Russian Crisis

7/28/2019 Russian Crisis

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Russian Currency

Crisis

Brian Billick

Davin Costa

Manuel Davila

Tom Degnan

Tom Lacny


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Russian Currency Crisis

Currency Crisis

Speculative attack on a countrys currency that

can result in a forced devaluation and possibledebt default

Russia 1998: led to the devaluation of the rubleand the default on public & private debt


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Declining productivity, an artificially high fixed exchangerate between the ruble and foreign currencies to avoid publicturmoil, and a chronic fiscal deficit were the reasons that led tothe crisis.

The economic cost of the first war in Chechnya (1994-1996),estimated at $5.5 billion (not including the rebuilding of the ruinedChechen economy), also contributed to the crisis.

When the East Asian financial crisis broke out in 1997, pricesfor 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 resultedin an economic chaos in the country where GDP per capita fell,unemployment soared, and global investors liquidated their Russianassets
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In an effort to prop up the currency and stem the flight of capital, in June1998 Kiriyenko hiked GKO (governments bonds) interest rates to150%.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 toRussian 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 governmentwould devalue the ruble, default on domestic debt, or both. Annualyields on the ruble denominated bonds were more than 200%. The

stock market was down 65%. From January to August 1998 the stockmarket had lost more than 75 percent of its value.


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History: Optimism April 1996

Russian officials began negotiations to reschedulepayment of foreign debt inherited from the former SovietUnion = 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


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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 foreign-exchange reserves

December 1997 Prices of oil & nonferrous metal (2/3 of Russias

earnings) begin to drop

In1998 real GDP declined 4.9%


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History: Problems February 1998

Russian government submits new tax code with fewer yetmore efficient taxes

Crucial parts intended to increase federal revenueignored

Russia fails to reach agreements for additional IMF

funding March 1998

President Yeltsin abruptly fires entire government

Conflict between the government & CBR shake investorconfidence

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 toassume impending devaluation of the ruble


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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 asa result of investor fears that the government woulddevalue the ruble, default on domestic debt, or both

Stock market closed for 35 minutes as prices

plummeted


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History: Aftermath

From January to August the stockmarket lost more than 75% of its value

On Augus t 17, the government f loatedthe exchange rate, defaulted on itsdomestic debt, halted payment on ruble-denominated debt, and declared a 90-daymoratorium on payment by commercialbanks to foreign creditors


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Interest Rates

During the summer of 1998, the Russianeconomy was primed for the onset of acurrency crisis

In an attempt to avert the crisis, the CentralBank of Russia intervened by decreasing thegrowth of the money supply & twice

increasing the lending rate to banks (raising itfrom 30% to 150%)


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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 andincreasing the interest rate did not increase thesupply of lending capital available to firmsAt the same time, foreign reserves held by the CBR

were so low that the government could no longerdefend the currency by buying rubles


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Inflation in Russia

Optimism before Crisis

Inflation had fallen from 131% in 1995 to22% in 1996 to 11% in 1997

Promising relations with West (WorldBank and IMF aid)

Output recovering slightly


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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 adevaluation of the ruble to increase the value of their exportsaffected by the decrease in oil prices.

The lending rate is boosted to 150% by the CBR.

August 13

th

1998 IMF approves emergency aid packageswhich raises the fears of devaluation by investors weakeningthe stock, bond and currency markets.


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GDP of Russia

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


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GDP Decline

There were numerous factors attributing to the decline in the GDPbetween the 3rd quarter in 1997 and the 4th quarter of 1998:

The high government debt that Russia had to deal with following the collapseof the Soviet Union, and the doubt that investors had to the ability of theRussian government to be able to pay back their debt and not default

The decreasing oil prices also contributed to the deficiencies in GDP growthas it lowered output this is due to the fact that Russia had to cutback on itsproduction of natural resources in order to maintain a level of profit in theproduction 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 todefend the Ruble in the late fall, and on November 11, 1997, the CBR loses $6billion

Finally, the impending short-term debt that Russia owed to other foreigncountries in 1998 caused the sharp decrease in GDP in 1998.


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Foreign Investments in Russia:before the currency crisis

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

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


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GDP of Russia

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


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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) accountfor 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 werequestioned), conducted in July 2001 by ComCon, a Moscow market researchfirm, found that the middle class (an estimated 1.16 million people out of atotal 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
http://www.cdi.org/russia/johnson/5485-8.cfmhttp://www.cdi.org/russia/johnson/5485-8.cfmhttp://www.cdi.org/russia/johnson/5485-8.cfmhttp://www.cdi.org/russia/johnson/5485-8.cfmhttp://www.cdi.org/russia/johnson/5485-8.cfmhttp://www.cdi.org/russia/johnson/5485-8.cfmhttp://www.cdi.org/russia/johnson/5485-8.cfmhttp://www.cdi.org/russia/johnson/5485-8.cfm


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Money Supply

M2: One measure of themoney supply that includes M1,plus savings and small timedeposits, overnight repos atcommercial banks, and non-institutional money marketaccounts.

CPI: Consumer Price Index.An inflationary indicator thatmeasures the change in the cost

of a fixed basket of products andservices


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Change in Annual Rate


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Fragile Financial Systems

The inability of banks and other financial institutions tocover their obligations when confidence falls andinvestors make panic withdrawals can lead to their collapse.

This f ragi l i ty is an intr insic character ist ic o f banking

sys tems and w i l l be heightened when banks hold assetsin local cu rrency wh i le having l iabi l i t ies in do l lars (the so-

called mismatch problem).

Fears of a crisis, which lead to depreciation of the currencycan then leave banks and corporations unable to cover theirliabilities and result in a self-fulfilling prophecy of financialcollapse.


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Trade Balances During the Russian Default of 98


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Implications of Trade Balance

Expect to see a general increase in trade deficit during a monetarycrisis. This, coupled with government deficit, can raise interest ratesand 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, soTD 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.

Documents

Russian Crisis