Excerpt
Table of Contents
Table of Figures
Abbreviations
1. Introduction
2. A Currency Crisis in the Macroeconomic Theory
3. History of the Russian Default
3.1. Optimism and Reform
3.2. Virtual Economy, Revenue, Investment, and Debt
3.3. The Asian Crisis
3.4. Government, Risk, and Expectations
3.5. Liquidity, Monetary Policy, and Fiscal Policy
3.6. Default and Devaluation
3.7. The Aftermath
4. Why Did the Rouble Collapse?
5. Lessons Learned
6. Conclusion
7. References
Table of Figures
Figure 1: Russian Merchandise Trade Balance 1994-2000
Figure 2: CPI Inflation: Percent Change over Previous Year 1995-2000
Figure 3: Exchange Rate Ruble/US $ 1995-2000
Figure 4: Lending Rate 1996-2000
Figure 5: The Russian Stock Market 1996-2001
Figure 6: Real GDP Growth 1995-2001
Abbreviations:
Central Bank of Russia (CBR)
International Monetary Fund (IMF)
Gosudarstvennoye Kratkosrochnoye Obyazatyelstvo (GKO)
Gross Domestic Product (GDP)
Russian Trading System (RTS)
„The Chinese use two brush strokes to write the word ‘crisis.’ One brush stroke stands for danger; the other for opportunity. In a crisis, be aware of the danger - but recognize the opportunity.“ 1
John F. Kennedy, April 12, 1959
1. Introduction
Once again Russia’s positive economic development outlook has been thrown into question by the global financial crisis. The country has faced a whole lot of economic problems in the past months. Russians have withdrawn 290 billion Dollars from the country’s banks in fear of a financial collapse. At first sight on the past two years’ events on Russia’s financial market one may have had an impression of a „déjà-vu”:
Since August 2008: the Rouble has dropped about one third against the Euro over 30 percent and against the Dollar even more than 40 percent.1 2 The incoming foreign investment of 28 billion Dollars which broke all records right in the year before has now shrunk up to a few billion. The country’s two stock markets, the Russian Trading System (RTS) and the Moscow Interbank Currency Exchange (MICEX), have fallen 78 percent and 67 percent respectively since their highs in May 2008.3 It appears as some cynical 10th anniversary of 17th of August 1998: when the Russian Government announced the gradual devaluation of the Rouble, the default on domestic and foreign debts, and declared a moratorium on payment by Russian commercial banks to foreign creditors. So the Rouble has dropped to the Dollar more than 300percent in the following months and was six times lower only a year after.
At the outset this paper sets the currency crisis into the framework of the macroeconomic theory and provides a historical overview by putting the 1998 crisis into its timeframe and showing the impacts on the Russian economy. Furthermore the following questions are discussed: Why did the Rouble collapse? Was this a home-made crisis or was it caused by exogenous factors such as the foregone turmoil on Asia’s financial markets?
Finally it shows what the conditions under which an economy can become vulnerable to a currency crisis are, what are and the right and the wrong options to resolve it and the lessons learned.
2. A Currency Crisis in the Macroeconomic Theory
A currency crisis as a type of financial crisis is defined as a speculative attack on country’s currency, brought about by agents attempting to alter their portfolio by buying another currency with the currency of that country. That leads to depreciation of the exchange rate substantially during a short period of time.4 There have been many currency crises during the post-war era which are often classified and categorized as first-, second- or third -generation models.5 In first-generation models the collapse of a fixed exchange rate regime is caused by unsustainable fiscal policy. A sudden speculative attack on a fixed exchange rate, can result from rational behaviour by investors who correctly foresee that a government can sell the currency to support it at the fixed rate and by running an excessive deficit, causing it to run short of liquid assets or „harder“ foreign currency. The Investors are willing to continue holding the currency as long as they expect the exchange rate to remain fixed, but when they anticipate that the peg is about to end, they flee the currency en masse.6
The second generation of models of currency crises doubts about whether the government is willing to maintain its exchange rate peg lead to multiple equilibria. It suggests that in possible self-fulfilling prophecies investors attack the currency because they expect other investors to do so.7 But those two concepts do not capture every aspect of the Russian crisis. Specifically, these models do not address the conduct of monetary policy.
How crises can have real effects on the rest of the economy because of interdependencies in the banking and financial system and various mechanisms is explained by the third generation models. Hence government guarantees lead to the possibility of self-fulfilling speculative attacs, liquidity exposure leads to the possibility of a bank run, firms’ balance sheets affect their ability to spend, and capital flows affect the real exchange rate. Enterprises face a liquidity problem because they finance risky longterm projects with foreign loans but have access to limited amounts of internationally accepted collateral.8
In Russia’s case, basic weaknesses in the economy rendered the country inefficient and inclined to crisis. The acute reasons for the currency crisis as a symptom of an ailing domestic economy, was the long-term deficit of the federal budget.
3. History of the Russian Default
3.1. Optimism and Reform
Up to 1998, after six years of economic reform in Russia, privatization and macroeconomic stabilization had experienced some limited success. Hence, the country no longer had a one party rule or an official ideology, no formal central planning or a fixed price system, no full employment or small income differences. Yet in August 1998, after recording its first year of positive economic growth since the fall of the Soviet Union, Russia was forced to default on its sovereign debt, devalue the Rouble, and declare a suspension of payments by commercial banks to foreign creditors.9
This section examines the sequence of events that took place in Russia from 1996 to 1998 and the aftermath of the crisis.
In April 1996, the negotiations to reschedule the payment of foreign debt inherited from the former Soviet Union began. This was meant as a major step toward restoring investor confidence. On the surface, 1997 should have been a turning point toward economic stability.10
Trade surplus was moving toward a balance between ex- and imports (see Figure1).
Abbildung in dieser Leseprobe nicht enthalten
Figure 111
Relations with the West were promising: the World Bank was prepared to provide expanded assistance of $2 to $3 billion per year and the International Monetary Fund (IMF) continued to meet with Russian officials and provide aid.
Inflation had fallen from 131 percent in 1995 to 22 percent in 1996 and 11 percent in 1997 (see Figure 2).
Abbildung in dieser Leseprobe nicht enthalten
Figure 212
Output was recovering slightly.
A narrow exchange rate band remained remarkably stable keeping the exchange rate between 5 and 6 Roubles to the Dollar (see Figure 3).
Figure 313
Fuels made up more than 45 percent of Russia’s main export commodities in 1997 - and oil was selling at $23 per barrel - a high price by recent standards.
In September 1997, Russia was allowed to join the Paris Club of creditor nations after rescheduling the payment of over $60 billion in old Soviet debt to other governments. Another agreement for a 23-year debt repayment of $33 billion was signed a month later with the London Club. Analysts predicted that Russia’s credit ratings would improve, allowing the country to borrow less expensively.
Limitations on the purchase of government securities by non-resident investors were removed, promoting foreign investment in Russia. By late 1997, roughly 30 percent of the GKO (a short-term government bill) market was accounted for by non-residents. The economic forecast appeared quite optimistic as Russia ended 1997 with reported economic growth of 0.8 percent.
3.2. Virtual Economy, Revenue, Investment, and Debt Despite the prospects for optimism, problems remained. On average, real wages were less than half of what they were in 1991, and only about 40 percent of the work force was being paid in full and on time. Per capita direct foreign investment was low, and regulation of the natural monopolies was still difficult due to unrest in the Duma, Russia’s lower house of Parliament.
Another weakness in the Russian economy was low tax collection, which caused the public sector deficit to remain high. The majority of tax revenues came from taxes that were shared between the regional and federal governments, which fostered competition among the different levels of government over the distribution.14
Russia’s huge sector of hopelessly non-competitive industrial enterprises and their struggle to survive in the new market environment had formed a new mutant system called „virtual economy”15 which is characterized by a set of informal institutions that permits the production and exchange of goods and services. Most of the so called „barter” exchanged goods were even less worth then the input value of their production. This barter system forced the companies to offer goods of a lover quality for barter and of a higher quality for cash.16 This system allows enterprises to avoid declaring income and to reduce the effective tax burden practicing tax offsets.17
Russia’s role as a creditor nation was based upon questionable qualifications in the Paris Club’s recognition.
One-fourth 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, and Vietnam. Recognition by the Paris Club was also based on the old, completely arbitrary official Soviet exchange rate of approximately 0.6 Roubles to the Dollar (the market exchange rate at the time was between 5 and 6 Roubles to the Dollar). The improved credit ratings Russia received from its Paris Club recognition were not based on an improved balance sheet. Despite this, restrictions were eased and lifted and Russian banks began borrowing more from foreign markets, increasing their foreign liabilities from 7 percent of their assets in 1994 to 17 percent in 1997.18
Meanwhile, Russia anticipated growing debt payments in the coming years when early credits from the IMF would come due. Policymakers faced decisions to decrease domestic borrowing and increase tax collection because interest payments were such a large percentage of the federal budget.
In October 1997, the Russian government was counting on 2 percent economic growth in 1998 to compensate for the debt growth. Unfortunately, events began to unfold that would further strain Russia’s economy; instead of growth in 1998, real GDP declined 4.9 percent.19
3.3. The Asian Crisis
The first shock was the Asian crisis, which shook world financial markets and reminded investors of the inherent dangers of „exotic” debt and equity. Similar to the one that eventually affected Russia but a few months earlier, in the summer of 1997, countries in the Pacific Rim experienced their currency crises. In November 1997, after the onset of this East Asian crisis, the Rouble came under speculative attack. The Central Bank of Russia (CBR) defended the currency, losing nearly $6 billion (U.S. Dollars) in foreign-exchange reserves.20 21
At the same time, non-resident holders of short-term government bills (GKOs) signed forward contracts with the CBR to exchange Roubles for foreign currency, which enabled them to hedge exchange rate risk in the interim period.
They did this in anticipation of the Rouble losing value, as Asian currencies had.21 Also, a substantial amount of the liabilities of large Russian commercial banks were off-balance-sheet, consisting mostly of forward contracts signed with foreign investors.
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1 http://www.quotationspage.com
2 http://www.oanda.com
3 http://www.stratfor.com
4 Burnside, Eichenbaum, Rebelo (2008), p.1
5 http://en.wikipedia.org/wiki/Currency_crisis
6 Komulainen (1998), p.17
7 Burnside, Eichenbaum, Rebelo (2008), p.4
8 Burnside, Eichenbaum, Rebelo (2008), p.5
9 cf. Chiodo, Owyang (2002)
10 cf. Desai, (2000), p.48
11 http://www.cbr.ru/ evaluated by Chiodo, Owyang (2002)
12 http://www.imf.org/external/data.htm evaluated by Chiodo, Owyang (2002)
13 http://www.imf.org/external/data.htm evaluated by Chiodo, Owyang (2002)
14 cf. Nikolov (1999), p. 22
15 Gaddy, Ickes (2002), p. 4
16 cf. Gaddy, Ickes (2002), p. 29
17 cf. Gaddy, Ickes (2002), p. 31
18 cf. Chiodo, Owyang (2002), p.12
19 cf. Nikolov (1999), p.17
20 cf. Chiodo, Owyang (2002), p.12
21 cf. Desai (2000), p.50