1998 Russian financial crisis

The Russian financial crisis (also called Ruble crisis or the Russian Flu) hit Russia on 17 August 1998. It resulted in the Russian government and the Russian Central Bank devaluing the ruble and defaulting on its debt. The crisis had severe impacts on the economies of many neighboring countries.

Background and course of events

Declining productivity, a 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, estimated at $5.5 billion (not including the rebuilding of the ruined Chechen economy), also contributed to the crisis. In the first half of 1997, the Russian economy showed some signs of improvement. However, soon after this, the problems began to gradually intensify.

Two external shocks, the Asian financial crisis that had begun in 1997 and the following declines in demand for (and thus price of) crude oil and nonferrous metals, severely impacted Russian foreign exchange reserves.^[1]

A political crisis came to a head in March when Russian president Boris Yeltsin suddenly dismissed Prime Minister Viktor Chernomyrdin and his entire cabinet on 23 March 1998.^[2] Yeltsin named Energy Minister Sergei Kiriyenko, then 35 years old, as acting prime minister.

On 29 May 1998, Yeltsin appointed Boris Fyodorov as Head of the State Tax Service.

In an effort to prop up the currency and stem the flight of capital, in June 1998 Kiriyenko hiked GKO interest rates to 150%.

A $22.6 billion International Monetary Fund and World Bank financial package was approved on 13 July 1998 to support reforms and stabilize the Russian market by swapping out an enormous volume of the quickly maturing GKO short-term bills into long-term Eurobonds. The Russian government decided to keep the exchange rate of the ruble within a narrow band, although many economists, including Andrei Illarionov and George Soros, urged the government to abandon its support of the ruble.

On 12 May 1998, coal miners went on strike over unpaid wages, blocking the Trans-Siberian Railway. By 1 August 1998 there were approximately $12.5 billion in debt owed to Russian workers. On 14 August 1998 the exchange rate of the Russian ruble to the US dollar was still 6.29. Despite the bailout, July 1998 monthly interest payments on Russia’s debt rose to a figure 40 percent higher than its monthly tax collections.

Additionally, on 15 July 1998, the State Duma dominated by left-wing parties refused to adopt most of the government anti-crisis plan so that the government was forced to rely on presidential decrees. On 29 July Yeltsin interrupted his vacation in Valdai Hills region and flew to Moscow, prompting fears of a Cabinet reshuffle, but he only replaced Federal Security Service Chief Nikolay Kovalyov with Vladimir Putin.

At the time, Russia employed a "floating peg" policy toward the ruble, meaning that the Central Bank decided that at any given time the dollar-to-ruble (or USD/RUB) exchange rate would stay within a particular range. If the ruble threatened to devalue outside of that range (or "band"), the Central Bank would intervene by spending foreign reserves to buy rubles. For instance, during the year prior before the crisis, the Central Bank aimed to maintain a band of 5.3 to 7.1 USD/RUB, meaning that it would sell rubles if the market exchange rate threatened to exceed 7.1 dollars per ruble. Similarly, it would buy rubles if the market exchange rate threatened to drop below 5.3.

The inability of the Russian government to implement a coherent set of economic reforms led to a severe erosion in investor confidence and a chain reaction that can be likened to a run on the Central Bank. Investors fled the market by selling rubles and Russian assets (such as securities), which also put downward pressure on the ruble. This forced the Central Bank to spend its foreign reserves to defend Russia's currency, which in turn further eroded investor confidence and undermined the ruble. It is estimated that between 1 October 1997 and 17 August 1998, the Central Bank expended approximately $27 billion of its U.S. dollar reserves to maintain the floating peg.

It was later revealed that about $5 billion of the international loans provided by the World Bank and International Monetary Fund were stolen upon the funds' arrival in Russia on the eve of the meltdown.^[3][4]

Crisis and effects

On 17 August 1998, the Russian government devalued the ruble, defaulted on domestic debt, and declared a moratorium on repayment of foreign debt.^[5] On that day the Russian government and the Central Bank of Russia issued a "Joint Statement" announcing, in essence, that:^[6]

1. the dollar/ruble trading band would expand from 5.3–7.1 USD/RUB to 6.0–9.5 USD/RUB;
2. Russia's ruble-denominated debt would be restructured in a manner to be announced at a later date; and, to prevent mass Russian bank default,
3. a temporary 90-day moratorium would be imposed on the payment of some bank obligations, including certain debts and forward currency contracts.^[7]

On 17 August 1998 the government declared that certain state securities (GKOs and OFZs) would be transformed into new securities.

At the same time, in addition to widening the currency band, authorities also announced that they intended to allow the USD/RUB rate to move more freely within the wider band.

At the time, the Moscow Interbank Currency Exchange (or "MICEX") set a daily "official" exchange rate through a series of interactive auctions based on written bids submitted by buyers and sellers. When the buy and sell prices matched, this "fixed" or "settled" the official MICEX exchange rate, which would then be published by Reuters. The MICEX rate was (and is) commonly used by banks and currency dealers worldwide as the reference exchange rate for transactions involving the Russian ruble and foreign currencies.

From 17 to 25 August 1998, the ruble steadily depreciated on the MICEX, moving from 6.43 to 7.86 USD/RUB. On 26 August 1998, the Central Bank terminated dollar-ruble trading on the MICEX, and the MICEX did not fix a dollar-ruble rate that day.

On 2 September 1998 the Central Bank of the Russian Federation decided to abandon the "floating peg" policy and float the ruble freely. By 21 September 1998 the exchange rate had reached 21 rubles for one US dollar, meaning it had lost two thirds of its value of less than a month earlier.

On 28 September 1998 Boris Fyodorov was discharged from the position of the Head of the State Tax Service.

The moratorium imposed by the Joint Statement expired on 15 November 1998, and the Russian government and Central Bank did not renew it.

Inflation

Russian inflation in 1998 reached 84 percent and welfare costs grew considerably. Many banks, including Inkombank, Oneximbank and Tokobank, closed as a result of the crisis.

Agriculture

The main effect of the crisis on Russian agricultural policy has been a dramatic drop in federal subsidies to the sector, about 80 percent in real terms compared with 1997, though subsidies from regional budgets fell less.^[8]

Political fallout

The financial collapse resulted in a political crisis as Yeltsin, with his domestic support evaporating, had to contend with an emboldened opposition in the parliament. A week later, on 23 August 1998, Yeltsin fired Kiriyenko and declared his intention of returning Chernomyrdin to office as the country slipped deeper into economic turmoil.^[9] Powerful business interests, fearing another round of reforms that might cause leading enterprises to fail, welcomed Kiriyenko's fall, as did the Communists.

Yeltsin, who began to lose his hold on power as his health deteriorated, wanted Chernomyrdin back, but the legislature refused to give its approval. After the Duma rejected Chernomyrdin's candidacy twice, Yeltsin, his power clearly on the wane, backed down. Instead, he nominated Foreign Minister Yevgeny Primakov, who on 11 September 1998 was approved by the State Duma by an overwhelming majority.

Primakov's appointment restored political stability, because he was seen as a compromise candidate able to heal the rifts between Russia's quarreling interest groups. There was popular enthusiasm for Primakov as well. Primakov promised to make the payment of wages and pensions his government’s first priority, and invited members of the leading parliamentary factions into his Cabinet.

Communists and the Federation of Independent Trade Unions of Russia staged a nationwide strike on 7 October 1998 and called on President Yeltsin to resign. On 9 October 1998, Russia, which was also suffering from a poor harvest, appealed for international humanitarian aid, including food.

Recovery

Russia bounced back from the August 1998 financial crash with surprising speed. Much of the reason for the recovery is that world oil prices rapidly rose during 1999–2000 (just as falling energy prices on the world market helped to deepen Russia's financial troubles), so that Russia ran a large trade surplus in 1999 and 2000. Another reason is that domestic industries, such as food processing, had benefited from the devaluation, which caused a steep increase in the prices of imported goods.^[10][11]

Also, since Russia's economy was operating to such a large extent on barter and other non-monetary instruments of exchange, the financial collapse had far less of an impact on many producers than it would had the economy been dependent on a banking system. Finally, the economy had been helped by an infusion of cash. As enterprises were able to pay off debts in back wages and taxes, in turn consumer demand for goods and services produced by the Russian industry began to rise.

See also

• Long-Term Capital Management, hedge fund sunk in the wake of the Russian crisis
• GKO-OFZ, Russian government bonds
• Great Recession in Russia
• Russian financial crisis (2014–present)

Contemporaneous financial crises:

• 1997 Asian financial crisis
• 1998–2002 Argentine great depression

General:

• Flight-to-liquidity
• Sovereign default
• Vulture fund

References

1. Russian Federation: International Reserves and Foreign Currency Liquidity, IMF, 25 June 2012
2. "Online NewsHour: Russia Shake Up- March 23, 1998". Pbs.org. Archived from the original on 9 November 2010. Retrieved 3 November 2010.
3. "Radio Free Europe/ Radio Liberty". Rferl.org. 27 June 2002. Archived from the original on 26 May 2011. Retrieved 14 May 2011.
4. Hirschler 1999.
5. Chiodo & Owyang 2002.
6. "Joint Statement by the Government of the Russian Federation and the Central Bank of the Russian Federation On the Exchange Rate Policy", 17 August 1998.
7. STATEMENT of the Government of the Russian Federation and the Central Bank of the Russian Federation 17 August 1998
8. Web Archives: View Archived Page. Ers.usda.gov. Retrieved on 2013-10-23.
9. "Online NewsHour: Russia's Crisis – September 17, 1998". Pbs.org. Archived from the original on 8 November 2010. Retrieved 3 November 2010.
10. Stiglitz, Joseph (9 April 2003). "The ruin of Russia". The Guardian (London). Retrieved 21 April 2010.
11. "CIA – The World Factbook – Russia". Cia.gov. Archived from the original on 14 May 2011. Retrieved 14 May 2011.

Further reading

• Boughton, James M. (2012). Tearing Down Walls: The International Monetary Fund, 1990–1999. Washington, DC: IMF. pp. 287–347. ISBN 978-1-616-35084-0.
• Buchs, Theirry D. (1999). "Financial crisis in the Russian Federation: Are the Russians learning to tango?". Economics of Transition 7 (3): 687–715. doi:10.1111/1468-0351.00031. (subscription required)
• Chiodo, Abbigail J.; Owyang, Michael T. (2002). "A Case Study of a Currency Crisis: The Russian Default of 1998" (PDF). Federal Reserve Bank of St. Louis Review 84 (6): 7–18.
• Desai, Padma (2000). "Why Did the Ruble Collapse in August 1998?". The American Economic Review 90 (2): 48–52. JSTOR 117190. (subscription required)
• Estrin, Saul (1998). "The Russian Default". Business Strategy Review 9 (3): 1–6. (subscription required)
• Gaidar, Yegor (1999). "Lessons of the Russian Crisis for Transition Economies" (PDF). Finance and Development 36 (2): 6–8.
• Gould-Davies, Nigel; Woods, Ngaire (1999). "Russia and the IMF". International Affairs 75 (1): 1–21. JSTOR 2625460. (subscription required)
• Henry, Brian; Nixon, James (1998). "The Crisis in Russia: Some Initial Observations". Economic Outlook 23 (1): 22–29. doi:10.1111/1468-0319.00148. (subscription required)
• Hirschler, Richard, ed. (1999). "Foreign Loans Diverted in Monster Money Laundering". Transition (World Bank) 10 (4): 11–13. Archived from the original (PDF) on 7 November 2010. Retrieved 3 April 2015.
• Kharas, Homi; Pinto, Brian; Ulatov, Sergei (2001). "An Analysis of Russia's 1998 Meltdown: Fundamentals and Market Signals". Brookings Papers on Economic Activity 2001 (1): 1–50. JSTOR 1209157. (subscription required)
• Lokshin, Michael; Ravallion, Martin (2000). "Welfare Impacts of the 1998 Financial Crisis in Russia and the Response of the Public Safety Net". Economics of Transition 8 (2): 269–295. doi:10.1111/1468-0351.00045. (subscription required)
• Medvedev, Alexei (2001). "International investors, contagion and the Russian crisis" (PDF). BOFIT Discussion Papers 2001 (6). Helsinki: Bank of Finland Institute for Economies in Transition. ISBN 951-686-954-8.
• Perotti, Enrico (2002). "Lessons from the Russian Meltdown: The Economics of Soft Legal Constraints". International Finance 5 (3): 359–399. doi:10.1111/1468-2362.00101. (subscription required)
• Pinto, Brian; Gurvich, Evsey; Ulatov, Sergei (2005). "Lessons from the Russian Crisis of 1998 and Recovery". In Joshua Aizenman and Brian Pinto, eds., Managing Economic Volatility and Crises: A Practitioner's Guide. New York NY: Cambridge University Press. pp. 406–438. ISBN 978-0-521-85524-2.
• Pinto, Brian; Ulatov, Sergei (2010). "Russia 1998 Revisited: Lessons for Financial Globalization" (PDF). Economic Premise (Washington, DC: World Bank) 37.
• Reisman, Daniel (1999). "Russia's Tax Crisis: Explaining Falling Revenues in a Transitional Economy". Economics & Politics 11 (2): 145–169. doi:10.1111/1468-0343.00056. (subscription required)
• Tompson, William (1999). "The Bank of Russia and the 1998 Rouble Crisis". In Vladimir Tikhomirov, ed., Anatomy of the 1998 Russian Crisis. Melbourne: Contemporary Europe Research Centre. pp. 108–144. ISBN 978-0-734-01728-4.
• Treisman, Daniel (2006). "Evaluating Exchange Rate Management" (PDF). In Timothy J. Colton and Stephen Holmes, eds., The State After Communism: Governance in the New Russia. Lanham, MD: Rowman & Littlefield. pp. 187–224. ISBN 978-0-742-53941-9.
• Chronology of the Russian Financial Crisis 1998 by Clifford Chance.
• Overview of Structural Reforms in Russia after 1998 Financial Crisis by S.A. Vasiliev, International Monetary Fund, 16 February 2000.
• 1999 IMF World Economic Outlook, Interim Assessment, Ch. II: The Crisis in Emerging Markets, International Monetary Fund, December 1999.
• Russia's Silent Middle Class, by Carol Clark, CNN, September 1998