A Case Study Of Currency Crisis

1192 words - 5 pages

A Case Study of Currency Crisis: The Russian Default of 1998

Background of Russia
Russian Federation was formed in 1991. The country tried to maintain a fixed exchange rate however, Russia had a “fragile fiscal position”(Economic Report)  which turned unstable as the world markets changed. Up until 1997 Russia had slow but eventually a year of positive economic growth, at which point the country started to stumble.
Russia launched a reform program in 1992. At the time of 1992, the monetary inherited from Soviet times resulted in an increase over 350 percentage of price level in a month. Rumbles was introduced in July 1992, inflation became the central concern in the relief. With ...view middle of the document...

Uncompetitive manufacturing firms could not generate profits to cover the costs and taxes. They did not have the ability to pay for the workers. Only about 40 percent of the work force was paid in full.
Government deficit still remained high. Associated loss of credibility and the tight monetary policy, government’s borrowing in a very high interest rate.

Cause of the 1998 crisis:
The Asian Crisis happened in the summer of 1997. In November, the ruble initially came under attack. The Central Bank of Russia defended the value of the currency and lost nearly 6 billion US dollars in foreign exchange reserves. Meanwhile foreign GKOs holders seized the opportunity to hedge exchange rate.
Government bond yields had increased to 47%. Inflation rate increased to 10%. With the high inflation rates and the lack of government’s confidence to repay the bond, depositors and investors became cautious of risk. The federal government began to collect more taxes in cash to lowered bank and firm’s liquidity. However, people feared to deposit their money in the banks. The CBR responded increasing the lending rate to banks from 30% to 50%, and used 1 billion reserves to defend the ruble. Low liquidity thus became very risky for rumble to hold the value. Meanwhile, oil price dropped by half. Oil and gas oligarchs advocated to devalue the ruble, therefore, it could increase the ruble value of Russian oil exports. The CBR then increase the lending rate again to 150%. In July 1998, monthly interest payments on Russia’s debt rose to an amount 40% higher than the country’s monthly tax collection. Debt could therefore only be financed by the issuance of more debt.
The Russian stock, bond and currency markets collapse as a result of fears for a ruble devaluation and a default on domestic debt. These fears had arisen during the previous months due to ongoing interest rate rises, capital outflows and the corresponding erosion of investor confidence in emerging markets. Annual yields on ruble-denominated bonds rise to more than 200%. 
The CBR made the decision to free float the ruble. The strong depreciation results in sharp price increases. Inflation rises to 27.6% in 1998 and 85.7% in 1999.

Macroeconomic Policies: Ingrid
* pre-crisis economic goals
* political instability

The government's first attempt to prevent the currency crisis was changing the crawling peg to a band at 6.2 rubles to the USD with a surrounding 15% on November 10, 1997. At the same time the CBR sold foreign reserves to support the newly established exchange rate, reserves fell US$6 billion, and attempted to tighten monetary...

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