 rubles to the dollar
 Oil (45% of Russia’s exports) selling at a high $23 per
barrel
History: Optimism
 September 1997
– Russia allowed to join the Paris Club of creditor
nations after rescheduling the payment of over
$60 billion in old Soviet debt to other governments
 October 1997
– Another agreement for a 23-year debt repayment
of $33 billion signed with the London Club
 Analysts predicted Russia’s credit ratings
would improve, allowing the country to borrow
less expensively
 Limitations on the purchase of government
securities removed, promoting foreign
investment in Russia
History: Problems
 Real wages less than half what they were in 1991
– Only about 40% of work force paid in full & on time
 Low tax collection causing the public sector deficit to remain
high
 Paris Club’s recognition of Russia as a creditor nation based on
questionable qualifications
– ¼ of the assets considered to belong to Russia were in the
form of debt owed to the former Soviet Union by countries
such as Cuba, Mongolia, & Vietnam
– Relied on old Soviet exchange rate of 0.6 rubles to the dollar
(despite market rate of 5-6 R/$)
 Despite problems, restrictions eased/lifted
– Foreign liabilities increased from 7% of assets in 1994 to
17% in 1997
History: Problems
 Summer 1997
– Pacific Rim countries experience currency crisis
– Soon after, the ruble comes under speculative
attack
 CBR defends currency, but loses nearly $6 billion in
foreign-exchange reserves
 December 1997
– Prices of oil & nonferrous metal (2/3 of Russia’s
earnings) begin to drop
 The Russian government was counting on
2% economic growth in 1998 to compensate
for its debt growth
– Instead 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 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 government’s 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 ruble-denominated
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 CBR
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 Russia’s 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 Defined
An increase in the general price level of goods and
services.
A decrease in purchasing power of the currency
measured as a percentage increase in the consumer
price index (CPI)
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.
Inflation in Russia
 Inevitable Devaluation
– Asian crisis made investors more conscious of possibility of
Russian devaluation and default
– Perception of crisis within Russian government
– Increasing domestic interest rates
– High speculation and low investor confidence reduce leverage
power of central bank
 Result
– Russian Government devalues the ruble on August 17th 1998
– Inflation rises dramatically
– Ruble is floated (Pegging system fails)
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
 Russia’s GDP resurged following the currency crisis:
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“Renewed consumer spending is not only helping fuel Russia's economic
recovery (high oil prices have also played a major role), it is helping
raise domestic production of consumer goods, increasing competition and
therefore boosting quality, and affecting company behavior.” http://www.cdi.org/russia/johnson/5485-8.cfm
Essentially, a middle class that makes up about 35% of the overall population of
Russia in 2000 (close to 60% lived in poverty) began to purchase more with
disposable income
“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
The increase in consumer spending paved the way for new shopping centers
and new commercial areas and allowed the economy of Russia to grow
following the 1998 currency crisis
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.
 Russia’s high BOP showed it could historically repay its debt,
something which looks good to outsiders.