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Lessons from the Russian Crisis of 1998 and Recovery. Brian Pinto, Evsey Gurvich and Sergei Ulatov Draft Chapter for: Managing Economic Volatility and Crises: A Practitioner’s Guide Edited by Joshua Aizenman and Brian Pinto. Related papers.

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lessons from the russian crisis of 1998 and recovery

Lessons from the Russian Crisis of 1998 and Recovery

Brian Pinto, Evsey Gurvich and Sergei Ulatov

Draft Chapter for:

Managing Economic Volatility and Crises:

A Practitioner’s Guide

Edited by Joshua Aizenman and Brian Pinto

related papers
Related papers
  • Pinto, Vladimir Drebentsov, Alexander Morozov: “Give macroeconomic stability and growth in Russia a Chance: Harden budgets by Eliminating Nonpayments”, Economics of Transition, vol 8 (2) 2000, 297-324.
  • Homi Kharas, Pinto and Ulatov: “An Analysis of Russia’s 1998 Meltdown: Fundamentals and Market Signals”, Brooking Papers on Economic Activity, 1:2001, 1-67.
  • Joshua Aizenman, Kenneth M. Kletzer and Pinto, “Sargent-Wallace Meets Krugman-Flood-Garber, or: Why Sovereign Debt Swaps Don’t Avert Macroeconomic Crises.” NBER WP 9190.
key dates and events
Key Dates and Events
  • July 1995 3-year stabilization program agreed with IMF
  • July 1996 Yeltsin re-elected in second round
  • Early 1997 GKO/OFZ market liberalized, “DREAM TEAM”
  • Oct 1997 Chronic tax problem prompts IMF to hold up disbursements
  • July 13, 98 $22.6 billion package announced
  • August 17 Ruble devalued, emergency measures


  • September 2 Ruble is floated
  • September 9 Exchange rate reaches 21 R/$ compared to 6.29 R/$

on August 14

the economic and political costs of the crisis
The Economic and Political Costs of the Crisis
  • GDP minus 4.9%
  • 12-month inflation 84% - target was 8%
  • Pensioners/ wage earners suffered
  • FX resources used up between Oct. 1997 and the Sept. 2, 1998 float $30 billion. $16 billion incurred in the last 10 weeks before the meltdown
  • Reformist government of Sergei Kirienko was dismissed
four part framework
Four-Part Framework
  • Fundamentals and Liquidity
  • Market Signals
  • Crisis Triggers
  • Moral Hazard
public debt dynamics


d public debt/GDP ratio, t time subscript (in years)

pd primary deficit/GDP

ndfs non-debt financing sources/GDP

r composite real interest rate

g real growth rate

Public Debt Dynamics

These are captured by the standard equation (1):

public debt dynamics cont d


share of domestic currency debt in total debt


real interest rate on domestic currency debt



real interest rate paid on foreign currency debt (e.g., interest


rate paid by government on US dollar borrowing adjusted

for US inflation)


% change in dollar-ruble real exchange rate


> 0 means a real appreciation)

Public Debt Dynamics (cont’d)

This brings us to equation (2), which contains an

expanded version of the composite real interest rate, r:


why were growth expectations in russia consistently belied
Why were growth expectations in Russia consistently belied?
  • Macroeconomic environment: high real interest rates and an appreciating real exchange rate
  • Serious structural problems (the non-payments problem)
real exchange rate rer
Real Exchange Rate (RER)
  • Was real appreciation an equilibrium phenomenon?
  • Current Account Balances vs. Sargent –Wallace
  • RER movements = f (oil prices, capital flows, stabilization strategy
  • Stabilization Strategy was the main influence on RER
what is the non payments problem
What is the non-payments problem?
  • Curious phenomenon unique to Russia and the FSU
  • Consisted of two parts: (i) arrears/overdue payments and (ii) growing use of non-monetary exchange
  • Became entrenched because of high interest rates
  • Killed growth and locked-in the fiscal deficit
  • Rational economic explanations
  • Enveloped the entire economy
  • Linked to PDD
  • Linked to growth
market signals
Market Signals
  • Foreign Currency Debt (FCD)
  • Domestic Currency Debt (DCD)
spread difference on the russian and indonesian 10 year eurobonds
Spread difference on the Russian and Indonesian 10-year eurobonds
  • June 10, 1998 -100 bps
  • June 25, 1998 0
  • July 24 (completion of debt swap) +160
domestic currency debt dcd
Domestic Currency Debt (DCD)

Yields on one-year GKOs were decomposed using equation (3) to get the sovereign or default risk premium (SRP) and devaluation risk premium (DRP) as a residual.

(3) id = if + SRP + (dx/x)* + DRP

srp and drp selected dates

GKO yield



May 15




July 13




July 14




July 24




August 10




August 14




SRP and DRP Selected Dates
timing of the crisis
Timing of the Crisis

Three factors played a role:

  • International liquidity
  • Balance and off-balance sheet exposures of banks
  • GKO-Eurobond swap and IFI liquidity injection
the outcome of the swap


max. cutoff spread



min. spread


Market Value of GKOs tendered ($ bn.)

The Outcome of the Swap

Bid Spread (basispoints)



why didn t the swap work as anticipated
Why didn’t the swap work as anticipated?
  • No free lunch with market-based swap
  • Interaction effects with existing asset portfolio
  • Implications for size of devaluation needed to restore government’s inter-temporal budget constraint balance
moral hazard
Moral Hazard
  • There are many ex-post studies showing MH is not a factor
  • What matters is how MH affects behavior by changing expected returns
  • MH is a particularly costly issue when you have unsustainable PDD and low liquidity
post crisis developments
Post Crisis Developments
  • Hard budgets and RER
  • Liquidity and PDD
  • Macro policy stance (RER, Fiscal Adjustment)
  • Debt Restructuring
  • Social Impact
so what s the bottom line lessons learned
So, What’s the Bottom Line?Lessons Learned
  • Extremely difficult to deal with unsustainable PDD and low liquidity simultaneously.
  • Inflation reduction at the expense of fiscal and growth fundamentals will simply not work.
  • Real appreciation with deteriorating enterprise performance and PDD is unlikely to be sustainable EVEN if CA in balance.
lessons learned cont d
Lessons Learned (Cont’d)
  • Liquidity – appropriate measures.
  • Why financial engineering will not help.
  • Social safety net lessons.
  • Politics