Russia another pegged currency victim

Russia is another victim of a pegged currency and the financialisation of its economy.

I took some notes at the time the Russian government defaulted which go like this. After the breakdown of the Soviet Union they made their first major mistake they pegged the ruble within tight range to US dollar – and thereby surrendered their currency sovereignty.

Their second mistake was to allow heavy borrowing in foreign currencies. There was considerable optimism in Russia at the time and all sorts of opportunists were set loose and their foreign currency exposure rose dramatically.

Then in November 1997, the Asian crisis causes a speculative attack on the ruble. The speculators knew that (a) it was going to try to maintain the peg; and (b) it was borrowed to the hilt in foreign currency. So, sell it short to death was a sure way to scoop the pool.

The problem was that the Russian government played right into their hands and instructed the central bank (CBR) to defend the ruble (that is, maintain the peg) and they lost around $US6 billion in reserves in doing so.

On top of the currency attack, a second shock came in late 1997 with the collapse of oil and nonferrous metal prices, upon which they heavily depended on to earn them foreign exchange.

Soon after (April 1998) there was another hedge-fund inspired speculative attack on the ruble which saw further foreign exchange reserves lost. The obvious reaction should have been to suspend the peg, float the currency and default on all foreign-currency loans (or negotiate conversion into local currency).

However, not to be beaten on May 19, 1998 the CBR increased their lending rate from 30 percent to 50 percent and spent a further $US1 billion defending the peg.

This mistake was magnified as oil prices kept dropping and the CBR kept bleeding US dollars.

Eight days later (May 27, 1998), the CBR increased the lending rate to 150 percent and the domestic economy was being scorched.

In August 1998 (the 13th), prices on Russian share and bond markets collapsed as investors sold off in the face of major fears of devaluation. Annual yields on ruble-denominated bonds exceeded 200 percent at this point.

Finally, four days later (August 17, 1998), the Russian government devalued the ruble, defaulted on domestic debt, and pronounced a moratorium on payments to foreign creditors (effectively a default).

On September 2, 1998, the government floated the ruble.

First, this was not a bank crisis. It was the result of the currency peg and the massive exposure to foreign-denominated debt.

Second, at any time they wanted to they could have floated which would have stopped the need to hike interest rates and kill their economy.

Third, they never needed to default on domestic debt. That was the act of sheer stupidity and the poor advice they were getting. There was never a solvency risk in their own currency. The IMF were in there telling the Russian government that they had to implement an austerity plan and convincing them that they needed to “raise money” to fund the deficit – both erroneous propositions.

They could have simply floated and become sovereign and then there was no solvency risk in all debts denominated in that currency.

The foreign debt was another question. Combined with the (voluntary) peg it was a lethal cocktail. The CBR lost huge stores of foreign exchange trying to defend the impossible. The rising interest rates to try to attract capital inflow to help shore up the excess supply of ruble into the foreign exchange markets only damaged the domestic economy further.

The problem stems from the early stages of capitalism where they embraced market liberalism with panache and allowed the foreign banks to hold them to ransom. It was madness to run a currency peg and then allow significant portions of the economy to borrow in foreign currencies.

They also go caught up in the Asian crisis and the collapse of oil prices.

The US, Japan, the UK, Australia and most nearly every other nation is nothing like this – (a) they have no foreign currency public debt; (b) they floats their currency; and (c) the IMF is not able to bully them around.