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Case Study - 5 - Russin Ruble Crisis
Case Study - 5 - Russin Ruble Crisis
Case Discussion Questions years South Korean enjoyed a strong recovery. If the
IMF had not stepped in, what might have occurred?
1. What role did the Korean government play in
creating the 1997 crisis?
Sources
2. What role did Korean enterprises play in creating
the 1997 crisis? 1. J. Burton and G. Baker, "The Country That Invested Its
3. Why was the Korean central bank unable to stop Way into Trouble," Financial Times, January 15, 1998,
p.8; J. Burton, "South Korea's Credit Rating Is
the decline in the value of the won?
Lowered," Financial Times, October 25, 1997, p. 3;
4. In late 1997, the IMF stepped in with a rescues J. Burton, "Currency Losses Hit Samsung Electronics,"
package that included $55 billion in emergency Financial Times, March 20, 1998, p. 24; and "Korean
loans to support the currency. These loans had the Firms' Foreign Exchange Losses Exceed US $15 Billion,"
effect of stabilizing the won and over the next few Business Korea, February 1998, p. 55.
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IMF loans. In February 1996, the IMF obliged with its was emasculated by antigovernment forces. The IMF re
second-largest rescue effort ever, a loan of $10 billion. In sponded by withholding $800 million of its first $5.6 bil
return for the loan, Russia agreed to limit the growth in lion tranche, undermining the credibility of its own
its money supply, reduce public-sector debt, increase program. The Russian stock market plummeted on the
government tax revenues, and peg the ruble to the dol news, closing down 6.5 percent. Selling of rubles accel
lar. Russia also rebased the value of the ruble, making erated. The central bank began hemorrhaging foreign
one ruble equivalent to 1,000 old rubles. exchange reserves as it tried to maintain the value of the
Initially the package seemed to have the desired ef ruble. Foreign exchange reserves fell by $1.4 billion in
fect. Inflation declined from nearly 50 percent in 1996 the first week of August alone, to $17 billion, while in
to about 15 percent in 1997; the exchange rate stayed terest rates surged again.
within its predetermined band of 4.3 to 4.8 rubles per Against this background, on the weekend of August
dollar; and the balance-of-payments situation remained 15-16, top Russian officials huddled to develop a re
broadly favorable. In 1997, the Russian economy grew sponse to the most recent crisis. Their options were lim
for the first time since the breakup of the former Soviet ited. The patience of the IMF had been exhausted.
Union, if only by a modest half of 1 percent of GDP. Foreign currency reserves were being rapidly depleted.
However, the public-sector debt situation did not im Social tensions in the country were running high. The
prove. The Russian government continued to spend government faced upcoming redemptions on $18 billion
more than it agreed to under IMF targets, while govern of domestic bonds, with no idea of where the money
ment tax revenues were much lower than projected. would come from.
Low tax revenues were in part due to falling oil prices On Monday, August 1 7, P rime Minister Sergei
(the government collected tax on oil sales), in part due Kiriyenko announced the results of the weekend's con
to the difficulties of collecting tax in an economy where clave. He said Russia would restructure the domestic
so much economic activity was in the "underground debt market, unilaterally transforming short-term debt
economy," and partly due to a complex tax system that into long-term debt. In other words, the government
was peppered with loopholes. In 1997, Russian federal had decided to default on its debt commitments. The
government spending amounted to 18.3 percent of GDP, government also announced a 90-day moratorium on
while revenues were only 10.8 percent of GDP, implying the repayment of private foreign debt and stated it
a deficit of 7 .5 percent of GDP, which was financed by would allow the ruble to decline by 34 percent against
an expansion in public debt. the U.S. dollar. In short, Russia had turned its back on
the IMF plan. The effect was immediate. Overnight,
CRISIS shops marked up the price of goods by 20 percent. As
the ruble plummeted, currency exchange points were
Dismayed by the failure of Russia to meet its targets, the only prepared to sell dollars at a rate of 9 rubles per dol
IMF responded by suspending its scheduled payment to lar, rather than the new official exchange rate of
Russia in early 1998, pending reform of Russia's complex 6.43 rubles to the dollar. As for Russian government
tax system and a sustained attempt by the Russian gov debt, it lost 85 percent of its value in a matter of hours,
ernment to cut public spending. This put further pres leaving foreign and Russian holders of debt alike sud
sure on the Russian ruble, forcing the Russian central denly gaping at a huge black hole in their financial
bank to raise interest rates on overnight loans to assets.
150 percent. In June 1998, the U.S. government
indicated it would support a new IMF bailout. The IMF AFTERMATH
was more circumspect, insisting instead that the Russian
government push through a package of corporate tax in In the aftermath of Russia's default on government debt,
creases and public spending cuts to balance the budget. the IMF effectively turned its back on the Russian gov
The Russian government indicated it would do so, and ernment, leaving the country to fix its own financial
the IMF released a tranche of $640 million that had mess. With no more IMF loans in the offing, the govern
been suspended. The IMF followed this with an addi ment had to find some other way to manage its large
tional $11.2 billion loan designed to preserve the ruble's public-sector deficit. The government took a two
stability. pronged approach; first, it slashed government spending,
Almost as soon as the funding was announced, how and second, it reformed the tax system. With regard to
ever, it began to unravel. The IMF loan required the the tax system, the government of Vladimir P utin ig
Russian government to take concrete steps to raise per nored the advice of the IMF, which wanted Russia to
sonal tax rates, improve tax collections, and cut govern raise tax rates and focus on tougher enforcement.
ment spending. A bill containing the required legislative Instead, the government replaced Russia's complex in
changes was sent to the Russian parliament, where it come tax code, which had a top marginal rate of
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414 Part 4 ei Cases
30 percent, with a 13 percent flat tax. Corporate tax Case Discussion Questions
rates were also slashed from 35 percent to 24 percent,
1. What were the causes of the surge in inflation in
and the tax code simplified, closing many loopholes.
Russia during the early 1990s? Could this have
Paradoxically, the cut in tax rates led to a surge in gov
been avoided? How?
ernment revenues as individuals and corporations de
cided it was easier to pay taxes than go to the trouble of 2. What does the decline in the value of the ruble
avoiding them, which they had long done. against the dollar between 1992 and 1998 teach
In addition to these government actions, a sharp rise you about the relationship between inflation rates
in commodity prices, and particularly world oil prices, and currency values?
helped the Russian economy enormously. Russia is now 3. During the mid-1990s, the IMF wanted Russia to
the world's largest oil exporter, ahead of even Saudi raise tax rates, close loopholes in the tax system,
Arabia. In addition, it exports significant amounts of and cut public spending. Russia was unable to do
natural gas, metals, and timber, all of which have seen this. Why?
sharp price increases since 1998. The country now runs 4. In the early 2000s Russia cut tax rates for individuals
a large current account surplus with the rest of the world and corporations, and government tax revenues
(in 2004 it hit $46 billion). surged. Why? Does this result suggest that the IMF
As a result of these changes, the Russian economy policy prescriptions were wrong?
grew at an average annual rate of 6.5 percent between
1998 and 2004. Foreign debt declined from 90 percent
Sources
of GDP in 1998 to about 28 percent in 2004, while for
eign reserves increased tenfold to $120 billion. The gov 1. S. Erlanger, "Russia Will Test a Trading Band for the
ernment has been running a budget surplus since 1999. Ruble," The New York Times, July 7, 1995, p. l;
C. Freeland, "Russia to Introduce a Trading Band for
In 2004 it took in some $13.1 billion more than it spent.
Ruble against Dollar," Financial Times, July 7, 1995, p. l;
Moreover, in January 2005 the Russian government re
J. Thornhill, "Russians Bemused by 'Black Tuesday, '"
paid its entire obligations to the IMF ahead of schedule.
Financial Times, October 12, 1994, p. 4; R. Sikorski,
Despite these positive developments, the Russian "Mirage of Numbers," The Wall Street Journal, May 18,
economy still has numerous structural weaknesses. The 1994, p. 14; "Can Russia Fight Back?" The Economist,
country is now very dependent on commodity prices, June 6, 1998, pp. 47-48; J. Thornhill, "Russia's Shrinking
and if they should fall, the economy will suffer a sharp Options,'' Financial Times, August 19, 1998, p. 19;
pullback. The banking system remains weak, the manu "Russia," The World Factbook 2005 (Washington, DC:
facturing infrastructure is poor, the country is still rife Central Intelligence Agency, 2005); "Change Those
with corruption, there is widespread mistrust in the in Light Bulbs: The Russian Economy," The Economist,
stitutions of government, and foreign investment is rela February 8, 2003, p. 43; and "The Kremlin Repents,
Maybe: Russia's Economy," The Economist, April 9, 2005,
tively low.1
p. 32.
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