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CHAPTER1 Putin’s Economic Inheritance President Boris Yeltsin was on vacation when the crisis smashed into Russia in mid-August 1998. Storm clouds had been gathering for months. Russia’s governmentwasdebt-riddenandnearlybankrupt,reliantonshort-termloans to pay pensions and fund basic public services. The Kremlin spent too much andraisedtoolittleintaxes,fillingthedifferencebyborrowingatextortionate interest rates or by printing money, which fueled inflation. By the summer of 1998, as Russia’s borrowing rates spiked ever higher, everyone knew that a painful adjustment was inevitable. The only question was when it would come—and how traumatic it would be. OnJuly13,theInternationalMonetaryFund(IMF)ledacoalitionofinternational lenders in announcing $22.6 billion of financial support for Russia.1 In exchange, Russia’s government promised sharp tax hikes and spending cuts, a package that was political suicide. But Russia’s leaders had no choice buttoagree.Yeltsincutshorthissummervacationtoassembleparliamentary support for the necessary legislative changes. By early August, however, the political process in Russia had ground to a halt. The government and the Duma disagreed over how to resolve the country’s budgetary imbalance. Everyone in Yeltsin’s government and in the Duma believed that Russia had time to debate, to discuss, and to play political games. They underestimated the speed with which debt investors were losing faith in Russia’s ability to repay—andlosinginterestinrepeatedlyrollingoverRussia’sshort-termdebt. Yeltsinhimselfwasdisengaged.Afterfailingtobrokerasolutiontothepolitical impasse, the president returned to his summer vacation just as the situation was beginning to spin out of control.2 Speculative attacks on emerging market currencies had sparked chaos in Thailand,Indonesia,andSouthKoreaearlierthatyear,andmanyinvestors— including those whose loans funded Yeltsin’s government—were nervously 2 | Putin’s Economic Inheritance asking whether Russia would be next. The victims of crisis in Southeast Asia had all been forced to devalue their currencies, a move that amounted to a tax on consumers. When the Indonesian rupiah and Thai baht crashed in 1997 and 1998, those countries’ citizens were made poorer in dollar terms, and in response they drastically cut back on purchases of imports, bought with dollars. This restored these countries’ financial balance at the cost of impoverishing consumers. Russia appeared on the brink of a similar fate. The currency was overvalued , and the central bank was spending huge sums to prop it up, keeping it pegged at a set rate against the dollar. The overvalued ruble not only made Russian exports less competitive but also created a dilemma for the central bank, which had a limited quantity of dollars with which to buy rubles.3 Yet Russians and foreigners alike were looking to sell rubles and get their hands onamorestablecurrency.Unlessthesituationturned,thecentralbankwould run out of dollars and be forced to abandon the ruble’s peg. Economists refer to such a move as floating the currency. This was the wrong metaphor: if the central bank stopped supporting the ruble, it would sink like a rock. Yeltsin “loudly and clearly” declared that Russia would not devalue the ruble. Prime Minister Sergey Kiriyenko promised that “there will be no changesinthemonetarypolicyofthecentralbank.”4Buttalkischeap,andthe Kremlin did not back it up with actions. The more the government insisted that it would stand by the currency and repay its debts, the more investors concluded that it was time to sell. On August 13, markets began to panic as investors raced for the exit. Foreigners and Russians alike dumped rubles andboughtdollars,forcingtheRussiancentralbanktospenddownitsdollar reserves to dangerously low levels. New lending to the Russian government all but stopped, as interest rates on one-month government bonds reached 160 percent. The Moscow stock exchange plummeted so rapidly that trading was repeatedly suspended.5 Something had to give. Prime Minister Kiriyenko appealed for more foreign aid but was turned down. He was left with no choice but to surrender. The central bank let the ruble fall against the dollar. Starting at six rubles per dollar, the ruble fell to twenty-five. Consumer prices more than doubled.6 Russians paid the cost of adjustment as they discovered that their wages suddenly bought only half as many goods as before. Atthesametime,thegovernmentannounceditwoulddefaultonitsdebts, forcingbondholderstobearsomepain,too.Russianbanksthatheldgovernmentbondsteeteredonthebrinkofbankruptcy ,atrendthatwasexacerbated bydepositorsrushingtowithdrawtheirmoneyandstuffitunderthemattress. Putin’s Economic Inheritance | 3 As the ruble plummeted, demand for dollars was so high that currency exchangeboothsranoutofcash .7“Russia,”grumbledonedisillusionedinvestor, “now ranks somewhere between Nigeria and Kenya.”8 The Roots of the Crisis Thefinancialcrashof1998waswidelyinterpretedasthefirstcrisisofRussian capitalism. In fact it was the last gasp of Soviet socialism. The disagreements about economic policy that divided Russia during the 1990s—conflicts so sharp that they led Yeltsin to shell parliament in 1993, as the country teetered on the brink of civil war—gave way to a...

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Additional Information

ISBN
9781469640686
Print ISBN
9781469640662
MARC Record
OCLC
1022831906
Pages
240
Launched on MUSE
2018-02-13
Language
English
Open Access
N
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