Lessons from the Russian Crisis of 1998 and Recovery: Lessons from the Russian Crisis of 1998 and Recovery Brian Pinto, Evsey Gurvich and Sergei Ulatov
Draft Chapter for:
Managing Economic Volatility and Crises:
A Practitioner’s Guide
Edited by Joshua Aizenman and Brian Pinto Related papers: Related papers Pinto, Vladimir Drebentsov, Alexander Morozov: “Give macroeconomic stability and growth in Russia a Chance: Harden budgets by Eliminating Nonpayments”, Economics of Transition, vol 8 (2) 2000, 297-324.
Homi Kharas, Pinto and Ulatov: “An Analysis of Russia’s 1998 Meltdown: Fundamentals and Market Signals”, Brooking Papers on Economic Activity, 1:2001, 1-67.
Joshua Aizenman, Kenneth M. Kletzer and Pinto, “Sargent-Wallace Meets Krugman-Flood-Garber, or: Why Sovereign Debt Swaps Don’t Avert Macroeconomic Crises.” NBER WP 9190. Key Dates and Events: Key Dates and Events
July 1995 3-year stabilization program agreed with IMF
July 1996 Yeltsin re-elected in second round
Early 1997 GKO/OFZ market liberalized, “DREAM TEAM”
Oct 1997 Chronic tax problem prompts IMF to hold up disbursements
July 13, 98 $22.6 billion package announced
August 17 Ruble devalued, emergency measures
September 2 Ruble is floated
September 9 Exchange rate reaches 21 R/$ compared to 6.29 R/$
on August 14
The Economic and Political Costs of the Crisis : The Economic and Political Costs of the Crisis GDP minus 4.9%
12-month inflation 84% - target was 8%
Pensioners/ wage earners suffered
FX resources used up between Oct. 1997 and the Sept. 2, 1998 float $30 billion. $16 billion incurred in the last 10 weeks before the meltdown
Reformist government of Sergei Kirienko was dismissed Four-Part Framework: Four-Part Framework Fundamentals and Liquidity
Moral Hazard Public Debt Dynamics: Public Debt Dynamics These are captured by the standard equation (1): Public Finances and Economic Growth: Public Finances and Economic Growth Public Debt Dynamics (cont’d): Public Debt Dynamics (cont’d) This brings us to equation (2), which contains an
expanded version of the composite real interest rate, r: (2) Why were growth expectations in Russia consistently belied?: Why were growth expectations in Russia consistently belied?
Macroeconomic environment: high real interest rates and an appreciating real exchange rate
Serious structural problems (the non-payments problem)
Real Exchange Rate (RER): Real Exchange Rate (RER) Was real appreciation an equilibrium phenomenon?
Current Account Balances vs. Sargent –Wallace
RER movements = f (oil prices, capital flows, stabilization strategy
Stabilization Strategy was the main influence on RER
What is the non-payments problem?: What is the non-payments problem? Curious phenomenon unique to Russia and the FSU
Consisted of two parts: (i) arrears/overdue payments and (ii) growing use of non-monetary exchange
Became entrenched because of high interest rates
Killed growth and locked-in the fiscal deficit
Rational economic explanations
Enveloped the entire economy
Linked to PDD
Linked to growth
Market Signals: Market Signals
Foreign Currency Debt (FCD)
Domestic Currency Debt (DCD) Foreign Currency Debt : Foreign Currency Debt Spread difference on the Russian and Indonesian 10-year eurobonds: Spread difference on the Russian and Indonesian 10-year eurobonds June 10, 1998 -100 bps
June 25, 1998 0
July 24 (completion of debt swap) +160 Domestic Currency Debt (DCD): Domestic Currency Debt (DCD) (3) id = if + SRP + (dx/x)* + DRP Yields on one-year GKOs were decomposed using equation (3) to get the sovereign or default risk premium (SRP) and devaluation risk premium (DRP) as a residual. SRP and DRP Selected Dates: SRP and DRP Selected Dates
Timing of the Crisis: Timing of the Crisis Three factors played a role:
Balance and off-balance sheet exposures of banks
GKO-Eurobond swap and IFI liquidity injection
The Outcome of the Swap: The Outcome of the Swap Bid Spread (basis points) 0 S Why didn’t the swap work as anticipated?: Why didn’t the swap work as anticipated? No free lunch with market-based swap
Interaction effects with existing asset portfolio
Implications for size of devaluation needed to restore government’s inter-temporal budget constraint balance Moral Hazard: Moral Hazard There are many ex-post studies showing MH is not a factor
What matters is how MH affects behavior by changing expected returns
MH is a particularly costly issue when you have unsustainable PDD and low liquidity Post Crisis Developments: Post Crisis Developments Hard budgets and RER
Liquidity and PDD
Macro policy stance (RER, Fiscal Adjustment)
So, What’s the Bottom Line?Lessons Learned: So, What’s the Bottom Line? Lessons Learned Extremely difficult to deal with unsustainable PDD and low liquidity simultaneously.
Inflation reduction at the expense of fiscal and growth fundamentals will simply not work.
Real appreciation with deteriorating enterprise performance and PDD is unlikely to be sustainable EVEN if CA in balance.
Lessons Learned (Cont’d): Lessons Learned (Cont’d) Liquidity – appropriate measures.
Why financial engineering will not help.
Social safety net lessons.
Politics Do Svidania!: Do Svidania!