1998 Russian financial crisis

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The 1998 Russian financial crisis arose in the aftermath of the East Asia crisis of 1997.

The crisis spread to Russia in the summer of 1998, when it defaulted on its sovereign debt, much of which was held by U.S. investment banks. The Russian default triggered a flight to quality in the bond market as huge differentials opened up between the interest rate paid on relatively safe U.S. Treasuries and the interest rates paid on less secure corporate bonds.[1]

The crisis

In 1997, the economic conditions in Russia seemed to stabilize. Inflation had fallen from 131 percent in 1995 to 22 percent in 1996 and 11 percent in 1997. Russian banks began borrowing more from foreign markets, increasing their foreign liabilities from 7 percent of their assets in 1994 to 17 percent in 1997.

In November 1997, after the onset of the East Asian crisis, the ruble came under speculative attack. The Central Bank of Russia (CBR) defended the currency, losing nearly $6 billion (U.S. dollars) in foreign-exchange reserves. At the same time, non-resident holders of short-term government bills (GKOs) signed forward contracts with the CBR to exchange rubles for foreign currency, which enabled them to hedge exchange rate risk in the interim period. They did this reportedly in anticipation of the ruble losing value, as Asian currencies had. Also, a substantial amount of the liabilities of large Russian commercial banks were off-balance-sheet, consisting mostly of forward contracts signed with foreign investors. Net obligations of Russian banks for such contracts were estimated to be at least $6 billion by the first half of 1998. Then another blow was dealt to the Russian economy: in December 1997, the prices of oil and nonferrous metal, up to two-thirds of Russia’s hard-currency earnings, began to drop.

With so many uncertainties in the Russian economy, investors turned their attention toward Russian default risk. To promote a stable investment environment, in February 1998, the Russian government submitted a new tax code to the Duma, with fewer and more efficient taxes. The new tax code was approved in 1998, yet some crucial parts that were intended to increase federal revenue were ignored. Russian officials sought IMF funds but agreements could not be reached. By late March the political and economic situation had become more dire, and, on March 23, President Yeltsin abruptly fired his entire government, including Prime Minister Viktor Chernomyrdin. In a move that would challenge investor confidence even further, Yeltsin appointed 35-year-old Sergei Kiriyenko, a former banking and oil company executive who had been in government less than a year, to take his place.

While fears of higher interest rates in the United States and Germany made many investors cautious, tensions rose in the Russian government. Investors’ perceptions of Russia’s economic stability continued to decline and big investors began to sell their government bond portfolios and Russian securities, concerned that relations between the United States and Russia were strained.

By May 18, government bond yields had swelled to 47 percent. With inflation at about 10 percent, Russian banks would normally have taken the government paper at such high rates, however, they lacked confidence in the government’s ability to repay the bonds. The federal government’s initiative to collect more taxes in cash also lowered banks’ and firms’ liquidity.

Also, household ruble deposits increased by only 1.3 billion in 1998, compared with an increase of 29.8 billion in 1997. The CBR responded by decreasing the growth of the money supply and increasing the lending rate to banks from 30 to 50 percent, and in two days used $1 billion of Russia’s low reserves to defend the ruble.

However, by May 27, demand for bonds had plummeted so much that yields were more than 50 percent and the government failed to sell enough bonds at its weekly auction to refinance the debt coming due.

Meanwhile, oil prices had dropped to $11 per barrel, less than half their level a year earlier. Oil and gas oligarchs were advocating a devaluation of the ruble, which would increase the ruble value of their exports. In light of this, the CBR increased the lending rate again, this time to 150 percent. CBR chairman Sergei Dubinin responded by stating "When you hear talk of devaluation, spit in the eye of whoever is talking about it."

The government formed and advertised an anticrisis plan, requested assistance from the West, and began bankruptcy processes against three companies with large debts from back taxes. Kiriyenko met with foreign investors to reassure them. Yeltsin made nightly appearances on Russian television, calling the nation’s financial elite to a meeting at the Kremlin where he urged them to invest in Russia. In June the CBR defended the ruble, losing $5 billion in reserves. Despite all of the government efforts being made, there was widespread knowledge of $2.5 to $3 billion in loans from foreign investors to Russian corporations and banks that were to come due by the end of September. In addition, billions of dollars in ruble futures were to mature in the fall. In July the IMF approved additional assistance of $11.2 billion, of which $4.8 billion was to be disbursed immediately. Yet between May and August, approximately $4 billion had left Russia in capital flight, and in 1998 Russia lost around $4 billion in revenue due to sagging oil prices. After losing so much liquidity, the IMF assistance did not provide much relief.

The Duma, in an effort to protect natural monopolies from stricter regulations, eliminated crucial parts of the IMF-endorsed anti-crisis program before adjourning for vacation. The government had hoped that the anti-crisis plan would bring in an additional 71 billion rubles in revenue. The parts that the Duma actually passed would have increased it by only 3 billion rubles. In vain, lawmakers requested that the Duma reconvene, lowering investors’ confidence even further.

On August 13, 1998, the Russian stock, bond, and currency markets collapsed as a result of investor fears that the government would devalue the ruble, default on domestic debt, or both. Annual yields on ruble-denominated bonds were more than 200 percent. The stock market had to be closed for 35 minutes as prices plummeted. When the market closed, it was down 65 percent with a small number of shares actually traded. From January to August the stock market had lost more than 75 percent of its value, 39 percent in the month of May alone. On August 17 the government floated the exchange rate, devalued the ruble, defaulted on its domestic debt, halted payment on ruble-denominated debt (primarily GKOs), and declared a 90-day moratorium on payment by commercial banks to foreign creditors.[2]


  1. Gene Callahan and Roger W. Garrison. "Does Austrian Business Cycle Theory Help Explain the Dot-Com Boom and Bust?" (pdf), The Quarterly Journal of Austrian Economics, Vol. 6, No. 2 (Summer 2003). Referenced 2011-07-01.
  2. Abbigail J. Chiodo and Michael T. Owyang. "A Case Study of a Currency Crisis: The Russian Default of 1998", 2002, The Federal Reserve Bank of St. Louis. Referenced 2011-07-01.