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27 July 2011
A history of debt defaults: Russia 1998
In the third of our five-part series, in which we look at five historical debt defaults – we look at the Russian crisis of 1998 and how it offers a lesson to eurozone leaders on the importance of managing contagion.


Sebastian Walsh (Financial News)

What happened
In 1997, Russia was on the verge of gaining the confidence of international investors after six years of post-Soviet reforms. Inflation seemed under control and the rouble was pegged to the dollar. 
But beneath the surface, all was not well. Real wages were less than half of their 1991 level – and the tax-gathering infrastructure was shambolic. Then the bursting of asset bubbles in Thailand, South Korea and Indonesia triggered the Asian crisis, which provoked a downward spiral in the commodity prices on which Russia relied. The rouble then began to be targeted by investors.
In July 1998, a $22.6bn IMF package was approved to stabilise the country. The centrepiece of the package was a swap of short-term government bills for longer-term eurobonds. However, by August the rouble sell-off was again in full swing. 
George Soros, among others, declared the only route out for Russia was devaluation – but the government continued to support the rouble, even as public sector wages went unpaid.

What was done
On 17 August, the Russian government finally bowed to market pressure and devalued. It also defaulted on all domestic debt – and declared a moratorium on foreign debt. Two weeks later, the rouble allowed it to float freely. 
But, according to Nick Firoozye, head of European interest rates strategy at Nomura, Russia did not default "in a manner that was considered appropriate". He said: "It was selective about who it paid". 
However, when the moratorium on foreign debt passed on November 15, the Russian government did not renew it – and recommenced paying holders of its eurobonds. 
Less than a year later, Russia's economy had recovered to pre-crisis levels – and it has continued to grow rapidly since, riding the boom in commodities.

What was learnt?
Alexey Moiseev, Head of Macroeconomy Analysis at VTB Capital, believes there is at least one clear lesson from the Russian crisis for eurozone leaders, – that managing contagion must be the foremost priority.
The Russian crisis dangerously undermined several central Asian states, as well as presenting problems in eastern Europe and the Baltics. These countries found that their substantial exports to Russia were decimated by the collapsing rouble – in addition to the increasing pressure placed on their treasuries by increasing spreads on emerging market bonds following the crisis.
The crisis also played a major role in the collapse of Long Term Capital Management, which had put big bets on falling spreads – following the Russian meltdown, the hedge fund lost $550m on August 21 alone, according to a World Bank working paper.
Russia itself, however, did recover remarkably quickly. 
Michala Marcussen, head of global economics at Societe Generale, believes this was, in part, because the policymakers "got their head around the problem relatively quickly".
"However, there was also a good deal of luck though", she adds: "Oil was critical to the recovery". Not something Greece can hope for. 
She adds that the Russian response did also pioneer one course of action that may offer Greece a path out of the current morass. "Russia saw the beginning of the reprofiling idea – imposing a moratorium on foreign creditors and averting a far worse banking crisis was not a bad idea at all in the context".
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