Best of the Week
Most Popular
1. Investing in a Bubble Mania Stock Market Trending Towards Financial Crisis 2.0 CRASH! - 9th Sep 21
2.Tech Stocks Bubble Valuations 2000 vs 2021 - 25th Sep 21
3.Stock Market FOMO Going into Crash Season - 8th Oct 21
4.Stock Market FOMO Hits September Brick Wall - Evergrande China's Lehman's Moment - 22nd Sep 21
5.Crypto Bubble BURSTS! BTC, ETH, XRP CRASH! NiceHash Seizes Funds on Account Halting ALL Withdrawals! - 19th May 21
6.How to Protect Your Self From a Stock Market CRASH / Bear Market? - 14th Oct 21
7.AI Stocks Portfolio Buying and Selling Levels Going Into Market Correction - 11th Oct 21
8.Why Silver Price Could Crash by 20%! - 5th Oct 21
9.Powell: Inflation Might Not Be Transitory, After All - 3rd Oct 21
10.Global Stock Markets Topped 60 Days Before the US Stocks Peaked - 23rd Sep 21
Last 7 days
How Stagflation Effects Stocks - 5th Dec 21
Bitcoin FLASH CRASH! Cryptos Blood Bath as Exchanges Run Stops, An Early Christmas Present for Some? - 5th Dec 21
TESCO Pre Omicron Panic Christmas Decorations Festive Shop 2021 - 5th Dec 21
Dow Stock Market Trend Forecast Into Mid 2022 - 4th Dec 21
INVESTING LESSON - Give your Portfolio Some Breathing Space - 4th Dec 21
Don’t Get Yourself Into a Bull Trap With Gold - 4th Dec 21
GOLD HAS LOTS OF POTENTIAL DOWNSIDE - 4th Dec 21
4 Tips To Help You Take Better Care Of Your Personal Finances- 4th Dec 21
What Is A Golden Cross Pattern In Trading? - 4th Dec 21
Bitcoin Price TRIGGER for Accumulating Into Alt Coins for 2022 Price Explosion - Part 2 - 3rd Dec 21
Stock Market Major Turning Point Taking Place - 3rd Dec 21
The Masters of the Universe and Gold - 3rd Dec 21
This simple Stock Market mindset shift could help you make millions - 3rd Dec 21
Will the Glasgow Summit (COP26) Affect Energy Prices? - 3rd Dec 21
Peloton 35% CRASH a Lesson of What Happens When One Over Pays for a Loss Making Growth Stock - 1st Dec 21
Stock Market Sentiment Speaks: I Fear For Retirees For The Next 20 Years - 1st Dec 21 t
Will the Anointed Finanical Experts Get It Wrong Again? - 1st Dec 21
Main Differences Between the UK and Canadian Gaming Markets - 1st Dec 21
Bitcoin Price TRIGGER for Accumulating Into Alt Coins for 2022 Price Explosion - 30th Nov 21
Omicron Covid Wave 4 Impact on Financial Markets - 30th Nov 21
Can You Hear It? That’s the Crowd Booing Gold’s Downturn - 30th Nov 21
Economic and Market Impacts of Omicron Strain Covid 4th Wave - 30th Nov 21
Stock Market Historical Trends Suggest A Strengthening Bullish Trend In December - 30th Nov 21
Crypto Market Analysis: What Trading Will Look Like in 2022 for Novice and Veteran Traders? - 30th Nov 21
Best Stocks for Investing to Profit form the Metaverse and Get Rich - 29th Nov 21
Should You Invest In Real Estate In 2021? - 29th Nov 21
Silver Long-term Trend Analysis - 28th Nov 21
Silver Mining Stocks Fundamentals - 28th Nov 21
Crude Oil Didn’t Like Thanksgiving Turkey This Year - 28th Nov 21
Sheffield First Snow Winter 2021 - Snowballs and Snowmen Fun - 28th Nov 21
Stock Market Investing LESSON - Buying Value - 27th Nov 21
Corsair MP600 NVME M.2 SSD 66% Performance Loss After 6 Months of Use - Benchmark Tests - 27th Nov 21

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

Will the 1998 Russian Financial Meltdown Repeat Itself?

Stock-Markets / Russia Feb 10, 2015 - 12:48 PM GMT

By: Arkadiusz_Sieron

Stock-Markets

History never repeats itself exactly, but many similarities between the past and the current Russian crisis suggest that the eastern bear could significantly falter in the future:

  1. The collapse of the ruble and its scope (Graph 2). The ruble lost over two thirds of its value in 1998. In 2014 it has lost more than half of its value against the dollar. Also the ruble’s unusual one-day falls are similar: Russian currency plunged 22 percent December 15 and 16, 2014 -an echo of the 27 percent fall August 17, 1998.

Graph 2: The USD/RUB exchange rate from 1993 to 2015

Source: tradingeconomics.com

  1. The currency meltdown is again driven to a large extent by falling oil prices. The Brent crude oil prices dropped from $23 at the beginning of 1997 to $12 in August, 1998 –a plunge of almost 50% (and not very different from the recent dive).
  2. In both cases we witnessed a dramatic hike of interest rates. In December, 2014, the Central Bank of Russia lifted the interest rate from 10.5% to 17%, while in May, 1998 the CBR increased it twice: first from 30% to 50% and then from 50% to 150%.
  3. The change of investors’ sentiment towards emerging markets. In 1998, investors shifted their money from Russia because of the rise in risk aversion due to 1997 Asian financial crisis. As we pointed out in the last edition of the Market Overview, they also did so because of the strong dollar and the declining profitability of the carry trade. The same is happening right now. The firm greenback, anticipation of a U.S. Federal Reserve rate hike and falling commodity prices are responsible for pressure on emerging-market currencies.

On the other hand, some analysts point out a few significant differences between 1998 and the current crisis in Russia and argue that today’s financial troubles will not be as severe as in the past. Why do they think so and why are they wrong?

  1. The ruble is not pegged to the dollar as it was in 1998. External shocks may be absorbed in the exchange rate whereas the Central Bank of Russia is not obliged to defend the ruble. On the other hand, the floating regime in Russia is not pure, it is dirty (managed), which means that the CBR may still be willing to support the domestic currency. And, as Ronald McKinnon from the Stanford University says, the exchange rate flexibility does not provide protection against the carry trade.
  2. Russia has much more in foreign exchange reserves. At the end of 2014 they amounted to $418 billion, far exceeding the $16 billion before the 1998 default. Undoubtedly, it puts Russia in a better position. However, the reserves are not infinite and are vanishing at an unsustainable rate. In only two weeks before December 26, Russia used $26 billion to defend the ruble. Having in mind that the 2008 intervention to defend the ruble cost $200 billion, the foreign reserves may protract the collapse, but will not prevent it, especially now that they are lower than the $700 billion of external debt. We should not forget that not all reserves are at immediate disposal. Part are accumulated in special funds and committed to long-term projects. According to some, the usable amount could be only around $200 billion.
  3. Russian public debt is much lower. In 1998, before the default, the government ran budget deficit of 8% of GDP and its cumulative public debt was 75% of GDP. Now, the budget deficit and public debt relations to GDP are very small and amount, respectively, to less than 1% and 10%. These facts make a default on public debt more unlikely, indeed, but not impossible. This is because Russian state, private sector companies and banks have accumulated $600 billion in foreign debt (around $100 billion is due this year). Moreover, the external debt to GDP ratio is similar to 1997 levels and higher than before Lehman bankruptcy. Investors should also remember that private companies in Russia are often quasi-sovereign and their ownership structure is rather fluid, so in reality the public debt is larger. This is why credit rating agencies will probably downgrade Russia’s rating to junk status soon.
  4. The risk for financial contagion is much lower. The 1998 Russian crisis caused the global flight to quality. Investors were selling various sorts of bonds and buying U.S. Treasuries, which eventually led to the collapse of Long Term Capital Management hedge fund and the stock market crisis in the USA, the S&P 500 index plunging about 20% between July and October of 1998. The level of interconnectedness between Russia, which makes up less than 3% of the global economy, and Western countries is now much lower because of current sanctions (suggesting that Russia cannot presently expect any international help).

Nevertheless, the global economy is rather weak and fragile right now. Volatility is up. The gold to oil ratio is above 20, which usually implies a crisis. The Swiss National Bank removed the franc’s peg to the euro, signaling no faith in euro. Thus, the growing problems of Russia may lead to even further elevations in global risk aversion and to portfolio rebalancing or capital outflows from other emerging markets which are more interconnected with developed markets. The fall of the ruble has already affected the currencies in many post-Soviet countries that are still economically tied to Russia. Leveraged investors may also try to cover their losses in Russia by selling debt tied to other emerging markets. Moreover, the deepening of the crisis may attract a landing of another geopolitical black swan released by the Russia. Indeed, fighting in the Ukraine continues to support gold prices.

So, is Russia heading to a new 1998 crisis? Public finances are in relatively good shape, so the government default is not as probable as in the late 1990s (so far). However, Russia is entering into a full-blown financial crisis with banks and companies’ defaults (which may entail a sovereign debt crisis in the future). A crisis caused by the falling ruble and following balance sheet problems, just as in 1998, when private banks as well as the state bank collapsed.
If you enjoyed the above article, we invite you to stay updated on the latest developments in the emerging markets and global economy by joining our gold newsletter. It’s free and you can unsubscribe in just a few clicks.

Thank you.

Arkadiusz Sieron

Sunshine Profits‘ Market Overview Editor

Disclaimer

All essays, research and information found above represent analyses and opinions of Przemyslaw Radomski, CFA and Sunshine Profits' associates only. As such, it may prove wrong and be a subject to change without notice. Opinions and analyses were based on data available to authors of respective essays at the time of writing. Although the information provided above is based on careful research and sources that are believed to be accurate, Przemyslaw Radomski, CFA and his associates do not guarantee the accuracy or thoroughness of the data or information reported. The opinions published above are neither an offer nor a recommendation to purchase or sell any securities. Mr. Radomski is not a Registered Securities Advisor. By reading Przemyslaw Radomski's, CFA reports you fully agree that he will not be held responsible or liable for any decisions you make regarding any information provided in these reports. Investing, trading and speculation in any financial markets may involve high risk of loss. Przemyslaw Radomski, CFA, Sunshine Profits' employees and affiliates as well as members of their families may have a short or long position in any securities, including those mentioned in any of the reports or essays, and may make additional purchases and/or sales of those securities without notice.


© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in