RUSSIA’S FINANCIAL MARKETS BOOM, CRISIS AND RECOVERY 1995–2001: LESSONS FOR EMERGING MARKETS INVESTORS by Ralph Süppel SUERF – The European Money and Finance Forum Vienna 2003 CIP Russia’s Financial Markets Boom, Crisis and Recovery 1995–2001: Lessons for Emerging Markets Investors By Ralph Süppel Vienna: SUERF (SUERF Studies: 2003/5) ISBN 3-902109-19-X Keywords: Russia, Transition Economies, Emerging Markets, Financial Crisis, Debt Restructuring JEL Classification Numbers: E44, E65, F31, F34 © 2003 SUERF, Vienna Copyright reserved. Subject to the exception provided for by law, no part of this publication may be reproduced and/or published in print, by photocopying, on microfilm or in any other way without the written consent of the copyright holder(s); the same applies to whole or partial adaptations. The publisher retains the sole right to collect from third parties fees payable in respect of copying and/or take legal or other action for this purpose. RUSSIA’S FINANCIAL MARKETS BOOM, CRISIS AND RECOVERY 1995–2001: Lessons for Emerging Markets Investors1 by Ralph Süppel Director of Global Securities Research & Economics, Emerging Markets Research, Merrill Lynch International Merrill Lynch Financial Centre 2 King Edward Street London EC1A 1HQ United Kingdom Tel: +44 (0) 20 7996 4994 Fax: +44 (0) 20 7996 2941 Mobile +44 (0) 7717 54 7713 e-mail:
[email protected] Abstract 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. fiscal consolidation and foreign direct investment. The gap between stabilization ambition and structural reality made the currency increasingly vulnerable. Also, the program did not provide a politically viable “emergency exit” from the exchange rate target corridor. Devaluation was postponed through heavy international support. The ultimate crisis escalation in August 1998 resulted in a partial government default and steep devaluation. However, the economy responded from 1999 with relief to the real depreciation, entering a phase of sustained expansion. Also, the crisis escalation united the political spectrum around a new fundamental consensus on economic policy. Post-crisis governments prioritized fiscal consolidation over disinflation. The more stable political and economic environment spurred broader economic reform from 2000, particularly in the areas of public finances and investment conditions. Together with persistent commitment towards international integration this heralds a long-term convergence of Russia’s economic structures with those in Central and Western Europe. TABLE OF CONTENTS 7 1 Introduction 2 Ambitious monetary stabilization and rising financial vulnerability: 1995 to 1997 11 2.1 Overview 11 2