Mclean Doran
History of Central Banks
Final Paper
Due: 14 December 2017
The Russian Ruble Crisis
The Russian Ruble Crisis (or “Russian Flu”) occurred in 1998 and was primarily caused by the Russian government’s (as well as the Central Bank’s) inability to adapt and see the many warning signs of a fiscal issues and imbalances that were already present in the economy. The economy is an interesting case study especially as a it transitioned from communism to a free market society and has never been a poster child for efficiency. “Russia remains a focal point of U.S. national interests. It is formidable country whose political and economic stability are critical for the rest of the former Soviet Union, Eastern and Central Europe and the areas those regions border. Russia is a nuclear superpower, has large supplies of some of the world’s most important natural resources, including oil, natural gas, and strategic metals (Congressional Research Service, 1).” In studying the Russian Ruble Crisis it is easy to see how many events can be linked to each other due to causality because of how interconnected the global economy is as a whole.
This paper will give background on the economic climate of Russia before the crisis occurred to help set the stage for the struggles to come. It will then move into the causes and catalysts of the crisis to help express why the economy was triggered in such a way, which were both direct as well as indirect. Then finally there will be an analysis and breakdown of the aftermath of the ruble crisis and conclusion of what occurred and how it affected Russia’s ability to develop a market economy.
To understand the causes and triggers of the crisis it is important to know about the economic climate in Russia before the actual crisis occurred. In 1991 the Soviet Union had collapsed and the Russian Federation (headed by President Boris Yeltsin) began to transition their economy from a system of communism to a free market economy. “When Boris Yeltsin proclaimed that Russia would become a market economy, he did not understand how difficult such a transformation would be, nor did we in the West (Goldman, 1).” It was assumed that Russia would react similarly to other “dysfunctional economies” (“when regulated prices were allowed to respond to market forced and state enterprises were privatized, Russia would begin to act like all other market economies and Russians like all other profit maximizers (Goldman,1.”) To be able to accomplish this the Russian Federation set forth a new mandate to privatize all of Russia’s state-owned assets which resulted in declining investment as well as as a quickly plummeting GDP, collapsing industrial output and significant hyperinflation increases. As a result of this, poverty became rampant as income disparity among the population increased significantly. To try and combat these issues the Russian Federation created and employed a stabilization program in 1995. This stabilization plan at its core was a currency peg plan to the US dollar. This program resulted in a definite growth in GDP as well as a significant decline in the fiscal deficit. These positives created rising economic optimism and overall positivity towards the new free market economy system that the Russian Federation under Boris Yeltsin had implemented.
The Russian Ruble Crisis was not just caused by one direct impact. There were a few things that triggered the ruble crisis both directly and indirectly. One of the largest indirect causes was the Asian Crisis of 1997. “The Asian Financial Crisis of 1997 was a financial crisis that affected many Asian countries including South Korea, Thailand, Malaysia, Indonesia, Singapore and the Philippines. After posting saw some of the most impressive growth rates in at the time, the so-called “tiger economy” saw their stock markets and currencies lost about 70% of their value (Kuepper).” Some Pacific-Rim countries experienced currency crisis which created a decrease in domestic demand throughout Asia and an overall slowdown in rates of growth in the world economy. Their already low level of commodity prices continued to decrease which essentially reduced overall demand for imports in developing countries. This meant that there was a significant shock to the rest of the worlds economies (especially for developing ones such as Russia’s coming out of a communist system) which had an indirect impact on Russia’s economy.
Another indirect impact of Russia’s Ruble Crisis was a drop in oil prices as a result of the Asian Crisis. During the time of the Asian Crisis there was a slow down in economic growth and a decline in consumer demands of oil. As the graph below illustrates, the peak of crude oil prices happened in the early 80s but then declined until the 90s. During the Asian Financial Crisis there was an OPEC 10% Quota increase. “In December 1997, OPEC increased its quota by 2.5 million barrels per day (10 percent) to 27.5 million barrels per day effective January 1, 1998. The rapid growth in Asian economies came to a halt. In 1998, Asian Pacific oil consumption declined for the first time since 1982 (Williams).” The fact that there was a lower demand for oil (and as a result an overall lower consumption) matched with higher OPEC production rates, prices were slashed. To try and respond to overall issues with pricing and demand “OPEC cut quotas by 1.25 million barrels per day in April and another 1.335 million in July (Williams).” This decline in prices continued until its bounce back in 1999. Fuels and gases made up a significant portion of Russia’s main export commodities (at more than 45%), so this decline in consumer demand of oils and gas came as a huge blow to the Russian economy as a whole.
The majority of Russia’s direct causes of the Ruble Crisis are its fiscal imbalances that are deeply rooted in its economic system. Some direct causes of the Russian Ruble crisis include the primitive economic structure, inability to address foreign as well as domestic debt and also general flaws in the Central Bank of Russia attempting to salvage the ruble as it saw its decline.
“The direct cause of crisis has been the Russian government’s failure to address fiscal imbalances (Congressional Research Service, 1).” As previously stated, Russia’s government was attempting to move from a system of communism into a system of free market society. This is a difficult feat for any economy but especially in the case of Russia: “The reformer should have moved gradually to create brand-new businesses and farms in order to build up a competitive market infrastructure-something that Poland never completely lost. Instead, the Russians concentrated on privatizing state enterprises, which seldom increases competition (Marshall, 1).” This is because Russian system previously relied upon communism and communist systems to run the economy for 70 years prior which were essentially decimated right before the crash (“how could it be otherwise after seventy years of communism (one generation more than in Poland), when anything associated with the market or private initiative was treated as antisocial and penalized as an economy crime.”) Russia’s government probably should have realized how important and influential basic market institutions are, and gradually introduced new businesses and farms to create competition rather than allow for monopolization that ensued. Basically this allowed private monopolies and perpetuated them.
“Less direct but more fundamental causes have been structural problems (Congressional Research Service, 1)”: Russia’s primitive economic structure was founded on a inefficient taxation system that was deeply embedded in their culture. In 1997, the Russian government received around 40% of its tax revenues in non monetary forms of payment. “The government has an inefficient tax regime that fails to generate sufficient revenues to meet fiscal obligations (Congressional Research Service, 1).” This is important to note because a lot of the data gathered throughout this essay as a whole is what has been reported but the Russian government but might not account for everything that is going on due to all the secrecy within their government as well as their economic systems. “More fundamentally, incomplete economic restructure has left an economy, much of which is run on barter, masks inefficient and even “value-subtracting” economic activities, and that makes attaining fiscal balances even more arduous (Congressional Research Service, 1).” Since a significant amount of the economic system that was in place was run by transactions that were based on bartering rather than fixed prices it was harder to create a standard and procedural system, while it was also difficult to erase this sort of behavior that was engrained in the culture.
In another effort to move into a free market society, the Central Bank of Russia attempted to maintain a currency peg to the US Dollar. When the Central Bank of Russia decided to peg the ruble to the US dollar in 1998 there was some push back. It is easy to see based on the graph below that there is a fairly steady incline in ruble inflation overall as the years go on, with a significant spike being during that target range of the crisis between 1998 and then leveling off in 1999. To attempt to maintain this peg the Central Bank of Russia exhausted revenue, but also proved unable to be able to maintain a stable exchange rate.
The crisis itself shook the nation and ended up leaving the country in a significant economic mess. The tipping point was August 17, 1998: “when the government of then-Premier Segei Kiriyenko abandoned its defense of a strong ruble exchange rate against the dollar, defaulted on government domestic debt forcing its restructure, and placed a 90-day moratorium on commercial external debt payments” (Congressional Research Service, 1). The government and Central Bank of Russia during this time finally could no longer peg the Russian ruble to the dollar and the government finally was forced to default to be able to keep up with their rapidly increasing external debt. Due to his inability to defend the ruble against the dollar and inability to keep government debt from defaulting: “Those actions led to Yeltsin’s dismissal of Kiriyenko on August 23, replaced, after a political standoff with the Duma, by a more leftward leaning government led by Premier Yevgennij Primakov” (Congressional Research Service, 1).
The significant turmoil and uncertainty of the direction of the ruble resulted in consumer panic, similar to the panic seen in the Great Depression when American investors pulled funds from their banks: “Panic set in as depositors sought first to convert their ruble bank deposits into dollar deposits, and then to withdraw them altogether, reinforcing the liquidity shortage” (Pinto & Ulatov, 29). This was because of the “growing margin calls on repos coincided with a large volume of syndicated loans falling due in August, a peak month for loan rollovers, which many banks had to repay in part or full. Margin calls and loan repayments meant a forced sale of GKOs to raise liquidity” (Pinto & Ulatov, 29). The system quickly started to implode as debt started to rack up. All the policies to be able to actually prevent the crisis ended up unraveling before the Central Bank of Russia and incredibly ineffective. ”CBR lost $4.5 billion in reserved over July 10—August 14 as portfolio investors exited the equity and GKO markets, barely offset by the IMF ($4.8 billion, July 21) and World Bank ($300 million, August 7) tranches received under the rescue package (Pinto & Ulatov, 30).” This short time period resulted in the defaulting and bonds failing on August 17th 1998 which was the official “date” of the crisis.
The Central Bank of Russia devalued the ruble to further prevent the crisis but it ended up just leading to significant inflation, yet another sign that the economic policy in place to act as a preventative measure failed. “The crisis (and Russian policymakers’ efforts to manage it) has already had an immediate economic impact on Russia and will have longer term implications for the Russian economy and Russia’s efforts to become a market economy (Congressional Research Services, 1).” It is easy to see from the graph above just how much the inflation rate soared at the end of 1998 in reaction to the Russian Ruble Crisis. “Monetary restraints were applied so rigidly that real interest rates soared to 150% or more, and few businesses were able to qualify for credit (Marshall, 1).” It became harder and harder for business incoming into the market to be able to enter into the new free market system as interest rates on businesses made it virtually impossible to qualify for such credit. The debt during the time of the Ruble Crisis was primarily external debt which is apparent in looking at the balance sheet during 1998: ”Cumulatively, Russian-era external debt had increased by close to $16 billion between June 1 and July 24, 1998, compared to a level of $36 billion at the start of the year (Pinto & Ulatov, 35).”
Moving forward it is important to note that the Russian Ruble Crisis of 1998 still continues to have significant impacts on Russia’s economy, even today. “The crisis (and Russian policymakers’ efforts to manage it) has already had an immediate economic impact on Russia and will have longer term implications for the Russian economy and Russia’s efforts to become a market economy (Congressional Research Services, 1).” As discussed earlier, one of the largest hurdles for Russia was the fact that their economy was transitioning from a Communist regime to a market economy. Part of the issue is there is a huge income disparity between the Russian population which means that many of lower income citizens are unable to contribute to the economy and create the same demand for goods that other more developed economies have: “According to a recent report by Credit Suisse, the “oligarchs,”or Russia’s richest 1%, own 30% of the entire population’s personal assets, a massive disparity in health that is purported to have held back Russia’s economic growth from its true potential (Aven)…” It is worth noting that the ruble crisis: “The August crisis also lowered Russians’ standard of living and has seriously set back Russia’s efforts toward establishing a market economy for years to come (Congressional Research Services, 1).” Russia has always had superior technology and advancements in technical products, however what their economy consistently lacks is design and marketability. The technology that is widely used by aviation and space travel (or research of our solar system) is Russian technology, and yet basic consumer goods such as cars, computers and clothes are significantly less advanced or desirable. Their market economy fails to present and design products that are desirable and affordable by the vast majority of the market. Pricing of goods is also a key issue that must be addressed in Russia to be able to completely stabilize: “Prices in Russia are greatly distorted (for example, fuel prices are heavily subsidized and still are quite close to those in the United States, utilities’ and state services’ prices are very low, while some food items are more expensive than in Europe) (Movchan).” This will be an issue that must be resolved over time as there is always a possibility for the Russian Central Bank to fall back into the old issue of inflation with the ruble, but was at least temporarily resolved by the redenomination of currency after the USSR fell and the ruble was able to stabilize.
The Russian Ruble Crisis was a significant economic crisis that impacted Russia’s ability to fully form a market economy in a post communism era: “The Russian economy was a collapse waiting to happen (Marshall, 1).” The 1998 crisis was caused by a few different catalysts both direct and indirect but these were primarily the Asian Crisis of 1997, the drop in oil prices following the Asian Crisis, the primitive economic structure (which was made up of non-monetary systems such as bartering), the inability to address foreign and domestic debt, and the Central Bank of Russia’s attempts to maintain a stable exchange rate by pegging the ruble to the US Dollar. All of the causes were directly impacted by each other which made this crisis so hard to curb for the Central Bank of Russia and other policy makers throughout the Russian government. The Asian Crisis was probably one of the biggest drivers of the Russian Ruble Crisis as their reduced overall demand as well as price of oils and gases which severely impacted Russia’s economy (primarily in the areas of foreign exchange reserves). The oil shocks continued to impact the Russian economy which made it hard to recover, especially since such large subsidizes were granted for oil companies. Inflation as well as inability to regulate the internal fiscal imbalances within Russia created a system that was doomed from the start. Russia continues to feel the effects of the ruble crisis years later but has learned to remedy some of the issues it faced as the Central Bank of Russia was able to learn from the previous mistakes.
Works Cited:
The Russian Financial Crisis of 1998: An Analysis of Trends, Causes, and Implications. Congressional Research Service. February 18, 1999. Print. 11 Nov 2017.
Goldman, Marshall. “The Russian Ruble and Why it Collapsed.” Challenge, 41(6), 9-13. November 1998. Print. 1 Dec 2017.
Kuepper, Justin. “What was the Asian Financial Crisis?” The Balance. 20 Mar 2017. Web. 4 Dec 2017.
Williams, James L. “Oil Price History and Analysis” WTRG Economics. 2011. Web. 20 Nov 2017.
Pinto, Brian and Sergei Ulatov. “Financial Globalization and the Russian Crisis of 1998” The World Bank. May 2010. Print. 1 December 2017.
Aven, Denis. “Russia’s Economic Transition: Challenges, Results and Overhang” The Yale Economic Review. 2 Apr 2013. Web. 2 Dec 2017.
Movchan, Andrey. “Decline, Not Collapse: The Bleak Prospects for Russia’s Economy” Carnegie Moscow Center. 2 Feb 2017. Web. 1 Dec 2017.
https://www.stratfor.com/sites/default/files/main/images/russia_inflation_rate2.jpg
http://carnegieendowment.org/images/article_images/fig_001-web_eng.jpg