Case Study: The Russian Ruble Crisis of 1998

1991 marks the breakup of the former Soviet Union and be beginning of new financial difficulties for Russia. Throughout the 1990s, Russian government spending exceeded their tax revenues, resulting in an increasing federal deficit. The deficit was financed by borrowings and by the printing of more currency, the ruble. In spite of these difficulties, the stability of the Russian ruble during the early 1990s was seen as a major success of the Russian Government.

During this time, the currency, the ruble, operated under a managed float. Under this exchange rate regime, the Russian government had established a range (trading band) within which they would let the currency float. For example, throughout 1996, 1997 and the first half of 1998, the trading band had been constantly adjusted, with the government allowing the band to slide daily at a 1.5% monthly rate. Each day, the Central Bank of Russia would announce an official exchange rate for the day (the rate at which they were willing to buy and sell the ruble), with the rates always within the official band. If the rate moved above or below the announced band, the Central Bank would intervene on its behalf.

From 1995 to 1998, Russian borrowers – both government and non-governmental – had borrowed large amounts in international capital markets. This external debt, which denominated in U.S. dollars and was estimated at $160 billion by 1998, required U.S. dollars for interest and principal repayments. Unfortunately, the U.S. dollars that Russia was earning on its trade and current account surpluses were leaving the country in the form of capital flight and thus were not available to service this growing external debt. In addition, a global fall in commodity prices, adversely affected Russia’s dollar earnings on exports of oil, timber, and gold. Sensing that Russia was running out of hard currency, speculative attacks against the currency ensued.

The Russian government responded in support of the ruble by repeatedly raising interest rates. By May 27, 1998, short term rates had reached 150% (in February 1998, these rates were 42%). Despite these high interest rates, investors were reluctant to hold on to the ruble and thus currency flight intensified.

In August, 1998, the ruble came under intense speculative pressure. On Friday, August 7, 1998, the Russian Central Bank announced that its hard currency reserves had fallen by $800 million over the most recent one week period. On Monday, August 10, 1998, Russian stocks fell on fears of a China devaluation of the yuan which, if it did take place, would hurt Russian exports and U.S. dollar earnings.

On Friday, August 14, 1998, President Boris Yeltsin, in a speech stated “There will be no devaluation [of the ruble], that’s firm and definite.” On that day, the ruble traded around Rub6.30/$.

On Monday, August 17, 1998, the Russian Central Bank announced that they would devalue the ruble by 34%, to Rub9.50/$. The markets took this as a panic move on Russia’s part and continued to sell the currency. The next day, on Tuesday, August 18, 1998, the ruble continued its fall and traded around Rub11.00/$.

On Thursday, August 27, 1998, the Russian Central Bank announced that they had spent $8.8 billion in the preceding eight weeks defending the ruble. The ruble was now trading at Rub13.00/$

On Friday, August 28, 1998, the Moscow currency exchange closed after 10 minutes of trading.

Faced with accelerating capital flight, the Russian government announced a shift it its exchange rate policy. The new policy included abandonment of ruble support and a move to a floating rate regime.

In the weeks leading up to August 17, 1998, the ruble range had been set at Rub5.750/$ to Rub6.350/$. When the ruble was floated, it immediately weakened on foreign exchange markets and by the end of the year was trading around Rub22.5/$

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