Currency crisis on the example of russia currency crisis 1998 and 2014

Currency crisis on the example of russia currency crisis 1998 and 2014 A currency crisis can be defined as a speculative attack on a country’s currency that can result in a forced devaluation and possible debt default. One example of a currency crisis occurred in Russia in 1998 and led to the devaluation of the ruble and the default on public and private debt. Currency crises such as Russia’s are often thought to emerge from a variety of economic conditions, such as large deficits and low foreign reserve

Currency crisis

on the example of Russia currency crisis 1998 and 2014

Content

1.Introduction

2.Currency crisis definition and reasons

3.Russian currency crisis 1998

3.1Crisis background and main reasons

3.2Chronology of events and default

3.3Impacts of crises on the economy

3.4Recovery process and lessons from the crisis

3.5 LTCM bankruptcy

4 Russian currency crisis 2014

4.1Chronology of events

4.2Main reasons

4.3 The Impact on Finance, Economics, and Society

4.4 Recovery Activities

5 The Impact of 2 crises on the Former Soviet States

6 Common and different features in 2 crises

6.1 Common features in 2 crises

6.2 Different features in 2 crises

7 Summary

1 Introduction

A currency crisis can be defined as a speculative attack on a country’s currency that can result in a forced devaluation and possible debt default One example of a currency crisis occurred in Russia in 1998 and led to the devaluation of the ruble and the default on public and private debt Currency crises such as Russia’s are often thought to emerge from a variety of economic conditions, such as large deficits and low foreign reserves

Currency crisis sometimes appear to be triggered by similar crises nearby, although the spillover from these contagious crises does not infect all neighboring economies—only those vulnerable to a crisis themselves In this paper, we examine and review the two currency crises in Russia, paying particular attention to the events, including analysis of the currency crisis in Russia, we discuss the impacts and the main reasons In addition, we review the recovery process that was undertaken to avoid the crisis and explain why those steps may have, in fact, hastened the devaluation The following section reviews two Russian currency crisis models, and compares their common and different features The six section

summarize effect of the both crises on the Russian and world economy

2 Currency crisis definition and reasons

2.1 Currency crisis definition

A currency crisis, which is also called a balance of payment crisis, is a speculative attack in the foreign exchange market It occurs when the value of a currency changes quickly, undermining its ability to serve

as a medium of exchange rate

A currency crisis is a type of financial crisis, and is often associated with a real economic crisis Currency crises can be especially destructive to small open economies or bigger, but not sufficiently stable ones Governments often take on the role of fending off such attacks by satisfying the excess demand for a given currency using the country’s own currency reserves or its foreign reserves (usually in the United States dollar, Euro or Pound sterling)

A currency crisis is brought on by a decline in the value of a country's currency This decline in value negatively affects an economy by creating instabilities in exchange rates, meaning that one unit of the currency no longer buys as much as it used to in another To simplify the matter, we can say that crises develop as an interaction between investor expectations and what those expectations cause to happen

Currency crises, which many economists define as a swift decline of more than 20 percent of a local currency against the dollar, have hit dozens of emerging markets over the past three decades, and have occasionally triggered regional recessions like the Latin American debt crises in 1982 and the Asian financial crisis in 1997–98 The United States has augmented aid packages arranged by the International Monetary Fund (IMF) in the past to help stabilize important trading partners and limit contagion,

recognizing that tremors even in small economies far away could hurt domestic growth Drawing on

lessons from previous crises, the IMF has developed new tools and a revised approach to avert the quick collapse of currencies Still, few economists are convinced the world has seen its last currency or

financial crisis

2.2 Currency crisis reasons

With the development of market economy and the acceleration of globalization, stagnation of economic growth is no longer the main reason of the currency crisis A large number of economists’ studies show that overvalued exchange rates, current account deficits, falling exports and economic activities’ slowing are the indication of a coming currency crisis During the actual running, currency crisis usually triggered

by the bursting of the bubble economy, the banks’ non-performing debts increasing, the serious

imbalance of payments, too massive external debt, financial crisis, political instability, the distrust to the government and so on

If investors' confidence in the stability of an economy is eroded, then they will try to get their money out

of the country This is referred to as capital flight Once investors have sold their domestic-currency denominated investments, they convert those investments into foreign currency This causes the exchange rate to get even worse, resulting in a run on the currency, which can then make it nearly impossible for the country to finance its capital spending Predicting when a country will run into a currency crisis involves the analysis of a diverse and complex set of variables There are a couple of common factors linking the more recent crises: most of the countries borrowed heavily (current account deficits); in some countries currency values increased rapidly; uncertainty over the government's actions made investors panic

3 Russian currency crisis 1998

3.1 Crisis background and main reasons

After the collapse of the USSR, Russia in the 1990s, almost constantly was experiencing financial

difficulties Therefore, it was in desperate need of foreign loans, but could not reliably guarantee the debt repayment A huge government debt became a consequence of the large external and internal debts

According to the Central Bank, at the time of crisis, the Central Bank reserves were $ 24 billion, liabilities

to non-residents in the STL / FLB (state short-term liabilities / federal loan bonds) market and the stock market - more than $ 36 billion The total amount of payments to non-residents by the state was

approaching 10 billion dollars a year

The situation with financial difficulties was compounded with the political struggle taking place between the Government appointed by Boris Yeltsin who adhered to liberal values, and the State Duma, which at that time was controlled by the Communist Party The imbalance in the relationship of the State Duma and the Cabinet was reflected in the growth of the state debt of the Russian Federation The fact that

Duma voted for unbalanced budgets, therefore increasing fiscal spending of the Government,

Government was looking for ways to close the budget hole, increasing the national debt by issuing state treasury bonds (T-bills)

"Black Tuesday" in October 1994 was one of the dates after which Government decided to finance budget deficit not through currency emission, but through so called non-inflationary sources, which actually

meant external and internal borrowing

Mass process of issuing T-bills started after the re-election of President Yeltsin If in 1995 the volume of T-bills issue was estimated at 160 billion dollars, in 1997, this number rose to 502 billion rubles Buyers

of state treasury bonds were offered high interest rates, so demand for T-bills was impressive Making it simple, for every ruble borrowed for one year, State promised to return 5-7 rubles of budget money So actually the system turned into a pyramid - the old obligations of the Russian Federation could be covered only due to the issues of new ones

In the 90th the Bank of Russia introduced so called "Currency corridor" in order to support the national currency exchange rate in the desired range, and ensure the profitability of T-bills in dollar terms At the same time, the Government allowed foreigners to invest in treasury bonds 1997 was the year when T-bills market became liberalized, and number of non-residents, who owned T-Bills counted as much as 30%

of the whole market Non-residents were happy to receive a high profit, and take their money out of the country while paying a modest 15 per cent tax

Very soon, economists understood that this is an alarm, arguing that the payments for T-bills are twice as big as the tax revenue of the state It became obvious that the bubble will soon burst At the time of the

default CBR reserves were only $ 24 billion, while Russia's obligations in the STL / FLB market and the stock market exceeded $ 36 billion, according to the Bank of Russia

One more reason of the currency crisis was that the situation was exacerbated by decline in world

commodity prices (especially oil, gas, metals) and the Asian financial crisis, that began in spring 1998 Because of these events, government revenues in foreign currency declined, while private foreign lenders became extremely reluctant in giving loans to countries with unstable economies

Besides starting from early 1992, when the so called liberalization of prices was made, and hyperinflation

of 356% occurred people start disbelieve the Government, and prefer not to invest their money anywhere

So, to sum it up we can see that the main reasons of the Russian financial and currency crises were low Government reserves, as Government spent much more than it could earn from the tax revenues; no plan

of economic development and local production; over issue of T-bills; external factors such as Asian Crisis and low prices on commodities (Oil)

3.2 Chronology of events Black august and default

According to experts, the alarm about a possible devaluation of the ruble and default sharply increased on

3rd of July 1998 after the statement of the Executive Director of the IMF, Michel Camdessus, who said, that even in the case of Moscow will fulfill all the requirements of the fund, the organization is unlikely to arrange a loan of 15 billion dollars, which is Russia requested

The chronology of events that preceded default can be seen as following:

July 7, 1998 Bank of Russia stopped issuing Lombard loans to banks

July 9, 1988 negotiations with the IMF were completed, the result was an agreement, that Russia will receive 22.6 billion dollar loans within 2 years

July 20, 1988, IMF decided to allocate the first tranche of Russian recovery loan in the amount of 14 billion dollars Ruble devaluation threat reduced

July 24,1988 the Central Bank of Russia lowered the refinancing rate to 60%

July 29, 1988 Director of the Institute of Economic Analysis Andrei Illarionov harshly criticized the policy of the CBR( Central Bank of Russia) and called for the early ruble devaluation by Government

August 5, 1998 the government decided increase the limit of foreign borrowings sharply - from 6 to 14 billion dollars In fact, this decision meant the impossibility of Government financing the budget from domestic sources

August 6,1998 IBRD decided to provide Russia a third loan for economic restructuring in the amount of

$ 1.5 billion Russian foreign debt liabilities rating reached the minimum values in the world market

August 11,1998 Russian securities on the stock market exchange fell down The fall in share prices on the RTS exceeded 7.5%, after which trading was stopped All day banks were actively buying up the

currency, and in the evening a number of the largest banks declared about suspension of the operations

August 12,1998 a sharp increase in demand for foreign currency has led to a halt of interbank credit

market and liquidity crisis CBR has reduced the limits on currency sale by large commercial banks, reducing its costs to maintain the ruble exchange rate

August 13, 1998 Moody's and Standard & Poor`s downgraded the credit rating of Russia An emergency meeting of the Finance Minister Mikhail Zadornov and Central Bank Deputy Chairman Sergei

Aleksashenko with representatives of the largest Russian banks was held The Government stated that the maintenance of the foreign exchange market and the market of state short-term bonds is the responsibility

of the commercial banks

August 14, 1998 Firs lines of people, who requested to return their deposits appeared in front of the banks

August 15,1998 President Boris Yeltsin, interrupted his vacation and returned to Moscow Prime Minister Sergei Kiriyenko held a meeting with the heads of the Central Bank, the Finance Ministry and the

Kremlin's special representatives in international financial institutions The Prime Minister instructed to develop measures to stabilize the situation

August 17, 1998 Prime Minister Sergei Kiriyenko announced the introduction of "a set of measures aimed

at the normalization of financial and fiscal policy," which actually meant a default and devaluation of the ruble Repayment of the loans to non-residents, transactions in the money market and collateral

operations were suspended for 90 days Purchase and sale of T-bills was also stopped

Along with the suspension of payments on T-bills, CBR moves to a floating exchange rate within the boundaries of the currency corridor of 6 to 9.5 rubles to the dollar The ruble fell against the dollar

immediately in half

The same day, the banks stopped returning deposits Streets were full with anxious depositors Central Bank of the Russian Federation made a statement in which explained the situation in a following way:

"The problem of the Russian banking system is that the majority of banks, especially large ones, have liabilities denominated in foreign currency and assets - in rubles In the case of devaluation they expect a very large hole in the balance sheet that not comparable with the volume of forward liabilities "

August 18, 1998 Alexander Livshits has resigned from the post of deputy head of the presidential

administration The international system Visa Int blocked "Imperial" bank cards and recommended other Russian banks to suspend issuing cash by the cards Central Bank announced a ban to banks to make a spread of foreign currency exchange more than 15%

August 19,1998 Government announced decision to postpone restructuring of the STL

August 20, 1998 deputy chairman Sergei Aleksashenko announced a refusal of the temporary

administration in commercial banks The new measures included providing bank with loans on condition

of collateral of the shares of the bank

August 21 Visa Int sent announcements to all foreign banks, recommending not to issue cash for a number of Russian banks` cards

As a result of devaluation, falling production and tax collection in 1998, gross domestic product

decreased three times - up to $ 150 billion - and became smaller than the GDP of Belgium Russia has become one of the largest debtors in the world Its external debt rose up to 220 billion dollars (165 billion

US dollars amounted to state debt, 30 billion - banks debt $ 25 billion – companies` debt) The amount was five times as big as the entire annual budget revenues and accounted for almost 147% of GDP Taking into account the domestic debt of the various authorities to state employees and enterprises on wages and general obligations on the government projects it exceeded $ 300 billion, or 200% of GDP

In August 1998, all fiscal and monetary system collapsed simultaneously in Russia Tax collection rates fell as low as possible Inflation accelerated three times, and altogether with the fourfold devaluation of the ruble treasury, citizens and businesses` incomes all felt down tremendously

A number of Russian banks could not survive the default Thus, the Bank of Russia revoked the license of Inkom bank, that was among the five largest banks in Russia

3.3 Impacts of crises on the economy

Though financial and currency crisis is always a tragedy for a nation, which is followed by long recovery process, we can actually distinguish both negative and positive impacts of the 1998 Russian financial and currency crisis

First of all we need remember that this was the first financial crisis in history, when government also defaulted on the debt in local currency As a rule state would emit more currency and in such way repay its debts But on August 17, 1998 Russian Government announced default both on external and internal debts Logically such actions resulted in a loss of confidence by both foreign and domestic investors in the solvency and competitiveness of the financial system in Russia This also resulted in a sharp decline

in the credit rating of Russia and all Russian companies A sharp outflow of capital from Russia began rapidly Ratings of Russian commercial banks were also lowered, which led to the loss of opportunities to attract foreign investment and foreign loans Being cut of both internal and external sources of financing the deficit of the state budget meant that Government was left with only one method of covering budget deficit - emission financing This has increased the rate of inflation and growth of consumer prices

There were serious violations in the work of the banking system and the implementation of payments Direct losses of commercial banks due to the Government's failure to service its debt obligations

estimated at $ 45 bln rubles The total losses of the Russian banking system caused by decisions of 17th

of August were estimated at 100-150 bln rubles As a result, many banks became insolvent A significant part of commercial banks went bankrupt

Due to the failure of many large banks to perform their obligations to depositors, under the reason of force majeure, the whole banking system of the country has lost the trust of the population, which has negative long-term implications not only for the domestic banks, but also for the country's economic system as a whole

Unmanaged devaluation of the ruble led to a sharp contraction of the money supply in real terms,

worsening liquidity crisis and rising defaults To overcome these effects, as well as to stabilize the

banking system in times of a massive outflow of deposits Government had to use currency emission heavily, which in its turn could lead to a inflationary spiral with long-term negative effects of

macroeconomic instability

Reduced real income and savings of the citizens in Russia, increased the number of people with income below the poverty line, high unemployment numbers all these were the consequences of default This situation happened due to harsh increase in domestic consumer prices, which was caused by depreciation

of the ruble income and savings, as well as the loss of people`s savings in banks that went bankrupt As a result of the decisions taken on August 17, real income of the population decreased by 31.1 percent in one month Lost savings in bank deposits were estimated by the International Confederation of Consumer Societies in the tens of billions of rubles

Companies were also seriously affected by the crisis, their deposits in troubled banks have been frozen In

1998, the entire Russian industry got struck in a payment crisis

If we want to mention positive consequence of the crisis of 1998 we should agree that due to the

devaluation of the ruble prices for imported goods in the country increased, while prices of domestic goods abroad fell, which allowed to increase export This gave new opportunities for domestic industry to gain profitability, cut off from its imports and increase export opportunities

Small businesses realized their strength and began to develop into a larger enterprises New types of businesses that were not common to countries with resource economics, like Russia start to develop at the time Since 1999, food processing, light industry, service industries, began to grow and consumer demand was also growing subsequently

The main positive result of the crisis of 1998 can be called abolishment of the raw model of the economy and development of the other sectors of economy, which were replaced by imports before the currency crisis

3.4 Recovery process and lessons from the crisis

The post-crisis decline in Russia was short and soon gave way to a large-scale growth A significant role

in this growth played a change in the macroeconomic policy of the Russian Government and the Central Bank

Overvalued exchange rate of the ruble was considered not useful as an anti-inflation measure and ruble has become almost completely floating currency Although this led to a short-term surge in prices, in most way this measure made a positive impact on the Russian economy Russian companies carrying costs in rubles, became more competitive both on global and domestic markets In addition, free

formation of the ruble value eased the accumulation of foreign exchange reserves of the Central Bank of the Russian Federation, which increased the stability of the financial system of the country

Monetary regulations were also relaxed Government completely abandoned the practice of restricting money supply by non-payment of salaries, pensions, and defaulting on government contracts This has contributed to the normalization of the situation in the financial sector and the growth of confidence in the actions of the state

In the post-default years fiscal discipline improved a lot The federal budget for 1999 was adopted with a deficit of 2.5% of GDP (for the budget for 1998, the same indicator amounted to 4.7% of GDP) It was also decided not to fund the budget deficit at the expense loans, because this measure on the one hand did not give the desired anti-inflationary effect, on the other hand was undermining the stability of the

economy The result was a decline in the profitability of investing in securities and, accordingly,

increasing the attractiveness of investments in the real sector of the economy, which contributed to

growth of production

An effective anti-crisis measure that was conducted by the Russian government in the early days after the default was the containment of the growth of prices for the products of natural monopolies (electric power, transportation, and so on) As a result, the rate of increase in these prices was twice less than the rate of inflation in the economy as a whole It was an additional impetus for the economic growth and it also contributed to the inflation slowdown

3.5 LTCM bankruptcy

In 1996 and 1997, the hedge fund managed by Long-Term Capital Management (LTCM) had an

outstanding series of success and has earned an unrivaled reputation in the management of financial risk However, in August 1998, Russia defaulted on its debt and a chain of unprecedented market movements began This brought a terrible outcome for LTCM Some say that the moral of the story is that the

management of risk in the fund was insufficient, although partners (participants) of the Fund were experts

in this field on Wall Street

The collapse of the hedge fund in 1998 was a stunning event Approximately half of the LTCM partners had PhD in Financial Sciences, most of them were from the Massachusetts Institute of Technology (the famous MIT) Two of the partners, Robert Merton and Myron Scholes received the Nobel Prize for their

research, which has become a cornerstone in the hedge derivative risks LTCM also included a group of traders with considerable experience in the markets and the leader of the "Dream Team" was a trader with

an outstanding reputation However, just a few months the fund has lost more than $ 4 billion, and LTCM was accused of a serious threat to the security of the global financial system Many argued that this collapse shows that modern financial risk management techniques did not work

4 Russian Currency Crisis 2014

4.1 Chronology of Events

In 2014,Russian currency crisis was about the collapse of the Russian ruble and sharp economic

slowdown in Russia The decline in the Russian ruble has increased the costs for Russian companies, they had to make interest payments on debt that issued in U.S dollar or other foreign currencies that have strengthened against the ruble; thus Russian companies need cost more ruble to repay their debt holders in dollars or other foreign currencies Investors decline confidence in the Russian economy and sell off their Russian assets, which led to a decline in the value of the Russian ruble and sparked fears of a Russian financial crisis

The crisis has affected the Russian economy, consumers and companies, and regional financial markets,

as well as Putin's ambitions regarding the Eurasian Economic Union The Russian stock market has experienced large declines, with a 30% drop in the RTS Index from the 16 December in 2014

The following graph shows events how to affect Russian ruble

Timetable of collapse of the Russian

Annexation of Crimea 18 March 2014 36.2477

Minsk Protocol 5 September 2014 37.0028

Donbas general elections 2 November 2014 43.0072

Central Bank intervention 16 December 2014 68.4910

4.2 Main Reasons

The main causes of Russian currency crisis in 2014 are the fall in the price of oil in 2014 and international economic sanctions

4.2.1 Fall in oil prices