Russian financial crisis

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Inkombank was one of the most high-profile casualties of the events of August 1998. Once one of Russia's largest banks, whose billboards proudly announced its motto "We are for real, we are here to stay", it closed its doors almost overnight. Their Nizhny Novgorod building, which was one of the city's symbols of the new Russian capitalism, looks rather shabby in the above picture, taken 2006. But above the name of its current owner, one can still see a not-quite-erased Inkombank logo.

The global recession of 1998, which started with the Asian financial crisis in July 1997, exacerbated Russia's financial crisis. Given the ensuing decline in world commodity prices, countries heavily dependent on the export of raw materials, such as oil, were among those most severely hit. (Petroleum, natural gas, metals, and timber account for more than 80% of Russian exports, leaving the country vulnerable to swings in world prices. Oil is also a major source of government tax revenue. [1]) The sharp decline in the price of oil had severe consequences for Russia.

[edit] Course of events

Prior to the culmination of the economic crisis, the GKO bonds issuance policy was described as similar to a pyramid scheme or Ponzi scheme^{[citation needed]}, with the interest on matured obligations being paid off using the proceeds of newly issued obligations.

Declining productivity, an artificially high fixed exchange rate between the ruble and foreign currencies to avoid public turmoil, and a chronic fiscal imbalance were the backcloth to the meltdown. 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.

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. [2] Yeltsin named Energy Minister Sergei Kiriyenko, aged 35, as acting prime minister (see also: Sergei Kiriyenko's Cabinet).

On May 29 Yeltsin appointed Boris Fyodorov Head of the State Tax Service.

In an effort to prop up the currency and stem the flight of capital, in June Kiriyenko hiked GKO interest rates to 150%.

A $22.6 billion International Monetary Fund and World Bank financial package was approved on July 13 to support reforms and stabllize 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 August 14 the exchange rate of the Russian ruble to the US dollar was still 6.29. Despite the bailout, Russia's monthly interest payments still well exceeded its monthly tax revenues. 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. On July 29 Yeltsin interrupted his vacation in Valdai Lake region and flew to Moscow, prompting fears of a Cabinet reshuffle, but he only replaced Federal Security Service Chief Nikolai Kovalyov with Vladimir Putin.

Realizing that this situation was unsustainable, investors continued to flee Russia despite the IMF bailout. Weeks later the financial crisis resumed as the real value of the ruble resumed its decline. Russians sought frantically to buy dollars, but these had become scarce. Foreign investment rushed out of the country, and the ensuing financial crisis triggered an unprecedented flight of capital from Russia.

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. [3][4]

On August 17, 1998, Russia was forced by an escalating payments crisis to devalue the ruble dramatically, declared its intention to restructure all official domestic currency debt obligations by the end of 1999 and imposed a 90 day moratorium on the repayment of private external debt, to aide its commercial banks suffering from the ongoing investors frenzy. On September 2 the Central Bank of the Russian Federation decided to float the ruble. By September 21 the exchange rate had reached 21 rubles to the US dollar. On September 28 Boris Fyodorov was fired from the position of the Head of the State Tax Service.

Russian inflation in 1998 reached 84 percent and welfare costs (pegged to inflation) grew considerably. Many banks, including Inkombank, Oneximbank and Tokobank, were closed down as a result of the crisis.

[edit] Political fallout

Boris Yeltsin and Yevgeny Primakov meeting in the Kremlin

The financial collapse resulted in a political crisis as Yeltsin, with his domestic support evaporating, had to contend with an emboldened opposition in the parliament. A week later, on August 23, Yeltsin fired Kiriyenko and declared his intention of returning Chernomyrdin to office as the country slipped deeper into economic turmoil. [5] Powerful business interests, fearing another round of reforms that might cause leading concerns to fail, welcomed Kiriyenko's fall, as did the Communists.

Yeltsin, who began to lose his hold on power as his health deteriorated, wanted Chernomyrdin back, but the legislature refused to give its approval. After the Duma rejected Chernomyrdin's candidacy twice, Yeltsin, his power clearly on the wane, backed down. Instead, he nominated Foreign Minister Yevgeny Primakov, who on September 11 was overwhelmingly approved by the Duma.

See also: Yevgeny Primakov's Cabinet

Primakov's appointment restored political stability, because he was seen as a compromise candidate able to heal the rifts between Russia's quarreling interest groups. There was popular enthusiasm for Primakov as well. Primakov promised to make the payment of wage and pension arrears his government’s first priority, and invited members of the leading parliamentary factions into his Cabinet. 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.

[edit] Recovery

Russia bounced back from the August 1998 financial crash with surprising speed. 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, have benefited from the devaluation, which caused a steep increase in the prices of imported goods. [6] [7] 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. 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.

Nevertheless, the political and social equilibrium of the country remains tenuous to this day, and power remains a highly personalized commodity. The economy remains vulnerable to downturn if, for instance, world oil prices fall at a dramatic pace.

[edit] References

[edit] See also

• Long-Term Capital Management
• GKO
• 1997 East Asian financial crisis

[edit] External links

• The Crisis in Russia: Some Initial Observations by Brian Henry and James Nixon, Economic Outlook, Vol. 23, No. 1, November 1998 (subscription required).
• An Analysis of Russia's 1998 Meltdown: Fundamentals and Market Signals by Homi Kharas, Brian Pinto and Sergei Ulatov, Brookings Papers on Economic Activity, #1, 2001 (subscription required).
• Lessons from the Russian Crisis of 1998 and Recovery by Brian Pinto, Evsey Gurvich, and Sergei Ulatov, The World Bank, February 2004.
• Why Did the Ruble Collapse in August 1998? by Padma Desai, The American Economic Review Vol. 90, No. 2, 2000 (subscription required).
• The Bank of Russia and the 1998 Rouble Crisis by William Tompson. In Vladimir Tikhomirov (ed.), Anatomy of the 1998 Russian Crisis (Melbourne: CERC, 1999).
• A Case Study of a Currency Crisis: The Russian Default of 1998 by Abbigail J. Chiodo and Michael T. Owyang.
• Chronology of the Russian Financial Crisis 1998 by Clifford Chance.
• Lessons of the Russian Crisis for Transition Economies by Yegor Gaidar, Finance and Development, Vol. 36, No. 2 (June 1999).
• Welfare Impacts of the 1998 Financial Crisis in Russia and the Response of the Public Safety Net] by Michael Lokshin and Martin Ravallion, The Economics of Transition 8 (2), July 2000 (subscription required).
• Overview of Structural Reforms in Russia after 1998 Financial Crisis by S.A. Vasiliev, International Monetary Fund, February 16, 2000.
• International investors, contagion and the Russian crisis by Alexei Medvedev, BOFIT #6, 2001.
• Financial crisis in the Russian Federation by Thierry D. Buchs, Economics of Transition 7 (3), 1999 (subscription required).
• The Russian Default by Saul Estrin, Business Strategy Review 9 (3), September 1998 (subscription required).
• Russia's Tax Crisis: Explaining Falling Revenues in a Transitional Economy by Daniel Treisman, Economics & Politics 11 (2), July 1999 (subscription required).
• 1999 IMF World Economic Outlook, Interim Assessment, Ch. II: The Crisis in Emerging Markets, International Monetary Fund, December 1999.
• Russia and the IMF by Nigel Gould-Davies and Ngaire Woods, International Affairs 7 (1), January 1999 (subscription required).
• Lessons from the Russian Meltdown: The Economics of Soft Legal Constraints by Enrico Perotti, International Finance 5 (3), 2002 (subscription required).