In 1998, Russia experienced a sovereign debt default, a massive ruble devaluation and a banking crisis. Triggered by the invasion of Ukraine, the value of the currency has fallen again – and this crisis could last longer and get worse without a move towards peace.
Following Russia’s invasion of Ukraine in February 2022, the value of the Russian ruble against the US dollar fell by more than 40% in just two weeks. A depreciation of this magnitude would be extraordinary for most countries, but this is not the first significant currency devaluation Russia has faced in recent history.
In 1998, Russia experienced a major currency crisis when the ruble lost more than two-thirds of its value in three weeks, as well as a default on its sovereign debt and a banking crisis. Are there lessons from this crisis that are relevant today?
Figure 1: USD/RUB exchange rate, January 1995-April 2022
Context and causes of the 1998 ruble crisis
The fall of the Soviet Union in 1991 preceded several years of policies of economic reform, privatization and macroeconomic stabilization in Russia. Central to this was the adoption of a currency peg – a type of exchange rate regime in which the value of one currency is pegged to the value of another currency.
This meant that the value of the ruble against the dollar was constant and could only fluctuate within a narrow band. The Bank of Russia would intervene by buying and selling the ruble as necessary to maintain the exchange rate.
The Russian economy has also been supported by financial aid from the World Bank and the International Monetary Fund (IMF), while negotiations to repay foreign debt inherited from the Soviet Union have improved investor confidence (Chiodo and Owyang, 2002).
In the first quarter of 1997, foreign investment in Russia increased sharply with the easing of restrictions on foreign portfolio investment. But investor expectations quickly changed following the Asian financial crisis, which began with the collapse of the Thai baht in July 1997. This crisis quickly spread to other Asian currencies, and in November the ruble has also been attacked by speculators (Chiodo and Owyang, 2002).
Despite the reforms introduced since 1991, fundamental institutional weaknesses remain in Russia (Sutela, 1999; Chiodo and Owyang, 2002). These weaknesses have been highlighted and exacerbated by the financial crisis in Asia.
A global recession and falling commodity prices have compounded weak tax enforcement in Russia and a costly war in Chechnya. This led to fiscal imbalances and raised questions about the government’s ability to pay its sovereign debts and maintain a fixed exchange rate (Desai, 2000; Kharas et al, 2010). This increase in default and exchange rate risk made capital flight from Russia and a devaluation of the ruble more likely.
In an attempt to encourage investors to hold ruble-denominated assets and support the fixed exchange rate, the Bank of Russia raised interest rates to 150%. But that meant that in July 1998, interest payments on Russian debt were 40% higher than the country’s. collection of tax. This had the effect of further eroding investor confidence and creating downward pressure on the currency.
In early August 1998, driven by fears of a domestic debt default and a devaluation of the rouble, Russian stock, bond and currency markets all came under severe pressure. Trading on the stock exchange was suspended for 35 minutes due to the sharp drop in prices.
Then, on August 17, the government announced a devaluation of the ruble’s fixed exchange rate, a default on its domestic debt, and a 90-day suspension of payments by commercial banks to foreign creditors.
Two weeks later, on September 2, the Bank of Russia abandoned its efforts to maintain a fixed exchange rate and let the ruble float freely. Within three weeks, the currency had lost about two-thirds of its value (Kharas et al, 2010).
Consequences and recovery
These events had important national and international consequences. The currency crisis and associated turmoil in financial markets contributed to a recession and contraction of the Russian economy by 5.3% in 1998, with GDP per capita falling to its lowest level since the formation of the Russian Federation. Russia in 1991.
Inflation in 1998 was 84% due to the depreciation of the rouble, which contributed to a dramatic drop in real wages and social unrest. Workers have staged large-scale strikes and demonstrations, including protests outside the Russian White House.
Increased political instability ensued: the prime minister and central bank governor were replaced; the first budget of the new prime minister was rejected; and the president’s popularity plummeted (Desai, 2000). In August 1999, less than a year after the crisis, Vladimir Putin became the fifth prime minister in 12 months.
The crisis has also had a significant effect on financial markets globally. Russia’s sovereign default was the largest in history at the time and contributed to the collapse of the hedge fund LTCM (Long Term Capital Management) in the United States, which required a $3.6 billion bailout of dollars. This has had significant knock-on effects in international markets (Dungey et al, 2002).
The Russian economy recovered relatively quickly from the 1998 crisis, with growth of 6.4% in 1999 and 10% in 2000. The sharp depreciation of the ruble made Russian exports attractive internationally and, combined with an increase in oil revenues, helped spur economic recovery. . Sovereign debt restructuring and a $4.8 billion IMF loan helped Russia regain access to international financial markets.
It is important to note that the forces behind the 1998 crisis and the current crisis are very different, both politically and economically. Yet there may be fundamental lessons about how crises evolve and their implications.
First, currency crises can be triggered by events that increase a country’s risk, reduce investor confidence, and change expectations about a country’s economic prospects, leading to capital flight.
As in 1998, the ruble devaluation in 2022 was fundamentally triggered by a sharp increase in Russia-related risk, although the source of this was very different in each case.
Second, currency crises often go hand in hand with other financial crises, such as sovereign debt defaults, stock market crashes, and banking crises, and can cause inflation and interest rates to rise. . These have important implications and in 1998 they culminated in a sharp rise in the cost of living, recession, social unrest and political instability in Russia.
The extent of Russia’s current financial market difficulties has so far been mitigated by extensive government restrictions. Nevertheless, interest rates have already increased from 9.5% to 20%, before being reduced to 14%, and inflation had accelerated to 16.7% in March.
Further economic difficulties could still arise in Russia, especially since there are currently no signs of abating political risk as the war continues and sanctions increase. But a default on Russia’s foreign debt looks increasingly likely and a deep recession seems certain.
As in 1998, this may have implications for social and political stability. Approval ratings of political leaders in Russia have been shown to track citizens’ perceptions of the state of the economy since 1991 (Treisman, 2011).
The 1998 crisis shows that economic shocks can spill over into global financial markets. Today, many countries are experiencing rising inflation and weaker growth as a direct result of the war in Ukraine, with interest rates likely to rise. Many international companies have written off their investments in Russia.
Unlike in 1998, Russia has adopted a floating exchange rate in recent years, which means capital flight out of the country should be immediately reflected in the exchange rate. Despite this and unlike in 1998, the ruble exchange rate recovered quickly after its initial fall in early March 2022.
Rather than a reflection of reduced risk or increased investor confidence in the Russian economy, this rally highlights Russia’s success in supporting the ruble through government interventions. These include trade restrictions, capital controls, an increase in interest rates and government requirements for companies to hold 80% of their income abroad in roubles.
This means that the ruble is no longer freely convertible and its value now tells us little about the reality of the Russian economy.
Notably, Russia was able to recover quickly from the 1998 crisis thanks to the stimulating effect of the weaker rouble, increased oil revenues and help from the West in the form of IMF loans. The rapid recovery of the ruble exchange rate in March 2022, combined with the increase in international sanctions, means that the expansionary forces that enabled a rapid recovery from the 1998 crisis seem extremely unlikely today.
These lessons suggest that the full economic effects of recent events in Russia have yet to manifest themselves, and without a move toward peace and geopolitical normalization, the impact will be longer and more severe than in 1998.
Where can I find out more?
Who are the experts on this issue?
- Paul Krugman
- Maurice Obstfeld
- Sergei Guriev
- Daniel Triesman
- Anders Aslund