Sergei Ulatov

Managing Economic Volatility and Crises: Lessons from the Russian Crisis of 1998 and Recovery

ABSTRACT: This case study covers events from mid-1995, when Russias quest for single-digit inflation began, to the end of 2002. The focus is on Russias 1998 crisis and subsequent recovery. These events offer valuable lessons for countries facing simultaneous problems of unsustainable public debt dynamics and low international liquidity – a list that in recent years has included Argentina, Brazil, and Turkey. Lessons include implications for the appropriate design of rescue packages, moral hazard, and factors driving postcrisis recovery. This study presents a framework that may make it possible to distinguish between a first-generation and second-generation crisis by juxtaposing economic fundamentals and market signals. This could help in making the judgment about whether a soft landing scenario supported by the announcement of a fiscal-structural reforms package and liquidity injections from the international financial institutions (IFIs) is feasible, or whether the abandonment of the exchange rate target and even a possible debt restructuring may be unavoidable. THE RUSSIAN MELTDOWN: IMPLICATIONS FOR OTHER CRISIS EPISODES In February 1998, Russia attained its goal of single-digit inflation set under the stabilization program that began in mid-1995. Only six months later, it experienced a comprehensive macroeconomic collapse, involving its exchange rate, the banking system, and public debt. This occurred soon after a large rescue plan put together by the international financial institutions (IFIs) took effect.

Financial Globalization and the Russian Crisis of 1998

Russia had more-or-less completed the privatization of its manufacturing and natural resource sectors by the end of 1997. And in February 1998, the annual inflation rate at last dipped into the single digits. Privatization should have helped with stronger micro-foundations for growth. The conquest of inflation should have cemented macroeconomic credibility, lowered real interest rates, and spurred investment. Instead, Russia suffered a massive public debt-exchange rate-banking crisis just six months later, in August 1998. In showing how this turn of events unfolded, the authors focus on the interaction among Russias deteriorating fiscal fundamentals, its weak micro-foundations of growth and financial globalization. They argue that the expectation of a large official bailout in the final 10 weeks before the meltdown played an important role, with Russias external debt increasing by

Securing Stability and Growth

16 billion or 8 percent of post-crisis gross domestic product during this time. The lessons and insights extracted from the 1998 Russian crisis are of general applicability, oil and geopolitics notwithstanding. These include a discussion of when financial globalization might actually hurt and a cutoff in market access might actually help; circumstances in which an official bailout could backfire; and why financial engineering tends to fail when fiscal solvency problems are present.

An Analysis of Russia's 1998 Meltdown: Fundamentals and Market Signals

Russia has seen even higher oil windfall in the past few months, which translates into likely fiscal surpluses 2011 and 2012. The government should not miss the opportunity provided by a large oil windfall to substantially improve its long-term fiscal position, further reduce inflation, and, therefore, ensure a strong basis for durable stability and healthy growth in the future. Rising domestic demand and credit activity are increasingly supporting solid growth. As a result, we maintain the growth outlook for Russia at 4.4 percent in 2011 and 4.0 percent in 2012, closer to the post-crisis long-term potential growth. Overall, labor market conditions improved recently while poverty was broadly flat during and after the crisis, but unemployment and poverty in many regions remain difficult. Further reductions in poverty will require greater policy focus and persistence in implementing more effective and targeted programs, especially in the poorest regions. Two new special-topic analyses focus on export diversification in Russia, and food and energy inflation in Europe and Central Asia region. In the first, results show that productivity is key to exports and that lack of competition and entrepreneurial innovation are relevant obstacles to the emergence of new, potentially exportable products. In the second, it is shown that food and energy prices in Russia and other countries in Europe and Central Asia are contributing significantly to consumer price inflation, complicating anti-inflation policy and poverty reduction.