Russian Fiscal Crisis 1998

1. Russian Fiscal Crisis 1998 Econ 490 By Erna Alexandra Avetian Jesus Medina

2. Content • Background • Lead up to Crash • GKOs • Exchange Rate • IMF • Crash • Aftermath • Lessons

3. Россия

4. Russia’s Geography • It is located in Northern Asia • Approximately 1.8 times the size of the United States • Largest country in the world terms of area • It boarders 14 countries

5. Natural Resources • Oil, natural gas, iron ore, magnesium, chromium, nickel, platinum, copper, tin, lead, tungsten, diamonds, phosphates, gold, timber, and nonferrous metals. • 20% of the worlds production of oil and natural gas. • In the forests of Siberia it holds 20% of the worlds timber.

6. The 1990’s; Lead up to Crash • The war with Chechnya cost a estimated 5.5 billion dollars on top of a undisclosed amount that went back to rebuilding the country. • Inherited Soviet Union debt • Cabinet Corruption, Favoritism, Bad privatization • Asian Crisis of 1997 • Depression in the Asian market • Large drop in demand for Russian crude oil and nonferrous metals

8. The 1990’s; Lead up to Crash (cont) • “New Russian” Millionaires • Money made in Russia was leaving the country • Most reinvestment was through foreign investment • Leaving the country sensitive to exchange rate volatility • The government spent approximately 15-20% of annual GDP for 3 years giving hidden subsidies to private enterprises and banks. Plus, many “non-payment” arrangements were made

9. Russian Oligarchs • Roman Abramovich • Russian orphan • High school drop out • Worked at a steal plant, eventually becoming manager • In 1992, the plant was scheduled to be privatized, he somehow managed to buy it. • Now: $18.2 billion net worth • Owns Chelsea FC • “Private Army” a staff of 40-guards

10. GKOs • By 1998 Russia had been issuing large amount of short term bonds. (GKOs) • The economy was in such bad shape that it began to be operated as a Ponzi scheme. • Most debt was issued to foreign investors leaving the Economy highly depended on foreign cash inflows • Which made the Economy vulnerable to large cash outflows if investors become fearful of economic development.

12. Exchange Rate • “Floating-Peg” policy of the Central Russian Bank • Became the catalyst to the Crisis • With in 1 year leading up to Aug. 1998 the Central Bank spend close to $27 billion of its reserves to maintain the exchange rate.

13. IMF (International Monetary Fund) • July 1998 • IMF and World Bank issued a $22.6 billion financial package to stabilize the economy • Replaced huge amounts of short-term GKOs with long-term Eurobonds. • On the eve of the crash a over night transfer was made by IMF, and in the morning it was discovered that $5 billion of IMF money had gone missing

14. August 13th 1998 • Russian stock, bond and currency markets crash

15. Government Action • Kremlin and Central Bank of Russia issued joint statement: • Exchange rate range widened • Ruble debt would be restructured • Temporary 90-day moratorium • By Sept 2nd Fixed exchange rate abandoned • Exchange rate jumped from 6-21 rubles for 1 dollar.

16. Aftermath and Recovery • Domestic food prices doubled • While imports quadrupled • Increase in price of imports fueled Russia’s domestic production of everything. • Every sector of the economy began to see improvement. • By 1999 and 2000 crude oil prices rose just as rapidly as they fell. • Giving Russia a needed trade surplus • Sales of crude oil went from 0% to 9.8% of the GDP by late 2000 • Government decided to build up reserves and let the nominal exchange rate appreciate.

18. Lessons • Subsidies to failing enterprises does little to help the economy • If public debt is unsustainable infusing the market with cash will have the opposite effect from what is expected • Prevention is much less costly then a cure.