Russias financial markets boom, crisis and recovery 1995-2001, Lessons for Emerging Markets Investors (original) (raw)

From 1995 to 2001 Russia witnessed an asset market boom, a deep financial crisis, and a surprisingly forceful recovery. An event study of this episode provides important insights for Emerging Market investment and Russia's medium-term prospects. The initial surge in bond and stock prices in 1995-97 owed to a highly ambitious monetary stabilization program, which compressed inflation much faster than other transition economies. Due to high dollarization, disinflation was based on the exchange rate. The program produced rapid real appreciation and a persistent need for capital inflows, while weak economic structures and lack of domestic political support prevented accompanying 1 The paper has been written as a follow up to the author's assignment as senior economist for Emerging Europe at J.P.Morgan Chase and with support of the European Central Bank. It is not related to his current assignment at Merrill Lynch nor does it reflect the views of either of the aforementioned institutions. TABLE OF CONTENTS 1 Introduction 2 Ambitious monetary stabilization and rising financial vulnerability: 1995 to 1997 2.1 Overview 2.2 Motivation and flaws of the stabilization program 2.2.1 A simple plan 2.2.2 A worsening fiscal Achilles heel 2.3 Signs of excessive ambition 2.4 Growing risks for macroeconomic stability 2.4.1 The vulnerability of the foreign-exchange regime 2.4.2 Inconsistency of monetary and fiscal objectives 2.4.3 Rising stakes in the foreign-exchange regime 3 External shocks and lack of flexibility lead to crisis: October 1997 to July 1998 3.1 Overview 3.2 The ruble under pressure: Triggers and consequences 3.3 Lack of policy options and exit strategy 3.4 Desperate measures to ward off devaluation 4 Devaluation and crisis escalation: August-October 1998 4.1 Overview 4.2 The final emergency package: Devaluation and local markets freeze 4.3 Consequences of the crisis escalation 5 Stabilization and creation of new political consensus: November 1998 to mid 1999 5.1 Overview 5.2 Post-crisis stabilization policy 5.2.1 Understanding the misunderstanding 5.2.2 The government's secret but aggressive fiscal tightening 5.2.3 Quick and positive response of the economy 5.3 Crisis as a catalyst for sustained policy change 5.4 The unexpected recovery Fiscal consolidation, economic recovery and rapid reform: Mid 1999 to 2001 6.1 Overview 6.2 Post-crisis fiscal policy: Prudence to the point of paranoia 6.3 Unambitious monetary stabilization 6.4 Accelerating economic reform 6.4.1 Rationale and strategy 6.4.2 Reform focus 1: The tax system 6.4.3 Reform focus 2: Investment conditions 6.5 International integration and convergence 7 Conclusion 8 References SUERF-Société Universitaire Européenne de Recherches Financières SUERF STUDIES