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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

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Russian Currency 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 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

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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

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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

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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

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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%

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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

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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 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

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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

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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%)

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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

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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)

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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

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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 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.

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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)

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GDP of Russia

Graph take from –

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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.

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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 -

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GDP of Russia

Graph take from -

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GDP Growth

  • Russia’s GDP resurged following the currency crisis:

  • “Renewed consumer spending is not only helping fuel Russia's economicrecovery (high oil prices have also played a major role), it is helpingraise domestic production of consumer goods, increasing competition andtherefore boosting quality, and affecting company behavior.” -

  • 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 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 consumerspending in the capital.” -

  • 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

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Money Supply

  • M2: One measure of the money supply that includes M1, plus savings and small time deposits, overnight repos at commercial banks, and non-institutional 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

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Change in Annual Rate

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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 so-called “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.

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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 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.

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