Investing in Frontier Markets by Graham Gavin Emid Al Feather David & Al Emid

Author:Graham, Gavin, Emid, Al, Feather, David & Al Emid
Language: eng
Format: epub
Publisher: Wiley
Published: 2013-07-30T16:00:00+00:00

Russian Debt Default of 1998

The International Monetary Fund and the World Bank intervened during the Asian crisis of 1997–98, but the ripple effect meant that markets in the United States, Europe and Russia declined as a result and triggered, among other consequences, the Russian devaluation and default in August 1998.

Russia, which had been one of the fastest-growing and most popular of the emerging markets due to the boom released by Boris Yeltsin's crony capitalism, saw its interest costs shoot up as a result of the crisis. It burned through its foreign exchange reserves, devalued the ruble and defaulted on its foreign currency debt, costing some investors up to 90 percent of their capital. The Asian crisis and Russian default together led to the notorious collapse of the big hedge fund Long-Term Capital Management (LTCM), which had enormously leveraged bets that yields on all sorts of emerging market government debt would converge, just as had happened with European countries during the mid-1990s in the run-up to the introduction of the euro.

LTCM had maintained that emerging markets were not correlated with each other, leading to the conclusion that what happened in Asia would not affect countries such as Russia and that the fund could invest with enormous amounts of leverage without risk. They were proven wrong, despite employing Nobel Prize–winning economists Myron Scholes and Robert Merton, coinventors of the well-known and widely used Black-Scholes option pricing model, and their collapse almost brought down several Wall Street banks, which had big loans outstanding to LTCM, an event that became an ironic sort of dry run for the collapse of Lehman Brothers 10 years later.

The United States Federal Reserve then bailed out the investment banks that were at risk due to LTCM's collapse, as detailed in Roger Lowenstein's excellent history of LTCM, When Genius Failed.6

Fifteen years later, Russia has become one of the BRIC nations, the rise in commodity prices has resulted in a rapid rebuilding of its foreign exchange reserves and trade balance, and Yeltsin's willingness to dismantle the pervasive Russian state, largely through a flawed system of privatizations via vouchers distributed to the entire population, has been replaced by former KGB operative Vladimir Putin's desire to use Russia's resources as a tool of foreign policy.

Russia provides a study in two extremes—corruption and economic possibility. There is a pervasive belief that Russia remains corrupt, although its rank in the Transparency International Corruption Perceptions Index is better than that of a number of former Soviet states and some other autocratic regimes. There is a strong belief by many observers that it has not gotten over its past history of crony capitalism and that those who could make money in Russia have moved their money outside the country. The recent expropriation of a portion of all bank deposits over 100,000 in Cyprus in March 2013 was justified by the assertion that much of this money represented offshore deposits of Russian criminal syndicates and the ill-gotten gains of well-connected Russian oligarchs, without much being produced in the way of evidence to support these statements.

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