Russian Currency Crisis Essay Research Paper Not

Russian Currency Crisis Essay, Research Paper

Not so long ago, business was bullish on Russia. Moscow was experiencing a construction boom driven by multinationals and local entrepreneurs demanding office space. In 1996, the benchmark stock index, the Russian Trading System (RTS) was up about 120% and continued to climb in the first quarter of 1997. Long-held hopes about Russia nourished this dynamic, notwithstanding considerable evidence that the country had yet to establish the rule of law, a critical prerequisite for any state to become a true market economy. By mid-1997, however, Russia was already showing signs of political gridlock and economic stagnation. Unfortunately, these signs materialized into the Russian financial crisis in August, 1998. From a chronological perspective, the crash of the Russian equity and debt crash markets began in Asia during October 1997. Prior to the Asian financial disaster, at the zenith of the Russian markets in late 1996 and 1997 floods of foreign investment poured into Russia. The inflows of capital into the debt markets drove up prices and brought yields to as low as 20%. The debt load grew to as much as $70 billion as the Russian government took advantage of low yields to finance its deficit spending. When Asia collapsed in October 1997, emerging market interest rates increased and Russia began to have problems servicing its debt.In July 1998 the Russian markets became increasingly uneasy when the U. N.’s Economic and Social Council concluded that short-term growth prospects in Russia had deteriorated considerably and unless reforms and stability are introduced GDP growth could fall below its target. At this point Russia’s public debt was four to five times larger than annual budget revenues.As of mid July 1998 the benchmark stock index, the Russian Trading System (RTS), had lost nearly 75% of its value since October 1997. In early August, interbanks were paralyzed by liquidity shortages and a lack of investor confidence. This depressed stock prices to their lowest level in two years.The events of August 17, 1998 demonstrated to the West that virtually every national economic crisis results from a collapse of the currency. On that day, the Russian government devalued the ruble, defaulted on $40 billion of its debt, and ordered a 90-day moratorium on payments of some foreign debt by Russian banks. Simultaneously, Russian abandoned its defense of the ruble and devalued it.Further, the value of Russian state bonds (GKOs), which represented a major portion of bank portfolios, was wiped out overnight. Compounding the problem were forward contracts into which Russian banks had entered with their Western counterparts. Because GKOs are denominated in rubles, foreign banks sought to hedge themselves against the risk of a currency devaluation by using forward contracts. Unfortunately, the ruble fell so far that Russian banks were unable to pay off the forward contracts. By year-end the ruble had slipped from 6 to 23 rubles on the dollar.The Institute for Economic Analysis in Washington estimates at $70 billion the overall losses on GKOs held by foreign and Russian investors. The European Bank for Reconstruction and Development in London projects at $169.50 million its own losses in Russia for the first nine months of 1998. Estimates of American pre-tax commercial and investment banking losses arising from activities in Russia exceed $1 billion. Direct foreign investment also took a hit. In a September 1998 survey of its members by the American Chamber of Commerce in Russia, 72% of the respondents stated that their funds had become inaccessible as a result of bank restructuring and other actions by the Russian government in connection with August 17. In addition, 58% reported non-payment of receivables, combined with a decline in demand for their products or services; 28% reported the full or partial collapse of their distribution network; and 36% were forced by the crisis to delay payments to their own creditors. In a follow-up survey the 50 businesses responding estimated their losses, in the aggregate, at $500 million. Currently, Russia owes the London Club of Creditors $20 billion and the Paris Club of Creditors $40 billion. Russia offered to pay foreign bondholders 10% in cash, 20% in non-coupon securities tradable for tax debts or shares in Russian banks, and 70% in ruble denominated interest-bearing securities with maturities of as long as five years. The majority of foreign investors have balked at the idea saying that the restructuring is worth 5 cents on the dollar in relation to their original investment. Many creditors have considered using foreign courts to seize Russian property such as energy companies like Gazprom. Lehman Brothers Inc. recently won court orders freezing $128 million in the British units of three Russian banks that failed to honor foreign exchange contracts. Basically, Russia is in a financial hurricane. Central Bank Chairman Viktor Geraschenko has been printing money to cover the carrying costs of its debt. The government has acknowledged that printing money may push inflation up to nearly 45% by the end of 1999. On January 15, 1999 Russia reopened its debt market. On opening day the market mainly consisted of long-term bonds, known as OFZs, not covered by the default and of new securities issued to compensate holders of the defaulted debt. Worries over Russia’s solvency are likely to keep the domestic market in the dold