Russian Ruble Crisis in 1998

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The Russian Ruble Crisis

In 1997, the Russian economy recorded economic growth for the first time since the formation of the federation in 1991. This event created perceptions that the country’s economy was headed for even greater growth in the future. However, the country’s fixed exchange rate regime became unsustainable in 1998 and halted the economic growth causing it to contract (Rabobank). Before the crisis, the Russian Ruble was fixed to the US dollar at the rate of 5 Rubles for 1 dollar. The currency was, however, allowed to fluctuate within a narrow band around this rate (Rabobank).  Following the crisis, the value of the Ruble to the US dollar fell rapidly as shown in Figure 1. Most of the decline in value occurred between August 1998 and March 2000.

Figure 1 : US Dollar and Russian Ruble Exchange Rate (Source: Federal Reserve Bank of St. Louis)


When the Russian Federation was formed in 1991 after the collapse of the Soviet Union, the country adopted a market economic model that would be characterized by a large private sector and free trade (Sachs). The aim of the reforms was to ultimately integrate the Russian economy with that of Western Europe as done in the case of Poland. Although some steps were taken to implement this objective, like the privatization the some state firms, other crucial measures of transitioning the economy were neglected. For example, price controls and subsidies to firms were not eliminated and the Ruble was pegged to the dollar, thus hampering free trade (Sachs). Moreover, government institutions were not reformed to eliminate corruption and pave way for a strong private sector.

The inadequate transition reforms created an economy that ensured the survival of inefficient Soviet era industrial enterprises. Due to their close ties to the government, the firms were able to get oil revenues from the government to support their operations. This process, however, became unsustainable when falling oil prices from 1997 reduced Russia’s oil revenues significantly. Investors and speculators, aware of the crisis that confronted the country, registered their sentiments through the collapse of Russian bond, stock and currency markets on 13 August, 1998 (Rabobank). The Ruble depreciated more than two times, annual yields on bonds denominated in the currency increased by 200%, while stocks lost more than 75% of their value at the beginning of the year. This event corresponded with interest rate hikes by the Russian Central Bank, increasing capital outflows from the country, and decreasing investor confidence in emerging markets (Rabobank).


The Causes of the Crisis

There are two main perspectives regarding the factors that caused the Russian Ruble crisis. According to one school of thought, the crisis resulted from structural problems in the Russian economy. The second perspective, on the other hand, holds that the crisis was caused by weaknesses in the global financial system (Birkenes and Pennell 1). It is highly likely that both structural problems in the country’s economy and weaknesses in the global financial system contributed to the crisis.

Structural Problems in the Russian Economy

According to IMF, the Russian Ruble crisis was caused by the country’s weak economic fundamentals, particularly in fiscal policy; unfavorable international events, including contagion effects from the Asian financial crisis and falling international oil prices; and vulnerability of the Russian economy and currency to market sentiment due to the country’s practice of paying foreign debts using short-term treasury bills and bonds that were placed on international markets (Birkenes and Pennell 4).

In May 1998 (three months before the Ruble experienced the sharp depreciation) the IMF had reported that Russia’s efforts in enhancing its budget procedures and tax systems, creating competent authorities for taxes and overseeing public expenditures, clarifying fiscal relationships between government agencies, and increasing transparency in government operations were insufficient. These measures were meant for reducing government debt, promoting private sector development, and decreasing vulnerability of the government fiscal position by restructuring treasury bills. By May 1998, investor confidence in the ability of the Russian government to carry out reforms in these areas had dwindled considerably.

Gaddy and Ickles, on the other hand, contend that the structural problems that led to the crisis were brought over from the Soviet era (Gaddy and Ickles 53). The fall of the Soviet Union and the formation of the Russian Federation were accompanied by liberalization of the new economy. This process was expected to lead to the collapse of uncompetitive manufacturing enterprises in operation during the central planning economy of the Soviet era. The firms, however, found a lifeline in what came to be known as “the Russian Virtual Economy”.

Under the virtual economic system, the uncompetitive firms engaged in barter trade instead of exchanging their products for cash so that they could sell their substandard products at above market prices. The firms would even pay taxes in goods rather than cash. For instance, an investigation into the causes of low rate of tax collection commissioned by the Russian government in 1996 found that the largest companies in the country conducted 73% of their business and paid taxes in barter and other non-monetary systems. The purpose of the virtual economy was to transfer resources from the oil sector to the uncompetitive Soviet-era manufacturing enterprises. Gaddy and Ickles argue that the large budget deficits and the inability of the Russian government to service foreign debt that resulted in the Ruble crisis were caused by explosion of the virtual economy (Gaddy and Ickles 54).

Weaknesses in the Global Financial System

The role played by international institutions in helping Russia to transition from a centrally planned economy to a market economy has been criticized for aggravating the economic situation in the country, leading to the Ruble Crisis. Jeffrey Sachs, for instance, blames the seriousness of the crisis on the International Monetary Fund (IMF) demand for tight fiscal and monetary policy in Russia during the crisis. When the country was experiencing the crisis, the IMF advised it to tighten its interest rates and reduce budget deficit, measures which exacerbated the crisis (Birkenes and Pennell 2). Sachs, who was a key advisor in Russia’s economic transition process between 1990 and 1994, contends that the crisis was a balance of payment problem that had resulted from excessive foreign borrowing by Russian government and firms and as such, the fund should have focused on floating of the Russian Ruble as its main solution.

George Soros, who was the largest individual investor in Russia before the crisis, on the other hand, blames the international banking system for the crisis (Birkenes and Pennell 3). According to the investor, international banks are willing to lend to risky enterprises if they believe that the government will bailout the firms in the event of a crisis. In the case of Russia, foreign banks were willing to lend to Russian firms even if the latter were highly risky due to their uncompetitiveness because the enterprises could be bailed out by the Russian government in they faced the risk of bankruptcy.

On its part, Russian government officials that were in office during the crisis attribute it to a weak fiscal and institutional environment. Yegor Gaidar, the then Prime Minister of Russia, blames the crisis on weak budgetary controls and high rates of corruption in government agencies in the Soviet era (Birkenes and Pennell 7). This situation led to high budget deficits and survival of enterprises with high risk of bankruptcy.

Effects of the Crisis

The crisis caused economic contraction in the country. The gross domestic product (GDP) grew by -4.6% in 1998 compared to 0.8% in 1997. Inflation, on the other hand, rose to 84.4% relative to 11% in 1997. Because of the economic contraction, the rate of unemployment increased sharply to 12%. The Central Bank of Russia also increased interest rates to curb rising inflation and to strengthen the Ruble. This move caused interest rates on treasury securities to rise up to 135.3% (Congressional Reserve Service 3). The poor economic conditions were expected to remain over a long period given the market structure of Russia. Although the country had taken step to liberalize its economy, important market imperfections such as inflexible prices and wages were still in place. Thus, consumer expectations regarding the future state of the economy and spending were negative.

Internationally, the crisis reduced exports to Russia as consumers in the country avoided the now more expensive imports in light of falling real wages and the depreciating Ruble. This led to reduced economic growth and employment in countries that depend heavily on the Russian market such as Moldova, Ukraine, Kazakhstan, and Georgia where Russia accounts for more than 30% of exports (Birkenes and Pennell 10). In Georgia, the crisis led to the widening of its economic deficit with Russia, forcing the country to float its currency Lira. The currency depreciated sharply after this event.

Other countries that suffered reduced growth are those that have many nationals working in Russia such as Armenia and Azerbaijan. These countries depend highly on remittances from Russia, which reduced due to the crisis (Birkenes and Pennell 11). In Armenia, for example, low remittances following the crisis increased poverty levels and reduced the ability of the government to finance education, healthcare, and other public expenditures.

Food prices also increased in the NIS countries (Armenia, Azerbaijan, Belarus, Georgia, Kazakhstan, Kyrgyzstan, Republic of Moldova, Russian Federation, Tajikistan, Turkmenistan, Ukraine, and Uzbekistan) because of devaluation of their currencies (Birkenes and Pennell 11). Since these countries’ economies are closely integrated with that of Russia, their economies became weaker when the crisis occurred, causing their currencies to depreciate against those of other countries that are not as dependent on Russia. Since the NIS countries import a significant portion of their food products from the latter countries, the situation led to an increase in food prices in the countries. In Belarus, for instance, the crisis led to food rationing after causing shortages of basic food items (Birkenes and Pennell 11).

Measures taken by Russia to Deal with the Crisis

The Russian government took a number of steps to resolve the crisis. The first was to widen the band in which the Ruble exchange rate to the dollar could fluctuate from 5.27-7.13 to 6.00-9.50. The purpose of this measure was to accommodate the increased demand for dollars that accompanied the crisis by devaluing the Ruble (Rabobank).

The second step was defaulting on short term treasury bills, or GKOs, and long term Ruble-denominated bonds (Rabobank). Because the government financed these bonds with foreign capital, it determined that it could not raise enough funds to repay the bonds in light of the weakening Ruble. Although the default was expected to impact the economy negatively by reducing the government’s access to foreign capital, it was also expected to reduce demand for dollars and, therefore, prop up the Ruble.

Thirdly, the government imposed a 90-day moratorium on commercial banks payments to foreign creditors (Rabobank). This decision was aimed at reducing dollar demand by banks for paying foreign creditors that had lent funds to private firms in Russia. The government hoped that the crisis would have been mitigated within this period thereby allowing Russian firms to pay or renegotiate their debt on favorable terms.

The above measures were, however, inadequate in tackling a problem that had taken many years to form. Upon this realization, the Russian government removed the currency band and made the Ruble a freely floating currency on 2 September, 1998. The currency depreciated sharply as a result. In two weeks it had lost over two thirds of its value. The depreciation increased inflation, especially in food prices, and led to social unrest in some Russian cities (Rabobank).


In further measures to address the crisis, Russia undertook sovereign debt restructurings in 1999 and 2000 on the debts that it had defaulted on. The restructuring involved debt relief and rescheduling of interest and principal payments and its purpose was to enable the country to regain access to international financial markets. IMF lent the country USD 4.5 billion in 1999 to facilitate this process (Rabobank).

The sharp depreciation in the Ruble, which continued in 1999, proved to be a boon for the economy together with an increase in oil prices. The economy grew by 6.40% in 1999, 10% in 200, and 5.3% in 2001 (Rabobank). Inflation and interest rates, however, remained high despite the rapid economic growth, a situation blamed on lack of transparency in the country’s monetary policy and irregularities in the banking sector.


The Ruble crisis was a symptom of problems in the Russian institutional and economic structure, and the international financial system. The Russian Federation inherited a weak institutional environment from the Soviet era. It was also bequeathed with inefficient manufacturing enterprises through a system of price controls, subsidies and virtual economy characterized by non-cash exchanges.  The firms were sustained by transfer of resources from the energy sector through the subsidies, price controls, and virtual economy, as well as lending by foreign banks, which believed that that enterprises would be bailed out by the Russian government in the event of default. The crisis was exacerbated by IMF’s advice to Russian Central Bank to raise interest rates and to the Russian government to cut budget deficits instead of advising the government to immediately float the Ruble.











Works Cited

“The Russian Crisis 1998.” Rabobank, 16 Sep. 2013, Accessed 1 Dec. 2017.

“The Russian Financial Crisis of 1998: An Analysis of Trends, Causes, and Implications.” Congressional Research Service, Accessed 1 Dec. 2017.

Birkenes, Robert and Pennell, John. “The Russian Financial Crisis: Causes and Effects on ENI Countries.” USAID, Accessed 1 Dec. 2017.

Clifford, Gaddy, and Ickes, Barry. “Russia’s Virtual Economy.” Foreign Affairs, vol. 77, no. 5, 1998, pp. 53-67.

Sachs, Jeffreys. “What I did in Russia.” Jeff Sachs, 14 Mar. 2012, Accessed 2 Dec. 2017.


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