Lessons from the Russian Crisis of 1998 and Recovery

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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

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Related papers Pinto, Vladimir Drebentsov, Alexander Morozov: "Give macroeconomic security and development in Russia a Chance: Harden spending plans 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.

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Key Dates and Events July 1995 3-year adjustment program concurred with IMF July 1996 Yeltsin re-chose in second round Early 1997 GKO/OFZ advertise changed, "DREAM TEAM" Oct 1997 Chronic assessment issue prompts IMF to hold up distributions July 13, 98 $22.6 billion bundle reported August 17 Ruble downgraded, crisis measures announced September 2 Ruble is glided September 9 Exchange rate achieves 21 R/$ contrasted with 6.29 R/$ on August 14

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The Economic and Political Costs of the Crisis GDP short 4.9% 12-month swelling 84% - target was 8% Pensioners/breadwinners endured FX assets spent between Oct. 1997 and the Sept. 2, 1998 buoy $30 billion. $16 billion brought about in the most recent 10 weeks before the emergency Reformist legislature of Sergei Kirienko was rejected

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Four-Part Framework Fundamentals and Liquidity Market Signals Crisis Triggers Moral Hazard

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(1) d public obligation/GDP proportion, t time subscript (in years) pd primary shortfall/GDP ndfs non-obligation financing sources/GDP r composite genuine loan fee g real development rate Public Debt Dynamics These are caught by the standard condition (1):

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Public Finances and Economic Growth

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w share of residential money obligation in absolute obligation r genuine loan cost on household cash obligation d r genuine financing cost paid on outside coin obligation (e.g., premium f rate paid by government on US dollar getting balanced for US expansion) r % change in dollar-ruble genuine conversion standard (r > 0 implies a genuine thankfulness) Public Debt Dynamics (cont'd) This conveys us to condition (2), which contains an extended rendition of the composite genuine loan cost, r: (2)

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Why were development desires in Russia reliably gave a false representation of? Macroeconomic environment: high genuine financing costs and an acknowledging genuine swapping scale Serious basic issues (the non-installments issue)

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Real Exchange Rate (RER) Was genuine gratefulness a balance wonder? Current Account Balances versus Sargent –Wallace RER developments = f (oil costs, capital streams, adjustment procedure Stabilization Strategy was the primary impact on RER

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What is the non-installments issue? Inquisitive marvel one of a kind to Russia and the FSU Consisted of two sections: (i) unpaid debts/late installments and (ii) developing utilization of non-money related trade Became dug in view of high loan costs Killed development and secured in the financial shortfall Rational monetary clarifications Enveloped the whole economy Linked to PDD Linked to development

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Market Signals Foreign Currency Debt (FCD) Domestic Currency Debt (DCD)

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Foreign Currency Debt

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Spread contrast on the Russian and Indonesian 10-year eurobonds June 10, 1998 -100 bps June 25, 1998 0 July 24 (consummation of obligation swap) +160

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Domestic Currency Debt (DCD) Yields on one-year GKOs were deteriorated utilizing condition (3) to get the sovereign or default chance premium (SRP) and downgrading hazard premium (DRP) as a lingering. (3) i d = i f + SRP + (dx/x)* + DRP

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GKO yield SRP DRP May 15 39.3 4.8 23.0 July 13 102.3 8.5 82.3 July 14 58.2 8.1 38.6 July 24 66.4 10.0 44.9 August 10 99.0 20.0 67.5 August 14 144.9 23.8 109.5 SRP and DRP Selected Dates

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Timing of the Crisis Three variables assumed a part: International liquidity Balance and reeling sheet exposures of banks GKO-Eurobond swap and IFI liquidity infusion

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S max. cutoff spread 940 837.5 min. spread 4.4 Market Value of GKOs offered ($ bn.) The Outcome of the Swap Bid Spread (premise focuses ) S 0

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Why didn't the swap fill in as expected? No free lunch with market-based swap Interaction impacts with existing resource portfolio Implications for size of debasement expected to reestablish government's between transient spending imperative adjust

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Moral Hazard There are numerous ex-post thinks about indicating MH is not a variable What makes a difference is how MH influences conduct by changing expected returns MH is an especially expensive issue when you have unsustainable PDD and low liquidity

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Post Crisis Developments Hard spending plans and RER Liquidity and PDD Macro approach position (RER, Fiscal Adjustment) Debt Restructuring Social Impact

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So, What's the Bottom Line? Lessons Learned Extremely hard to manage unsustainable PDD and low liquidity at the same time. Swelling decrease to the detriment of monetary and development essentials will just not work. Genuine gratefulness with weakening endeavor execution and PDD is probably not going to be feasible EVEN if CA in adjust.

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Lessons Learned (Cont'd) Liquidity – suitable measures. Why monetary building won't help. Social wellbeing net lessons. Governmental issues

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Do Svidania!