Transcript The Russian Default of 1998

The Russian Default of
1998
A case study of a currency
crisis
Francisco J. Campos, UMKC
10 November 2004
What’s a currency crisis?
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It can be defined as a speculative
attack on a country’s currency.
It can lead to forced devaluation and
debt default.
It might happen when investors fear
that the government is going to
devalue the domestic currency.
What’s a currency crisis?
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A devaluation occurs when there is
market pressure to increase the
exchange rate because the country
cannot or will not be able to support
its currency.
In order to maintain the exchange
rate peg, the central bank must
intervene in the FX market buying up
its currency with foreign reserves.
Currency crises: what does
macroeconomic theory suggest?
Macroeconomic models
First-Generation Models
Second-Generation Models
Third-Generation Models
First-Generation Models
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Causes of a currency crisis:
government debt and inability to
control the budget.
People believe financing the debt
becomes the government’s major
concern.
People expect the monetization of
the fiscal deficit.
Second-Generation Models
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They suggest that a devaluation in
one country affects the price level or
the current account of the countries
around it.
Economic events, such as war or oil
price shocks.
Expectations.
Third-Generation Models
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They suggest that a currency crisis is
brought on by a combination of factors:
High debt
Low foreign reserves
Falling government revenues
Increasing expectations of devaluation
Domestic borrowing constraints
(increasing the interest rate reduces the
amount of loans)
The Russian default: A brief history
1996 and 1997
In 1997, Russia seemed to be
turning toward economic stability
The Russian default: A brief history
1996 and 1997
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The trade surplus was moving toward a balance between
exports and imports.
Inflation had fallen from 131% in 1995 to 11% in 1997.
The Russian default: A brief history
1996 and 1997
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The exchange rate was kept between 5 and 6
rubles to the dollar.
The Russian default: A brief history
1996 and 1997
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Output was recovering slightly. Russia ended up
1997 with a 0.9% growth.
The Russian default: A brief history
1996 and 1997
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Annual Percentage Change in GDP for
Russia (1990-2004).
The Russian default: A brief history
1996 and 1997
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Structural problems still remained.
Real wages were less than half of what
they were in 1991. Only about 40% of
workers were paid in full and on time.
Per capita direct foreign investment was
low.
Privatization of public enterprises was still
difficult due to internal opposition within
the government.
Low tax collection
Public Sector Deficit
The Russian default: A brief history
1996 and 1997
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In November 1997, the ruble
suffered its first speculative attack.
The CBR spent nearly $6 billion of its
foreign reserves to defend the ruble.
In December 1997, the price of oil
began to drop.
The Russian default: A brief history
1998
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With some many uncertainties in the
economy, investors turned their attention
toward Russian default risk.
The government increased tax collection,
lowering bank’s and firm’s liquidity.
The CBR responded by increasing the
lending rate to banks, first from 30% to
50%, and finally to 150%.
The price of oil was as low as $11 per
barrel
The Russian default: A brief history
1998
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In June 1998, the ruble came under attack for
the second time.
In July the IMF approved assistance of $11.2
billion, of which $4.8 was given immediately.
By August, $4 billion had left Russia in capital
flight.
The final attack happened 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 = DEVALUATION
How the theory explains the
Russian crisis
A fixed exchange
rate
expectations
Fiscal deficits
and debt
monetary policy
and interest rates
How the theory explains the
Russian crisis: Exchange rate
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The CBR was willing to defend the
exchange rate peg.
The first two speculative attacks
depleted Russia’s foreign reserves.
Once depleted, the government had
no choice but to devaluate following
the August attack.
How the theory explains the
Russian crisis: Fiscal deficit
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High debt and low revenues. Causes:
Low output.
Competition between local governments to
attract firms.
The decrease in the price of oil.
Large amount of short-term foreign debt
due in 1998.
Under a fixed exchange rate, Russia was
unable to finance its deficit by printing
money.
How the theory explains the
Russian crisis:
Monetary policy and interest rates
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The rise in the interest rate had two
effects:
It increased revenue problems and
debt.
It did not increase the amount of
loans available to firms.
How the theory explains the
Russian crisis: Expectations
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Three aspects increased expectations
of devaluation:
The Asian crisis.
Public relations errors.
Low revenues.
Conclusions
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Factors of risk for a currency crisis: a fixed
exchange rate, fiscal deficits and debt, the
conduct of monetary policy and
expectations of default.
Under certain conditions, contractionary
monetary policy can accelerate
devaluation.
First and Second-Generation models
explain fiscal deficits; the ThirdGeneration model, financial sector fragility.
Questions?