In 1998, Russia experienced sovereign debt default, a massive devaluation of the rouble and a banking crisis. Triggered by the invasion of Ukraine, the currency’s value has again tumbled – and this crisis may be longer lasting and more severe without a move towards peace.
Following Russia’s invasion of Ukraine in February 2022, the value of the Russian rouble relative to the US dollar fell by over 40% in just two weeks. A depreciation of such scale would be extraordinary for most countries, but this is not the first significant currency devaluation that Russia has faced in its recent history.
In 1998, Russia experienced a major currency crisis when the rouble lost over two-thirds of its value in three weeks, as well as a default on its sovereign debt and a banking crisis. Are there any lessons from that crisis that are relevant today?
Figure 1: USD/RUB exchange rate, January 1995-April 2022
Background and causes of the 1998 rouble crisis
The fall of the Soviet Union in 1991 preceded several years of economic reform, privatisation and macroeconomic stabilisation policies in Russia. A central element of this was the adoption of a currency peg – a type of exchange rate regime in which a currency's value is fixed against the value of another currency.
This meant that the value of the rouble relative to the dollar was constant and only allowed to fluctuate within a narrow band. The Bank of Russia would intervene by buying and selling the rouble as necessary to maintain the exchange rate.
The Russian economy was also supported by financial aid from the World Bank and the International Monetary Fund (IMF), while negotiations to repay foreign debt inherited from the Soviet Union improved investor confidence (Chiodo and Owyang, 2002).
In the first quarter of 1997, foreign investment in Russia rose sharply with the relaxation of restrictions on foreign portfolio investment. But investor expectations soon changed following the Asian financial crisis, which began with the collapse of the Thai baht in July 1997. This crisis quickly spread to other Asian currencies and by November, the rouble also came under attack by speculators (Chiodo and Owyang, 2002).
Despite the reforms introduced since 1991, fundamental institutional weaknesses remained in Russia (Sutela, 1999; Chiodo and Owyang, 2002). These weaknesses were highlighted and exacerbated by the financial crisis in Asia.
A global recession and a fall in commodity prices compounded weak tax enforcement in Russia and an expensive war in Chechnya. This led to fiscal imbalances and raised questions about the government’s ability to pay its sovereign debts and maintain a fixed exchange rate (Desai, 2000; Kharas et al, 2010). This increase in default and exchange rate risk made capital flight from Russia and a devaluation of the rouble more likely.
In an attempt to encourage investors to hold rouble-denominated assets and support the fixed exchange rate, the Bank of Russia increased interest rates to 150%.But this meant that by July 1998, interest payments on Russia’s debt were 40% higher than the country’s tax collection. This had the effect of further eroding investor confidence and creating downward pressure on the currency.
In early August 1998, driven by fears of a default on domestic debt and a rouble devaluation, the Russian stock, bond and currency markets all came under severe pressure. Trading on the stock market was suspended for 35 minutes due to sharp falls in prices.
Then on 17 August, the government announced a devaluation of the rouble’s pegged exchange rate, a default on its domestic debt and a 90-day suspension on payments by commercial banks to foreign creditors.
Two weeks later, on 2 September, the Bank of Russia abandoned its efforts to maintain a fixed exchange rate and allowed the rouble to float freely. In three weeks, the currency had lost about two-thirds of its value (Kharas et al, 2010).
Consequences and recovery
There were significant domestic and international consequences of these events. The currency crisis and associated financial market turmoil contributed to a recession and contraction of the Russian economy by 5.3% in 1998, with GDP per capita reaching its lowest level since the formation of the Russian Federation in 1991.
Inflation in 1998 was 84% because of rouble depreciation, contributing to a dramatic fall in real wages and social unrest. Workers staged strikes and large scale protests, including demonstrations in front of the Russian White House.
Increased political instability followed: both the prime minister and central bank governor were replaced; the new prime minister’s first budget was rejected; and the president’s popularity collapsed (Desai, 2000). In August 1999, within a year of the crisis, Vladimir Putin became the fifth prime minister in 12 months.
The crisis also had a significant effect on financial markets globally. Russia’s sovereign default was the largest in history at the time and contributed to the collapse of the LTCM (Long Term Capital Management) hedge fund in the United States, which required a $3.6 billion bailout. This led to substantial spillover effects in international markets (Dungey et al, 2002).
The Russian economy recovered relatively quickly from the 1998 crisis, growing by 6.4% in 1999 and 10% in 2000. The sharp depreciation of the rouble made Russian exports attractive internationally and, combined with an increase in oil income, helped to stimulate the economic recovery. Sovereign debt restructuring and an IMF loan of $4.8 billion helped Russia to regain access to international financial markets.
Lessons for today
It is important to note that the forces driving the 1998 crisis and today’s crisis are very different, both politically and economically. Yet there may be fundamental lessons about how crises evolve and their implications.
First, currency crises can be triggered by events that increase a country’s risk, reduce investor confidence and change expectations of a country’s economic outlook, causing capital flight.
As in 1998, the devaluation of the rouble in 2022 was fundamentally triggered by a large increase in Russia-related risk, although the source of this was very different in each case.
Second, currency crises often go hand-in-hand with other financial crises, such as sovereign debt defaults, stock market crashes and banking crises, and can lead to higher inflation and interest rates. These have important implications and in 1998, they culminated in a sharp increase in the cost of living, recession, social unrest and political instability in Russia.
The full extent of financial market difficulties in Russia today has, so far, been moderated by extensive government restrictions. Nevertheless, interest rates have already increased from 9.5% to 20%, before being reduced to 14%, and inflation had accelerated to 16.7% by March.
Further economic difficulties may still unfold in Russia, particularly as there is currently no sign of political risk abating as the war continues and sanctions increase. But a default on Russian foreign debt seems increasingly likely and a deep recession appears certain.
As in 1998, this may have implications for social and political stability. It has been shown that approval ratings of political leaders in Russia have tracked citizens’ perceptions of the state of the economy since 1991 (Treisman, 2011).
The 1998 crisis illustrates that economic shocks can reverberate throughout global financial markets. Today, many countries are experiencing rising inflation and weaker growth as a direct result of the war in Ukraine, with rising interest rates likely to follow. Numerous international companies have written down investments in Russia.
In contrast to 1998, Russia has adopted a floating exchange rate in recent years, which means that capital flight from the country should immediately be reflected in the exchange rate. Despite this and in contrast to 1998, the rouble exchange rate has recovered rapidly from its initial fall in early March 2022.
Rather than a reflection of reduced risk or increased investor confidence in the Russian economy, this recovery highlights Russia’s success at supporting the rouble with government interventions. These include trading restrictions, capital controls, increased interest rates and government requirements for business to hold 80% of overseas revenue in roubles.
This means that the rouble is no longer freely convertible and its value now tells us little about the reality of the Russian economy.
Notably, Russia was able to recover quickly from the 1998 crisis thanks to the stimulatory effect of the weaker rouble, increased oil revenue and help from the West in the shape of IMF loans. The rapid recovery of the rouble exchange rate in March 2022 combined with increasing international sanctions means that the expansionary forces that enabled a quick recovery from the 1998 crisis seem extremely unlikely today.
These lessons suggest that the full economic effects of recent events in Russia are yet to unfold, and without a move towards peace and geopolitical normalisation, the impact will be longer and more severe than in 1998.
Where can I find out more?
- Currency crises in emerging markets: Council on Foreign Relations explainer on currency crises.
- Has financial collapse saved Russia?: Anders Åslund on Russia’s 1998 crisis and recovery.
- The price of war: Macroeconomic effects of the 2022 sanctions on Russia: Anna Pestova, Mikhail Mamonov and Steven Ongena on the economic effects on the Russian economy.
- Economic spillovers from the war in Ukraine: The proximity penalty: Jonathan Federle, André Meier, Gernot Müller and Victor Sehn on stock market reactions to the invasion of Ukraine.
- Russian consumers are already feeling the cost of war: The Economist compares current Russian inflation with the 1998 crisis.
- The economic consequences of the war in Ukraine: The Economist on the geopolitical risk and economic consequences.
Who are experts on this question?
- Paul Krugman
- Maurice Obstfeld
- Sergei Guriev
- Daniel Triesman
- Anders Åslund