On August 13, 1998, the Russian stock and bond markets crashed amid widespread investor anticipation that the Russian government would devalue the ruble and default on its debt. The stock market lost 75 percent of its value between January and August 1998 (Chiodo and Owyang, 2002). Annual yields on ruble-denominated bonds rose above 200 percent. The expectation of crisis accelerated the crisis. On August 17, the Russian government devalued the ruble, defaulted on its debt, and declared a moratorium on payments to foreign creditors (Chiodo and Owyang, 2002). On September 2, 1998, the Russian government let the ruble float. By April 1999, the ruble traded at 22 percent of its value compared to where it stood before it began to drop in August 1998 (McKay, April 1999).
In 1997, the outlook in Russia remained optimistic. After reporting negative growth in 1995 and 1996, Russian economic growth inched into positive territory at 0.8 percent for 1997 (Chiodo and Owyang, 2002). Inflation subsided to the 11 percent range compared to over 200 percent inflation in 1994 (Chiodo and Owyang, 2002). Oil sold in the $23 per barrel range, a relatively high price at the time. Oil and nonferrous metals accounted for up to two-thirds of Russia’s foreign exchange earnings. Large foreign exchange earnings from trade provide resources to keep domestic currencies strong in foreign exchange markets. Russia’s credit rating was improving, and by late 1997, about 30 percent of short-term government debt belonged to nonresidents (Chiodo and Owyang, 2002).
Some problems remained. One vulnerable point was the public sector deficit, which remained high because of
Russia’s inefficient tax system. In August 1997, speculative attacks sparked currency crises in East Asian economies. This episode alerted foreign investors to other possible soft spots in the global financial system. In November 1997, the Russian ruble came under speculative attack, causing the Central Bank of Russia to lose $6 billion in foreign exchange reserves (Chiodo and Owyang, 2002).
The Russian government was counting on 2 percent economic growth in 1998 to help pay for rising debt. As the price of oil and nonferrous metal fell in the wake of the East Asian Crisis, Russia’s economic situation began to deteriorate. Output would actually fall by nearly 5 percent in 1998. In February, the Russian government requested an aid package from the International Monetary Fund (IMF). It was be July before the IMF approved an emergency aid plan for Russia. The IMF demanded certain reforms before approving the plan.
In April 1998, the ruble came under another speculative attack. On May 19, the Central Bank of Russia increased its lending interest rate from 30 to 50 percent (Chiodo and Owyang, 2002). With inflation in the 10 percent range, these interest rates were unusually high. This action increased the interest rate paid by ruble-denominated assets. Raising domestic interest rates tends to shore up the value of a currency in foreign exchange markets. The currency becomes a ticket to higher interest rates. On May 27, 1998, the Central
Bank of Russia raised its lending interest rate to 150 percent (Chiodo and Owyang, 2002).
Missteps in public relations may have aggravated the crisis. Early in May, the chair of the Central Bank of Russia warned government ministers of a debt crisis. The warning came at a meeting with reporters in the audience. At about the same time, the prime minister of Russia stated in an interview that tax revenue was 26 percent less than targeted, and that the government was “quite poor now” (Chiodo and Owyang, 2002). When the prime minister refused to meet with a deputy secretary of treasury of the United States, regarding him as not high enough in the government, big investors became worried, and began selling Russian bonds and stocks.
Russian gross domestic product (GDP) growth recovered, growing 8.3 percent in 2000 and roughly 5 percent in 2001 (Chiodo and Owyang, 2002). The year following the crisis, Russia saw consumer prices soar
92.6 percent (Chiodo and Owyang, 2002). By 2000 and 2001, consumer price inflation had subsided to a range of 20 to 22 percent. In 2000, a world escalation of oil and commodity prices put the government’s budget in the surplus column for the first time since the formation of the Federation.
See also: Currency Crises, Foreign Debt Crises
References
Chiodo, Abbigail J., and Michael T. Owyang. “A Case Study of a Currency Crisis: The Russian Default of 1998.” Review, Federal Reserve Bank of St. Louis, vol. 84, no. 6 (November/December 2002): 7–18.
McKay, Betsy. “Ruble’s Decline Energizes Russian Firms Who Manage to Win Back Consumers.” Wall Street Journal (Eastern Edition, New York) April 23, 1999, p. B7A.
Sesit, Michael R., and Sara Webb. “Ruble’s Woes Could Shake Market Anew.” Wall Street Journal (Eastern Edition, New York) July 6, 1998, p. C1.
