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Russian Financial Crisis Essay

2376 words - 10 pages

            The Russian financial crisis occurred on August 17, 1998, exacerbated by the global recession caused by the Asian financial crisis in 1997. Russia was highly dependent on exports of raw materials, with petroleum, natural gas, metals and timber accounting for more than 80% of its exports. With the drop in global demand, prices of those commodities began to decline. This resulted in an impact on its foreign exchange reserves since Russia had a fixed exchange rate regime during this period of time, where the ruble was only allowed to move within a narrow band. With the speculative attacks caused by the Asian financial crisis along with the decline in global demand, the Central Bank ...view middle of the document...

Investors continued to view the market with caution, the ruble continued to devalue, and capital flight continued out of Russia despite the bailout.
            The stock, bond, and currency markets in Russia collapsed on August 13, 1998, as investors feared further devaluation of the ruble and possible default on domestic debt. The annual yields on ruble denominated bonds were at an all time high of over 200%.  Prices for the financial instruments dropped quickly and were down by 65% at the end of the day. This caused the government to implement a floating exchange rate. On August 17, 1998, the government  “devalued the ruble, defaulted on its domestic debt, halted payment on ruble-denominated debt (primarily GKOs), and declared a 90-day moratorium on payment by commercial banks to foreign creditors”.
Taking a look at the fundamentals of the Russian economy and analyzing them will give us an idea of what exactly happened in 1998 and the preceding years. Our objective is to explain the different aspects and underlying causes of the currency crisis.
Analysis of the Fundamentals:
The PPP adjusted GDP was trending downwards from 1992 to 1998 with only one year of positive growth in 1997. Annualized growth rates ranged from -15% to -4% with the positive 1997 exception of around +1.5%.
Federal Budget and Federal Debt:
Looking at the federal budget, we can see that there have been significant deficits (5-11% of GDP) over the years from 1992-1998. As a result, more borrowing caused the federal debt to GDP ratio to jump from around 20% in 1992 to more than 50% in the beginning of 1998. Large proportions of the debt were coming from foreign lenders, however the share of domestic debt was increasing due to the creation of a domestic short-term Treasury Bill (GKO) market in 1995.
The federal debt level to GDP became unsustainably high and debt service payments were increasing significantly. In combination with a negative growth of real GDP, this turned out to be a vicious circle for the Russian economy. In order to finance their budget deficits they had to raise more money, which was only possible at higher interest rates. This again caused the level of debt and debt service payments to increase.
One problem that they had was that due to the fixed exchange rate regime, they could not inflate away the value of foreign debt. Money creation by the Central Bank of Russia therefore only reduced the value of domestic debt.
During the transition period from the soviet system to a market economy, Russia experienced hyperinflation of several hundred percent per year. Starting from 1994 however, there was a clear down trend and inflation was decreasing gradually over the next years until 1997, when it reached a minimum of 11%.
Interest rates (Lending rates):
Significantly decreasing interest rates from 1995 to 1997 were an indicator of lower inflation rates and therefore a positive sign for economic recovery after the transition from the...

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