The Soviet Union was one of the countries that emerged as a superpower after the Second World War. The post war economic system was basically a competition between the American capitalist system and the Soviet based socialist system.
The decades after the war were often referred to as the cold war as these two superpowers opposed each other’s plans for world domination. However, the Soviet Union ended up disintegrating in the 1990’s. As a result of this disintegration 15 countries were formed. None of these 15 countries were in great economic shape. However, Russia which was the modern incarnation of the mighty Soviet Union went bankrupt in 1998! Russia had to peg its currency to the very dollar that they vehemently opposed! They later had to break the peg, significantly devalue their currency and default on their debt obligations.
For a country which had plans of world domination, the events that happened in 1998 were nothing short of a humiliation. Russia has recovered from the shock. However the story of the 1998 ruble crisis still makes an interesting case. In this article we will find out more about this crisis.
Foreign Denominated Soviet Debt
Russia being the modern incarnation of the Soviet Union had inherited all of the Soviet’s debt. A major portion of this debt was in foreign denominations. Hence, the Russian economy was in essence facing a debt crisis ever since the day it was born. The Russians made valiant attempts to pay off the debt. However, the damage had been caused long before the issue came to their hands.
Russia did not have enough foreign exchange reserved to fulfill its debt obligations. Currency speculators were aware of this shortfall and therefore in 1998, after the Asian contagion, Russian became the next victim to fall to a currency attack mounted by powerful speculators.
Subsidies for Private Enterprises
The Russian economy may have become capitalistic in nature after it broke off from the Soviet Union. However, the Soviet socialist spirit was still present. As a result of the disintegration of the empire, a lot of private enterprises were in their nascent stages and as a result were not making profits. Some statistics estimate that after government abandoned employing everybody, only 40% of the workers were paid on time wages by private enterprises that struggled to make any profits!
As such, the Russian government intervened and started providing subsidies to Russian enterprises that were employing a lot of workers if they paid their workers on time! The problem was that the Russian government was already bankrupt! An already bankrupt government was forced to periodically raise more debt in order to provide subsidies. The Russian debt was therefore increasing at an unsustainable rate.
High Public Debt
To add to that, the government of Russia was also used to spending money the way it did in the socialist Soviet Union. The Russians therefore paid no regard to the fact that their tax collections were dwindling and the government was not generating any significant revenue. They kept on spending money with the high handedness derived from the former powerful Soviet Union. This ended up adding to the debt that was being piled on by servicing Soviet’s old debt and the debt that had to be taken on because of subsidies.
In order to cut their debt, the Russian government attempt privatization of its resources as this would create additional revenue in the form of taxation as well as receipts from sale. However, the Russian privatization attempt was marred by corruption as Oligarchs used their government contacts to acquire resources at bargain basement prices and make a fortune for themselves in the process. Thus, the hope of the Russian government to be able to mobilize cash by selling its resources failed.
The last blow to the Russian economy came after the Asian crisis of 1997. This crisis led to the fall in the prices of oil and metals in several nations which came as a severe shock to the Russian economy. The Russian economy was largely dependent on the export of oil. However, the Asian crisis caused asset prices all over the world to collapse and this caused the oil prices to go down as well. Hence, Russia which was already facing difficulty paying off its existing debt was not only mounting more debt as a result of subsidies but also faced a declining income. This was when the currency speculators took over and started hammering the ruble. Wave after wave of panic selling hit the market and the Russian central bank was no match for the negative sentiment generated by the currency speculators. The Forex reserves set aside by Russian central bank were depleted by the speculators in a matter of hours with their relentless selling.
The ruble ended up losing 40% of its value in a matter of a few days. This caused the Russian government’s finances to be strained and one of the mightiest nations in the world ended up defaulting on its debt obligations in the bond market. The Russian default had several casualties. One of the biggest one was a fund called Long Term Capital Management which ended up destroying close to a trillion dollars in value!