1998 Russian Financial Crisis ("Ruble crisis") Courses, Process and Effects Analysis

1998 Russian financial crisis ("Ruble crisis") Courses and Effects Analysis
[Courses]:
1. The Russian financial crisis (also called "Ruble crisis") hit Russia on 17 August 1998. It was triggered by the Asian financial crisis, which started in July 1997. During the ensuing decline in world commodity prices, countries heavily dependent on the export of raw materials were among those most severely hit. Petroleum, natural gas, metals, and timber accounted for more than 80% of Russian exports, leaving the country vulnerable to swings in world prices. Oil was also a major source of government tax revenue. 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, also impacted Russian foreign exchange reserves.
2. 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 background to the meltdown.
3. The economic cost of the first war in Chechnya that is estimated at $5.5 billion (not including the rebuilding of the ruined Chechen economy) was also a cause of the crisis.
[Process]:
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 March 23.Yeltsin named Energy Minister Sergei Kiriyenko, aged 35, as acting prime minister On May 29, Yeltsin appointed Boris Fyodorov 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: In an effort to prop up the currency and stem the flight of capital, in June 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 the major budget items (pensions, communal utilities, transportation etc.).
A $22.6 billion, the International Monetary Fund and World Bank financial package was approved on July 13 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[citation needed] by July 24, 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 May 12, 1998 Coal miners went on strike over unpaid wages, blocking the Trans-Siberian Railway. By August 1, 1998 there were approximately $12.5 billion in unpaid wages owed to Russian workers.
On August 14 the exchange rate of the Russian ruble to the US dollar was still 6.29. Despite the bailout, July monthly interest payments on Russia's debt rose to a figure 40 percent greater than its monthly tax collections.
Additionally, on July 15 the State Duma dominated by left-wing parties refused to adopt most of government anti-crisis plan so that the government was forced to rely on presidential decrees.
At the time, Russia employed a "floating peg" policy toward the ruble, meaning that the Central Bank at any given time committed that 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.
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 the ruble, which in turn further eroded investor confidence and undermined the ruble. It is estimated that between October 1, 1997 and August 17, 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 August 13, 1998, the Russian stock, bond, and currency markets collapsed as a result of investor fears that the government would devalue the ruble, default on domestic debt, or both. Annual yields on ruble denominated bonds were more than 200 percent!
The stock market had to be closed for 35 minutes as prices plummeted. When the market closed, it was down 65 percent with a small number of shares actually traded. From January to August the stock market had lost more than 75 percent of its value, 39 percent in the month of May alone!
[The Crisis]:
On August 17, 1998, the Russian government and the Central Bank of Russia issued a "Join Statement" announcing, in substance, that:
1. 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,
2. a temporary 90-day moratorium would be imposed on the payment of some bank obligations, including certain debts and forward currency contracts.
3. At the same time, in addition to widening the currency band, the 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 iterative 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 August 17 to August 25, the ruble steadily depreciated on the MICEX, moving from 6.43 to 7.86 RUR/USD. On August 26, the Central Bank terminated ruble-dollar trading on the MICEX, and the MICEX did not fix a ruble-dollar rate that day.
On September 2 the Central Bank of the Russian Federation decided to abandon the "floating peg" policy and float the ruble freely. By September 21 the exchange rate had reached 21 rubles to the US dollar, meaning it had lost two thirds of its value of less than a month earlier.
On September 28 Boris Fyodorov was fired from the position of the Head of the State Tax Service.
The moratorium imposed by the Joint Statement expired on November 15, 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 1 percent of the federal budget. By August of that year, 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 or washing powder. The crisis has reduced demand for food and lowered food consumption, because substantial depreciation of the ruble significantly raises domestic prices for food stuffs. 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 ceased to exist as millions of people lost their life savings from the bank closures!
Communists and the Federation of Independent Trade Unions of Russia staged a nationwide strike on October 7 and called on President Yeltsin to resign.
On October 9, Russia, which was also suffering from a bad harvest, appealed for international humanitarian aid, including food!
Recovery
Russia bounced back from the August 1998 financial crash with surprising speed.
1. 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.
2. 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.
3. ===> Finally, the economy has been helped by an infusion of cash; as enterprises were able to pay off arrears in back wages and taxes!
it in turn allowed consumer demand for the goods and services of Russian industry to rise. For the first time in many years, unemployment in 2000 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.