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.
- 1 Background and course of events
- 2 Crisis and effects
- 3 Recovery
- 4 Effects on countries in the world
- 5 See also
- 6 References
- 7 External links
Background and course of events
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, 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. 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 Russia’s 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.
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. Yeltsin named Energy Minister Sergei Kiriyenko, then 35 years old, as acting prime minister.
By May 18, government bond yields had swelled to 47%. With inflation at about 10 percent, Russian banks would normally have taken the government paper at such high rates. Lack of confidence in the government’s ability to repay the bonds and restricted liquidity, however, did not permit this. As depositors and investors became increasingly cautious of risk, these commercial banks and firms had less cash to keep them afloat. The federal government’s initiative to collect more taxes in cash lowered banks’ and firms’ liquidity.
On 29 May 1998, Yeltsin appointed Boris Fyodorov as Head of the State Tax Service. The growth of internal loans could only be provided at the expense of the inflow of foreign speculative capital, which was attracted by very high interest rates.
The government formed and advertised an anti-crisis plan, requested assistance from the West, and began bankruptcy processes against three companies with large debts from back taxes. Kiriyenko met with foreign investors to reassure them. Yeltsin made nightly appearances on Russian television, calling the nation’s financial elite to a meeting at the Kremlin where he urged them to invest in Russia. In June the Russian Central Bank defended the ruble, losing $5 billion in reserves.
In an effort to prop up the currency and stem the flight of capital, in June 1998 Kiriyenko hiked GKO 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 the end of 1997, the situation with the tax receipts was very tense, and it had a negative effect on the financing of major budget items (pensions, communal utilities, transportation etc.).
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. This had started to be implemented with some success by 24 July 1998, yet 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 ruble-to-dollar (or RUR/USD) 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 RUR/USD, meaning that it would buy rubles if the market exchange rate threatened to exceed 7.1 rubles per dollar. Similarly, it would sell 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.
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 percent. The stock market had to be closed for 35 minutes as prices plummeted. When this happened, it was down 65 percent with a small number of shares actually traded. From January to August 1998 the stock market had lost more than 75 percent of its value, 39 percent in the month of May alone.
Crisis and effects
On 17 August 1998, the Russian government devalued the ruble, defaulted on domestic debt, and declared a moratorium on payment to foreign creditors. On that day the Russian government and the Central Bank of Russia issued a "Joint Statement" announcing, in essence, that:
- the ruble/dollar trading band would expand from 5.3–7.1 RUR/USD to 6.0–9.5 RUR/USD;
- 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,
- a temporary 90-day moratorium would be imposed on the payment of some bank obligations, including certain debts and forward currency contracts.
On 17 August 1998 the government declared in the Joint Statement of the Government of the Russian Federation and the Central Bank of the Russian Federation that the state securities (GKOs and OFZs), with due dates through 31 December 1999, would be transformed into new securities. The terms of the GKO/OFZ restructuring were also determined in the following acts:
- Decree of the Government of the Russian Federation №1007 of 25 August 1998
- Decree of the President of the Russian Federation №888 of 25 August 1998
- Decree №1787-р of 12 December 1998 on novation of state securities
- Federal Law on Top-Priority Measures in the Field of Budget and Tax Policy
GKO bondholders made few attempts to pursue litigation in domestic courts.
At the same time, in addition to widening the currency band, authorities also announced that they intended to allow the RUR/USD 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 RUR/USD. On 26 August 1998, the Central Bank terminated ruble-dollar trading on the MICEX, and the MICEX did not fix a ruble-dollar 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.
Russian inflation in 1998 reached 84 percent and welfare costs grew considerably. Many banks, including Inkombank, Oneximbank and Tokobank, were closed down as a result of the crisis. The salaries of miners alone were to consume $919 million, more than one percent of the federal budget. By August 1998, the government had paid $4 billion to settle miners’ strikes. Prices for almost all Russian food items had gone up by almost 100%, while imports had quadrupled in price.
Many citizens were stocking up for bad times and throughout the country shop shelves were being emptied, leaving a shortage of even the most basic items, such as vegetable oil, sugar, matches or washing powder. The crisis reduced demand for food and lowered food consumption, because substantial depreciation of the ruble significantly raised domestic prices for food products. The crisis also increased social tension. The middle class that was already forming by that time had some hope for stability.
The confidence of crisis prevention crumbled as millions of people lost their life savings due to banks closing. On 7 October 1998, demonstrations were held in many cities: around 100,000 took to the streets in Moscow, In Vladivostok 4,000, in Krasnoyarsk 3,000 and in Yekaterinburg 6,000. Defence Minister Igor Sergeyev cancelled his scheduled visit to Greece in the first week of October 1998, in order to be at hand should matters get out of control. Select military units were placed in a state of readiness. On 20 October 1998, President Boris Yeltsin also signed a presidential decree banning "mass protests" in Moscow between the hours of 10 pm and 7 a.m.and limiting them to a maximum of five days.
As the crisis deepened, regional governors had been introducing emergency measures: In Krasnoyarsk Krai in Siberia, governor Aleksandr Lebed, had signed a resolution to hold down prices "using administrative methods", a television report said. The authorities in the far eastern city of Vladivostok had banned deliveries of food to areas beyond the port city, and there had been talks of introducing rationing there. In Russia's Kaliningrad enclave on the Baltic, the governor announced a suspension of tax payments to the federal authorities.
Regional budgets also suffered from the 1998 crisis. Spending[specify] declined from 18.2% of the GDP in 1997 to 14.8% of the GDP. Spending on the economy (by 1.5% of the GDP) and social expenditures (by 1.6% of the GDP) were reduced especially heavily. The expenditures continued to decline in the following period. They[specify] dropped another 1% of the GDP in 1999 to 13.8% of the GDP, and to 10.8% of the GDP in the first quarter of 2000. One of the main factors in the reduction was the decline in subsidies for housing and municipal services, from 3.5% to 2.7% of the GDP.
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.
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. 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; in a televised address to the nation, Yeltsin said that “heavyweights” such as Chernomyrdin, who was ousted as prime minister in March 1998 for failing to vigorously promote economic reforms, were needed to stem the nation's financial collapse. Yeltsin also suggested that Chernomyrdin would be named his successor as president when Yeltsin's term expired in 2000. 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 wage and pension 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 bad harvest, appealed for international humanitarian aid, including food.
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.
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.
For the first time in many years, in 2000 unemployment fell as enterprises added workers. Since the 1998 crisis, the Russian government has managed to keep social and political pressures under control, and this has played a vital role in bringing about the current recovery.[dubious ]
Effects on countries in the world
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The financial crisis spread panic throughout the world financial system.
The Russian crisis affected Baltic countries more than expected. Estonia, Latvia and Lithuania sank into recession. Figures for 1999 showed a heavy decline in exports from these countries to Russia, in addition to a significant decline in growth rates of these economies. Food and beverage as well as processing industries as a whole suffered the most.
Overall, economic activity slowed down substantially in the immediate aftermath of the Russian crisis, with output growth falling from about 8.5 percent in 1998 to 3.4 percent in 1999. Both exports and imports contracted substantially, resulting in a drop in the current account deficit from a 6.1 percent GDP in 1998 to 2.2 percent in 1999. Externally, exports to Russia, which accounted for more than 60 percent of total exports, fell during the second half of 1998 by 10 percent.
Demand for Belarusian products was weak through 1999, showing signs of recovery only during the final quarter, with the revival of economic activity in Russia. Also, in the first quarter of 1999, compared to 1998, except for investments, all budget expenditures were smaller. The biggest cuts were made in national security (a 1.9 GDP, compared to 2.5 percent in the first quarter of 1998) and social policy (1.5 and 2.4 percent of GDP, respectively) where expenditures were lowered almost by one third.
The Russian crisis was a hard blow to the Kazakh economy. Kazakhstan lost its pricing competitiveness and its exports were in shambles. On the other hand, cheap Russian goods were flowing into the country, essentially killing domestic industries. There was huge pressure on the tenge, the Kazakh currency, and Kazakhstan's balance of payments worsened. However, the NBK continued to maintain the value of the tenge. In fact, they had spent close to a billion dollars to maintain the level of tenge. Their foreign exchange reserves halved.
Moldova received an IMF special mission advising the government on how to cope with the effects of the Russian crisis. At that time Russia bought 85% of Moldova's wine and brandy, as well as most of its canned goods and tobacco. After the ruble crashed, most Russian importers put deals with Moldova on hold. Moldovan president Petru Lucinschi was quoted as saying that the Russian crisis had cost Moldova as much as five per cent of its GDP. The country's parliament was discussing a programme aimed at reducing imports and searching for new markets outside Russia.
The U.S. stock market, following a decade of rapid and accelerating increases, began to slip in early August 1998, amid fears about Asia and Russia. The Dow Jones Industrial Average fell 984 points, or 11.5%, in 3 days at the end of August, to a level 19% below its July peak. This more than erased the year's market gains. The U.S. stock market remained depressed until October, when a series of interest rate reductions by the Federal Reserve propelled it back upward.
In the central Asian state, the government banned free unlicensed sales of food, most of which is imported from Russia, as a preventative measure against prices rising and subsequent panic.
- Long-Term Capital Management, hedge fund sunk in the wake of the Russian crisis
- GKO-OFZ, Russian government bonds
Contemporaneous financial crises:
- Russian Federation: International Reserves and Foreign Currency Liquidity, IMF, 25 June 2012
- Russian Financial Crisis of 1998: An Economic Investigation, International Journal of Applied Econometrics and Quantitative Studies Vol. 1-4 ,2004.
- "Online NewsHour: Russia Shake Up- March 23, 1998". Pbs.org. Archived from the original on 9 November 2010. Retrieved 3 November 2010.
- "Radio Free Europe/ Radio Liberty". Rferl.org. 27 June 2002. Archived from the original on 26 May 2011. Retrieved 14 May 2011.
- "Foreign Loans Diverted in Monster Money Laundering". Worldbank.org. Archived from the original on 7 November 2010. Retrieved 3 November 2010.
- A Case Study of a Currency Crisis: The Russian Default of 1998
- "Joint Statement by the Government of the Russian Federation and the Central Bank of the Russian Federation On the Exchange Rate Policy", August 17, 1998.
- STATEMENT of the Government of the Russian Federation and the Central Bank of the Russian Federation 17 August 1998
- Federal Law No 192-ФЗ of 12 December 1998 on Top-Priority Measures in the Field of Budget and Tax Policy.
- e.g. Federal Commercial (Arbitrazh) Court of Moscow District [FASMO] No КГ-А40/172-00 of 1 February 2000.
- Web Archives: View Archived Page. Ers.usda.gov. Retrieved on 2013-10-23.
- "Online NewsHour: Russia's Crisis – September 17, 1998". Pbs.org. Archived from the original on 8 November 2010. Retrieved 3 November 2010.
- Stiglitz, Joseph (9 April 2003). "The ruin of Russia". The Guardian (London). Retrieved 21 April 2010.
- "CIA – The World Factbook – Russia". Cia.gov. Archived from the original on 14 May 2011. Retrieved 14 May 2011.
- David M. Kotz, "Russia's Financial Crisis: The Failure of Neoliberalism?", University of Massachusetts, 1998
- The Crisis in Russia: Some Initial Observations by Brian Henry and James Nixon, Economic Outlook, Vol. 23, No. 1, November 1998 (subscription required).
- An Analysis of Russia's 1998 Meltdown: Fundamentals and Market Signals by Homi Kharas, Brian Pinto and Sergei Ulatov, Brookings Papers on Economic Activity, #1, 2001 (subscription required).
- Lessons from the Russian Crisis of 1998 and Recovery by Brian Pinto, Evsey Gurvich, and Sergei Ulatov, The World Bank, February 2004.
- Why Did the Ruble Collapse in August 1998? by Padma Desai, The American Economic Review Vol. 90, No. 2, 2000 (subscription required).
- The Bank of Russia and the 1998 Rouble Crisis by William Tompson. In Vladimir Tikhomirov (ed.), Anatomy of the 1998 Russian Crisis (Melbourne: CERC, 1999).
- A Case Study of a Currency Crisis: The Russian Default of 1998 by Abbigail J. Chiodo and Michael T. Owyang.
- Chronology of the Russian Financial Crisis 1998 by Clifford Chance.
- Lessons of the Russian Crisis for Transition Economies by Yegor Gaidar, Finance and Development, Vol. 36, No. 2 (June 1999).
- Welfare Impacts of the 1998 Financial Crisis in Russia and the Response of the Public Safety Net by Michael Lokshin and Martin Ravallion, The Economics of Transition 8 (2), July 2000 (subscription required).
- Overview of Structural Reforms in Russia after 1998 Financial Crisis by S.A. Vasiliev, International Monetary Fund, 16 February 2000.
- International investors, contagion and the Russian crisis by Alexei Medvedev, BOFIT #6, 2001.
- Financial crisis in the Russian Federation by Thierry D. Buchs, Economics of Transition 7 (3), 1999 (subscription required).
- The Russian Default by Saul Estrin, Business Strategy Review 9 (3), September 1998 (subscription required).
- Russia's Tax Crisis: Explaining Falling Revenues in a Transitional Economy by Daniel Treisman, Economics & Politics 11 (2), July 1999 (subscription required).
- 1999 IMF World Economic Outlook, Interim Assessment, Ch. II: The Crisis in Emerging Markets, International Monetary Fund, December 1999.
- Russia and the IMF by Nigel Gould-Davies and Ngaire Woods, International Affairs 7 (1), January 1999 (subscription required).
- Lessons from the Russian Meltdown: The Economics of Soft Legal Constraints by Enrico Perotti, International Finance 5 (3), 2002 (subscription required).
- Russia's Silent Middle Class, by Carol Clark, CNN, September 1998