Jason Corcoran in Moscow
11 Aug 2008
Russia surprised the world this week by going to war with its neighbour Georgia over the future of breakaway province South Ossetia. The military conflict is a marked change from 10 years ago this week, when it took three days for the global markets to react to Russia defaulting on its sovereign debt. When the news sank in, investors panicked. Their haste to buy safe assets in place of risky securities heavily damaged the world’s largest hedge fund, Long-Term Capital Management, and brought the world close to financial meltdown
The default was as unexpected as it was unwanted. Russia defaulting on its debt was the last thing anybody wanted to hear in 1998 and many tried to persuade themselves that the Government would never do it.
The US and European Union had spent billions of dollars supporting President Boris Yeltsin since he stood on a tank in 1991 to defend democracy against the Communists, and the International Monetary Fund and World Bank were making fresh loans to the former Soviet republic – a default would be madness, but Russia did it.
The fallout resulted in a host of western bulge-bracket banks leaving or scaling back their activities in Russia and heralded the growth of local banks.
Most of the US and European banks took big hits as a result of the collapse of the stock market and the Russian Government’s default on its short-term debt.
When Russia opted to default, the value of Russian treasury bills, or GKOs, went to virtually zero, leaving the banks nursing large losses. Creditors heavily exposed to Russian treasury debt included Lehman Brothers, Bankers Trust, Salomon Brothers, Credit Suisse, Nomura, and Merrill Lynch. Hedge funds and speculators such as George Soros racked up billions of dollars in losses through investments in stocks, treasury debt and dollar-denominated bonds.
Ten years later, many of the big names have returned, tempted by oil and energy prices, a high growth rate and a boom in capital markets. Credit Suisse, one of the pioneers in Russia, was heavily exposed to the debt market and sustained a loss of $500m (€323m). It scaled back after the crash but has doubled its Moscow investment banking personnel during the past 18 months in a bid to reclaim a leading position.
Lehman Brothers, which is believed to have recovered just a fraction of its undisclosed losses, this month moved into offices in Moscow after securing a broking and dealing licence in January. Peter Ghavami, Lehman’s head of capital markets in Moscow, said the rollercoaster ride was worth it, considering Russia’s superior position today.
He said: “With continued high commodity prices, record foreign exchange reserves, hardly any external debt and budget surpluses, the situation today could hardly be more different than 1998. This has led to strong capital inflows, especially over the past few years, and a massive expansion of the banking industry, with both domestic and foreign banks greatly increasing their activities.”
The collapse hit Russian banks and brokerages and led to the collapse of SBS-Agro, Inkombank, Most Bank and Russky Kredit. Local brokerages Brunswick, UFG, Renaissance and Troika emerged soon after from the financial rubble. UFG and Brunswick were absorbed by Deutsche Bank and UBS respectively, while Renaissance and Troika have resisted takeover overtures and gone from strength to strength. Renaissance and Troika have in the past three years grown from junior banks into international contenders for bookrunner roles on flotations and bond issues.
Even though Russia’s current account reserves are more than $500bn and growth is coming from outside extractive industries, the basis of the economy and more than half of budget revenues are vulnerable to the price of oil. Chris Weafer, chief strategist at financial corporation Uralsib, arrived in Russia three weeks before the crisis and remains wary of potential seismic shocks to the economy.
He said: “It is all very well to say that the economy can withstand a fall in oil price to $50 per barrel in financial terms, but much of the success or failure of this next phase in the development will depend on investor and consumer confidence, and a great deal will depend on effective management by the Government.
“A falling oil price has tested both in the past. Without any meaningful progress in reducing the dependency on oil revenues, it surely will again."
Yeltsin: defended democracy against the Communists
Timeline to the August 1998 default
How the Russian crisis unfolded...
1997: November: Russian stocks begin to drop in the wake of the Asian financial crisis. Oil and gas lead the way as global commodity prices decline.
1998: March 23: Russian President Boris Yeltsin complains about the pace of reforms and dismisses his entire cabinet, including Prime Minister Viktor Chernomyrdin. Energy Minister Sergei Kirienko is appointed acting Premier.
May 12: Coal miners strike over unpaid wages, blocking the Trans-Siberian Railway.
May 27: Financial markets continue to tumble, forcing the central bank to triple interest rates to 150% to avert a collapse of the rouble.
July 1: Russia’s lower house of Parliament, the Duma, postpones action on spending and tax reforms needed to close the budget deficit and qualify for IMF loans.
July 10: US President Clinton calls on the IMF to conclude negotiations over emergency loans for Russia after a telephone call for help from Yeltsin.
July 13: The IMF announces an additional package of $23bn of emergency loans from foreign lenders. Russian stocks climb.
July 20: The IMF gives final approval to the package but the Duma rejects some conditions for the loans and the first two planned instalments are cut from $5.6bn to $4.8bn.
August 3: Wall Street responds to the deepening crisis after the US stock market falls almost 10% in a matter of weeks.
August 6: The World Bank approves a $1.5bn loan for Russia.
August 13: Trading on the Russian Trading System stock exchange is suspended as blue chips fall more than 20% in the first hour of trading. International speculator George Soros highlighted the crisis with a letter publishedin the Financial Times, in which he said the meltdown in Russian
financial markets had “reached the terminal phase”.
August 14: Yeltsin declares “there will be no devaluation” of the rouble and refuses to return to Moscow from his holiday.
August 16: Russian oligarchs and business leaders meet with members of Yeltsin’s administration in the White House to push for a moratorium on debt repayment.
August 17: Russia announces a devaluation of the rouble and freezes repayment of $40bn in foreign debt, triggering panic in Moscow as Russians line up to buy dollars.
August 19: Russia fails to pay its debt on Gosudarstvennye Kratkosrochnye Obyazatelstva short-term treasury bills, officially falling into default. The IMF and Group of Seven (G7) say they will not provide additional loans to Russia until it meets existing promises.
August 21: Duma calls on Yeltsin to resign as the negative effects trigger sell-offs in the US, Europe and Latin America.
August 23: Yeltsin dismisses Kirienko as Prime Minister and brings back Viktor Chernomyrdin.
August 28: Trading in the rouble is suspended. Yeltsin says he will stay in power until 2000.
September 3: Chernomyrdin appeals to Russians not to be panicked into withdrawing savings from private banks.
September 6: The European Union rules out offering Russia any moratorium on its foreign debts with its member states.
September 10: Chernomyrdin is rejected as Prime Minister in a parliamentary vote and Yeltsin nominates Yevgeny Primakov to end the stalemate.
September 21: The exchange rate reaches 21 roubles to the US dollar, meaning the rouble has lost two-thirds of its value in less than a month.
September 23: William McDonough, president of the New York Federal Reserve, convenes a meeting of the heads of nine Wall Street banks to effect a $3.65bn rescue of US hedge fund Long-Term Capital Management, whose portfolio had been undermined by the Russian crisis.
October 6: A year after hitting a high of more than 570 points, the RTS hits a low of 37.4.
October 31: The IMF refuses to release a $4.3bn instalment from the promised aid package until a realistic budget is set.
November 5: Russia reaches a deal with foreign investors to accept repayment in roubles of $40bn of debt frozen in August, but says it will not be able to repay $17.5bn of debts due in 1999 and will reschedule them.
1999: August 16: Vladimir Putin is appointed Prime Minister.
December 31: Putin replaces President Yeltsin. Russia bounces back from the crisis following a climb in world oil prices.
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