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Диплом The financial crisis in Russia of 1998

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Тип работы: Диплом. Добавлен: 27.04.2012. Страниц: 87. Уникальность по antiplagiat.ru: < 30%

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contents:

abstract
Literature review
introduction
Methodology
Analysis/findings
1. What are the characteristics of financial crisis situations?
2. what are the identificators of currency crisis?
3. what is the essence of financial crisisies of 1997-1998?
4. Can the RUssian Financial crisis of 1998 be seen from an exchange rate point of view?
5. WHat effects did the Russian Financial Crisis of 1998 have on the exchange rate, and what were the causes of the crisis`?
6. Could the Russian Financial Crisis of 1998 have been forseen, and how did it affect the exchange rate during the period of the crisis?
7. Recommendation. When looking at the Russian Financial Crisis of 1998 from an exchange rate point of view, what lessons can be learned and what led to the crisis?
conclusion
bibliography
appendixies
abstract

The actuality and scientific significance of the given research was caused with the fact that the Asian crisis and the more recent Russian default of 1998 and the subsequent virtual closing of international capital markets to many developing countries have been advanced and widely discussed by policy makers, in academic literature and press reports. The crisis is still evolving and it is unwise to think that all the lessons that may need to be learned have already been identified.
The Asian Crisis of 1997 and the Russian Crisis of 1998 as perhaps the most prominent cases naturally renewed interest in the study of the relevant causes, consequences, and cures for such episodes. In the wake of these recent events, one very important question has been the need and the feasibility of predicting such crises.
Purpose of Research. The given paper was aimed at deriving lessons from the Russian financial crisis through examining the root causes of macroeconomic and financial sector indicators spanning the period 1997-1999.
Subject of Research - the financial crisis in Russia of 1998.
Objects of Research. The significant variables of Russian economy at 1998 state - foreign direct investment, inflation, world oil prices, real interest rates, current account, foreign exchange reserves, stock prices, real exchange rate, and export growth were examined in the work.
Tusks of Research were:
to study the conception of financial crisis in economics;
to give a notion of the financial crisis of 1998 in Russia;
to study the causes of the financial crisis of 1998 in Russia;
to give characteristics of the currency crisis of 1998 in Russia;
to describe the process of the development of the currency crisis of 1998 in Russia;
to work out recommendations on regulation techniques of the financial crisis.
The theoretical base of research composed the following works.
Kaminsky et al (1998, 90) presents an extension of previous work which employs the signals approach to identifying and predicting currency crises.
Epitomized by Krugman (1979, 99), the First Generation Models tend to focus on the role of economic and financial fundamentals such as the unsustainable fiscal policies in the face of the fixed exchange rate as the major cause of an eventual currency crisis.
The development of the so-called Second Generation Models of the currency crises were motivated by the EMS currency crisis in 1992-93 where some countries such as the UK and Spain suffered crises despite having adequate international reserves, manageable domestic credit growth and non-monetized fiscal deficits - characteristics that ran counter to the necessary conditions asserted by the first generation models. Obstfeld (1994, 190) and Krugman (1998, 67) addressed the concerns raised by these counter-examples. These models allow for "multiple equilibria" and, under certain (generally untenable) circumstances of perfect information-based decision making, could argue that predicting crises may not be feasible due to the self-fulfilling nature of the expectations of the crisis.
Finally, the Third Generation Models are based on the notion of contagion where the mere occurrence of a crisis in one country increases the likelihood of a similar crisis elsewhere As described in Masson (1998, Working Paper 120), three related scenarios can be identified to represent the paradigm of contagion: monsoonal effects, spillover effects and pure contagion effects.
The Resource basis of the analytical part of research included:
The Analytical Report & Macroeconomic Analysis by short-term forecasting institute of economic forecasting of the Russian Academy of Science; describes bank system of Russia per 1996-2000 and presents models of functioning, the tendency, and prospect of development.
The World Economic Outlook Reveiw (1998) presents the IMF staff’s analysis and projections of economic developments at the global level, in major country groups (classified by region, stage of development, etc.), and in many individual countries.
Financial Stability Review Financial Crisis Management Articles 1998 (1999). The Financial Stability Review is essentially aimed at financial sector players and observers, such as decision makers, academics and market participants.
The annual report of the Central Bank of Russia (1998). Aimed at encouraging analysis and exchanges of views, the Financial Stability Review is divided into two parts. The overview provides a detailed account of recent developments in the international environment and the financial system addresses financial vulnerabilities and sheds light on the initiatives designed to enhance financial stability.
Methodology of research embraced the following stages:
1. Statement of theory of hypothesis.
2. Obtaining the data:
a) Primary data (interviews, periodical materials); (Appendix 2)
b) Analytical foundation (statistics, analytical reports). (List of resources)
3. Estimation of the parameters of the data. The basic tool for this purpose is served by the financial analysis, through which it is possible objectively to estimate the internal and external attitudes of analyzed object.
The approach estimates a probit or logit model of the occurrence of a crisis with lagged values of early warning indicators as explanatory variables. This approach requires the construction of a crisis dummy variable that serves as the endogenous variable in the probit or logit regression. Classification of each sample time point as being in crisis or not depends on whether or not a specific index of vulnerability exceeds an arbitrarily chosen threshold.
For example, for currency crises, the index of vulnerability is sometimes based on a weighted average of percentage changes in nominal exchange rates, gross international reserves and short-term interest rate differentials (e.g. local versus US rates when dealing with crises in the Philippines).
Explanatory variables typically would be variables in the real sector of the economy, financial variables, external sector and fiscal variables. This approach has the advantage of providing a framework for statistically measuring the magnitude and significance of the effects of various potential explanatory variables on the onset of a crisis. The estimated model also allows the estimation of the probability of occurrence of a crisis in the future given projected or anticipated values of the explanatory variables.
The tested 10 indicators are selected on the basis of currency crisis theories and previous empirical literature. In addition to the traditional macroeconomic variables, we include several indicators describing the vulnerability of domestic banks. These indicators include the growth of bank deposits, the ratio of the lending rate to the deposit rate, and the ratio of bank reserves to assets. We also employ variables that indicate vulnerability to a sudden stop of capital inflows. These variables are public debt, broad money to reserves, and private sector liabilities.
The used probit model assumes that the probability distribution function corresponds to normal distribution. Since in currency crisis situation a successful attack leads to sharp currency depreciation and substantial reserve losses, both the signal approach and limited dependent models traditionally define a currency crisis as a discrete event. One common technique is to construct an index of exchange market pressure as a weighted average of exchange rate changes and reserves changes (as well as interest rates in some cases). The crisis is said to occur when the index exceeds a certain threshold level.
At this point, we’ll calculate an exchange market pressure index (EMP) for Russia. The index includes exchange rate depreciation and loss of reserves, which are weighted to influence equally. The exchange market pressure index takes the form:
EMP = ?e – (s e/s r)*?r (2)
where ?e denotes the change in exchange rate and ?r in international reserves,
se and sr denote the standard deviation of exchange rate alteration and reserves, respectively.
We’ll determine the values of the EMP index more than two standard deviations above the mean as a crisis. Since macroeconomic variables often worsen prior to the actual crisis, we define as a crisis not only the crisis month but also the eleven months before. In other words, we use a one-year window for our variables.
4. Stating of the conclusions.
Analysis was devoted to studying of all the questions enlightened the main characteristics of the financial crisis in economics; the basic features of financial crisis of Russian economy in 1998; the state of the Russian economy in 1998, of the bank system and inner market state.
The research examined the default identifications in 1998 in bank system and causes of financial crisis of Russian economy in 1998, and also sequences of financial default in 1998 in Russian economy.
Hypothesis of research stating that political genesis in complex with macroeconomical factors of financial crisis in Russia of 1998 was proved.
In the third quarter of 1998, Russia experienced what seemed a classical financial crisis, combining a currency crisis, a debt crisis and a banking crisis. The Russian crisis was also evidently connected with the earlier Asian crisis, and sent shock waves across global financial markets.
Still, a closer look shows that the Russian crisis was mostly home made, typically caused by excessive public sector debt, and the mechanisms of crisis can not be understood without an understanding of the peculiarities of the Russian economic system, including demonetization and insider ownership. Such factors also go a long way in explaining the emergence of Russia from the crisis.
Powerful business interests, fearing another round of reforms that might cause leading concerns to fail, welcomed Kiriyenkos fall, as did the Russian financial institutions have developed, generally speaking, through speculative activities rather than by playing the role of intermediaries.
In Conclusion the lessons from the situation of Russian default of 1998 were stated.
1. Crisis prevention requires minimizing balance sheet vulnerabilities and avoiding crisis triggers (good macro policies, insulation from contagion by differentiating through adherence to standards, data transparency).
2. The IMF can contribute to crisis prevention through surveillance, technical assistance, and programs - by providing liquidity, inducing stronger policies, enhancing credibility and discipline, and signaling markets.
3. It is necessary to admit that money matters, but policies matter as well - and if policies are poor and existing balance sheet vulnerabilities are large, then the marginal impact of IMF resources on crisis prevention is also low. The Russian case proves it.
In the process of the post-crisis
bank restructuring,
networks,
political interests,
bargaining among governments and other economic and political actors have played a much stronger role than market institutions (like bankruptcy).
After the financial crisis, the improvement of banks’ market adaptability must go hand in hand with the strengthening of government intervention. Banking sector reorganization has been not only market-led but also state-driven. On the surface at least, there seems to be a correlation between bank restructuring and their financial recovery. Bank capital, debt and assets exceed pre-crisis levels, bringing some analysts to argue that Russia has completed the first stage of its financial recovery.
In particular, the increases of bank profits and long-term loans will be regarded as the most important achievements of banking sector reforms and can provide stability of currency rate.
In particular, the following characteristics of the transition in the banking sector could be observed.
1. Path-dependence and rent seeking have marked the development of Russian banks. Government intervention and striving to get access to the resulting rents have been strong.
2. Economic liberalization has opened many speculative opportunities for banks.
3. Banks’ moral hazard has been caused by cozy ties between banks and governments as well as by the possibilities to gain speculative profit.
4. Although banks do not play their traditional role of financial intermediaries, they have served as channel through which the government kept pumping subsidies to firms.
Resuming all the written above, in this paper we investigated the events that lead up to a currency crisis and debt default and the policies intended to avert it.
Three types of models exist to explain currency crises. Each model explains some factor that has been hypothesized to cause a crisis. After reviewing the three generations of currency crisis models, we conclude that four key ingredients can trigger a crisis:
a fixed exchange rate,
fiscal deficits and debt,
the conduct of monetary policy,
and expectations of impending default.
Three components fueled the expectations of Russia’s impending devaluation and default.
First, the Asian crisis made investors more conscious of the possibility of a Russian default.
Second, public relations errors, such as the publicized statement to government ministers by the CBR and Kiriyenko’s refusal to grant Lawrence Summers an audience, perpetuated agents’ perceptions of a political crisis within the Russian government.
Third, the revenue shortfall signaled the possible reduction of the public debt burden via an increase in the money supply. This monetization of the debt can be associated with a depreciation either indirectly through an increase in expected inflation or directly in order to reduce the burden of ruble-denominated debt.
Each of these three components acted to push the Russian economy from a stable equilibrium to one vulnerable to speculative attack.
Using the example of the Russian default of 1998, we show that the prescription of contractionary monetary policy in the face of a currency crisis can, under certain conditions, accelerate devaluation.
We conclude that the modern currency crisis is a symptom of an ailing domestic economy. In that light, it is inappropriate to attribute a single prescription as the prophylactic or cure for a currency crisis.
Structure of Research. The given research includes presentation; introduction; seven analytical parts; conclusion; List of Tables, Graphs and Illustrations; list of references and appendix.
Volume of Research. The given paper consists of 96 pages.


literature review

The decade of the 1990s was certainly marked by a rather unusual number of financial and economic crises with the Asian Crisis of 1997 and the Russian Crisis of 1998 as perhaps the most prominent such cases. These crises naturally renewed interest in the study of the relevant causes, consequences, and cures for such episodes. In the wake of these recent events, one very important question has been the need and the feasibility of predicting such crises.
The preliminary research has shown that literature on financial crises is categorized into three mainstream models, namely first-generation models, second-generation models, and third-generation models. (See the list of bibliography)
Epitomized by Krugman (1979, 99), the First Generation Models tend to focus on the role of economic and financial fundamentals such as the unsustainable fiscal policies in the face of the fixed exchange rate as the major cause of an eventual currency crisis. Given a fixed exchange rate regime, the persistent need to finance government budget deficits through monetization would surely lead to a reduction in the international reserves held by the Central Bank.
Since such reserves are finite the speculative attack on the currency is the eventual outcome of this scenario. This rather simple model suggests certain fundamental imbalances such as the gradual decline in international reserves, growing budget and current account deficits, domestic credit growth, and gradual exchange rate overvaluation as the potential early warning indicators of speculative attacks.
The development of the so-called Second Generation Models of the currency crises were motivated by the EMS currency crisis in 1992-93 where some countries such as the UK and Spain suffered crises despite having adequate international reserves, manageable domestic credit growth and non-monetized fiscal deficits - characteristics that ran counter to the necessary conditions asserted by the first generation models.
Obstfeld (1994, 190) and Krugman (1998, 67) addressed the concerns raised by these counter-examples. The main innovation of these Second Generation Models lies in identifying the role that the expectations of the market agents may play in precipitating currency crises. These models allow for "multiple equilibria" and, under certain (generally untenable) circumstances of perfect information-based decision making, could argue that predicting crises may not be feasible due to the self-fulfilling nature of the expectations of the crisis.
Finally, the Third Generation Models are based on the notion of contagion where the mere occurrence of a crisis in one country increases the likelihood of a similar crisis elsewhere As described in Masson (1998, Working Paper 120), three related scenarios can be identified to represent the paradigm of contagion: monsoonal effects, spillover effects and pure contagion effects.
While the different types of crises could range from "garden variety" currency crises to rather esoteric real estate bubbles, studies of such crises exhibit empirical and theoretical commonalties which will be highlighted below (for types of crises, see IMF World Economic Outlook, 1998). Also, these crises can have significant social costs as noted in Shabbir (1999).
In an attempt to note possible empirical regularities, Kaminsky et al (1998, Vol. 45, No 1) reviews about twenty-five relevant studies. Due to the disparate nature of the studies in terms of their methodologies and specifications, the overall empirical results do not provide "a clear-cut answer concerning the usefulness of each of the potential indicators of currency crisis".
Kaminsky et al (1998, 90) also presents an extension of previous work which employs the signals approach to identifying and predicting currency crises. Based on empirical results for a sample of fifteen developing countries and five industrial ones during 1970-95, the authors report that the variables with the best track record in anticipating crises include output, exports, real exchange rate deviations, equity prices and the ratio of broad money to gross international reserves.
The representative study that uses the logit/probit framework is by Kindleberger (2001, 90) and it deals with predicting banking crises. Based on observations for 1980-94 for a large sample of developed and developing countries, it reports that banking crises tend to occur when the macroeconomic environment is weak especially when growth rate of GDP is low and inflation is high.
As a matter of fact, there are essentially two alternative methodologies that have been employed in the empirical studies of the Early Warning Systems for different kinds of crises:
a) The relatively more popular approach is to use probit or logit models. (As illustrated by Eichengreen and Rose (1998) for currency crisis and Demirguc-Kunt and Detragrache (1998) for prediction of banking crises.);
b) Alternatively, the methodology adopted by Kaminsky and Reinhart (1996), and Kaminsky, Lizondo and Reinhart (1998) is known as the "signals" approach which essentially optimizes the signal to noise ratio for the various potential indicators of crisis.
The above noted two approaches are discussed in some detail later on in the section on Methodology (For additional related studies see Goldstein (1996), Klein (1998), Lau and Park (1995) and Mishkin (1998)).
There are also a handful of studies which try to predict economic and/or financial crises, see Ozmucur & Shabbir (1999); Onis & Ozmucur (1989a, 1989b) used logit and probit models to predict "need for IMF programs" and "bottlenecks" in the economy.
Real exchange rate, real interest, external terms of trade, excess demand (money supply growth- real GDP growth), and share of current account balance in GNP, all with one or two lags, are used as explanatory variables in their model.
Also, high real interest rates, balance of payment deficits and presence of deposit insurance scheme were found to be significant precursors of banking crises.
Given the fact, that the currency crises may be preceded by multiple economic and even political problems, the modeling of currency crisis prediction should involve a relatively broad range of indicators.
The variables that receive ample support as useful predictors of currency crises include:
1. M2/International reserves - official foreign currency reserves in the central bank, in financial bodies of the country or in the international currency - credit organizations. Currency reserves are intended for international payments, on a case of unforeseen situations, for the purposes of reception of the income and regulation of the currency market. In the balance of payments of the country currency reserves are an active. (Economic tools // [E-resource])
2. The real exchange rate which is defined as RER, where P is the domestic price level and P * the foreign price level. P and P * must have the same arbitrary value in some chosen base year. Hence in the base year, RER = e.
The RER is only a theoretical ideal. In practice, there are many foreign currencies and price level values to take into consideration. Correspondingly, the model calculations become increasingly more complex. Furthermore, the model is based on purchasing power parity (PPP), which implies a constant RER. The empirical determination of a constant RER value could never be realized, due to limitations on data collection. PPP would imply that the RER is the rate at which an organization can trade goods and services of one economy (e.g. country) for those of another. (Kaminsky, Lizondo, Reinhart 1998, 34)
For example, if the price of good increases 10% in the UK, and the Japanese currency simultaneously appreciates 10% against the UK currency, then the price of the good remains constant for someone in Japan. The people in the UK, however, would still have to deal with the 10% increase in domestic prices. It is also worth mentioning that government-enacted tariffs can affect the actual rate of exchange, helping to reduce price pressures. PPP appears to hold only in the long term (3–5 years) when prices eventually correct towards parity.
More recent approaches in modeling the RER employ a set of macroeconomic variables, such as relative productivity and the real interest rate differential.
3. Domestic inflation in classical economics is an increase in the total stock of money. As the consequence of that, so called price inflation occurs and is revealed in a rise in general level of prices of goods and services over time. Although "inflation" is sometimes used to refer to a rise in the price of a specific set of goods or services, a rise in price of one set (such as food) without a rise in others (such as wages) is not included in the original meaning of the word. Increases in the price of financial assets (stocks, bonds, etc.) are not included in the calculation of inflation by governmental or banking agencies. (Bustelo Paper. No.16)
4. Trade Balance is one of the key indicators. It is the value of the goods and services sold to other countries and bought from them, it forms part of the balance of payment (Current Account).
The balance of trade is a correlation between the sum of money gained by some country economy by exporting goods and services to other countries and the cost of goods and services imported to the country that is the difference between export and import. At first export is analyzed as it has direct impact on the economic acceleration. Whereas import reflects demands for goods within the country (import increase reflects stocks forming, which may signify possible further slow increase in selling).
Rate of exchange affects trade balance as it corrects the nominal value of the imported goods and services. In case the sum of exported goods and services exceeds the price of imported ones Trade Balance is positive (surplus), in case import surpasses export it is negative (deficit). Surplus (or decrease of deficit) is favorable for the national currency rate of exchange advance. Trade balance volatility may be significant for GDP forecasts, as import volume is subtracted from GDP (See below) whereas export volume is added to it. (Berg 1999, 567)
5. Export performance which is the relative success or failure of the efforts of a firm or nation to sell domestically-produced goods and services in other nations. (Lages 2005, 80)
6. Real GDP growth - the gross domestic product (GDP) or gross domestic income (GDI) is one of the measures of national income and output for a given countrys economy. GDP is defined as the total market value of all final goods and services produced within the country in a given period of time (usually a calendar year). It is also considered the sum of value added at every stage of production (the intermediate stages) of all final goods and services produced within a country in a given period of time, and it is given a money value.
The most common approach to measuring and understanding GDP is the expenditure method: GDP = consumption + gross investment + government spending + (exports − imports), or, GDP = C + I + G + (X-M);
- and the fiscal deficit as potential early warning indicators. (Dooley 1997, Working Paper Number 6300)
On the other hand, the variables associated with the external debt profile or the current account balance did not fare well.

Findings.
Literature review has shown four major factors which influence the onset and success of a speculative attack.
These key ingredients are
(1) an exchange rate peg and a central bank willing or obligated to defend it with a reserve of foreign currency,
(2) rising fiscal deficits that the government cannot control and therefore is likely to monetize (print money to cover the deficit),
(3) central bank control of the interest rate in a fragile credit market, and
(4) expectations of devaluation and/or rising inflation.
Krugman’s (1979) first generation model explains the factors that made Russia susceptible to a crisis.
The second-generation models show how contagion and other factors can change expectations to trigger the crisis.
The third generation models show how the central bank can act to prevent or mitigate the crisis.

introduction


Actuality and Scientific Value. The decade of the 1990s was certainly marked by a rather unusual number of financial and economic crises with the Asian Crisis of 1997 and the Russian Crisis of 1998 as perhaps the most prominent such cases. These crises naturally renewed interest in the study of the relevant causes, consequences, and cures for such episodes. In the wake of these recent events, one very important question has been the need and the feasibility of predicting such crises.
Purpose of Research. The given paper will be aimed at deriving lessons from the Russian financial crisis through examining the root causes of macroeconomic and financial sector indicators spanning the period 1997-1999.
Subject of Research - the financial crisis in Russia of 1998.
Objects of Research. The significant variables of Russian economy at 1998 state - foreign direct investment, inflation, world oil prices, real interest rates, current account, foreign exchange reserves, stock prices, real exchange rate, and export growth will be examined in the work.
Tusks of Research:
to study the conception of financial crisis in economics;
to give a notion of the financial crisis of 1998 in Russia;
to study the causes of the financial crisis of 1998 in Russia;
to give characteristics of the financial crisis of 1998 in Russia;
to describe the process of the development of the financial crisis of 1998 in Russia;
to work out recommendations on regulation techniques of the financial crisis.
The theoretical base of research composed the following works.
While the different types of crises could range from "garden variety" currency crises to rather esoteric real estate bubbles, studies of such crises exhibit empirical and theoretical commonalties which will be highlighted below (for types of crises, see IMF World Economic Outlook, 1998). Also, these crises can have significant social costs as noted in Shabbir (1999).
In an attempt to note possible empirical regularities, Kaminsky et al (1998, Vol. 45, No 1) reviews about twenty-five relevant studies. Due to the disparate nature of the studies in terms of their methodologies and specifications, the overall empirical results do not provide "a clear-cut answer concerning the usefulness of each of the potential indicators of currency crisis".
Kaminsky et al (1998, 90) also presents an extension of previous work which employs the signals approach to identifying and predicting currency crises. Based on empirical results for a sample of fifteen developing countries and five industrial ones during 1970-95, the authors report that the variables with the best track record in anticipating crises include output, exports, real exchange rate deviations, equity prices and the ratio of broad money to gross international reserves.
Epitomized by Krugman (1979, 99), the First Generation Models tend to focus on the role of economic and financial fundamentals such as the unsustainable fiscal policies in the face of the fixed exchange rate as the major cause of an eventual currency crisis. Given a fixed exchange rate regime, the persistent need to finance government budget deficits through monetization would surely lead to a reduction in the international reserves held by the Central Bank.
Since such reserves are finite the speculative attack on the currency is the eventual outcome of this scenario. This rather simple model suggests certain fundamental imbalances such as the gradual decline in international reserves, growing budget and current account deficits, domestic credit growth, and gradual exchange rate overvaluation as the potential early warning indicators of speculative attacks.
The development of the so-called Second Generation Models of the currency crises were motivated by the EMS currency crisis in 1992-93 where some countries such as the UK and Spain suffered crises despite having adequate international reserves, manageable domestic credit growth and non-monetized fiscal deficits - characteristics that ran counter to the necessary conditions asserted by the first generation models.
Obstfeld (1994, 190) and Krugman (1998, 67) addressed the concerns raised by these counter-examples. The main innovation of these Second Generation Models lies in identifying the role that the expectations of the market agents may play in precipitating currency crises. These models allow for "multiple equilibria" and, under certain (generally untenable) circumstances of perfect information-based decision making, could argue that predicting crises may not be feasible due to the self-fulfilling nature of the expectations of the crisis.
Finally, the Third Generation Models are based on the notion of contagion where the mere occurrence of a crisis in one country increases the likelihood of a similar crisis elsewhere As described in Masson (1998, Working Paper 120), three related scenarios can be identified to represent the paradigm of contagion: monsoonal effects, spillover effects and pure contagion effects.
The basis Resources of the analytical part of research includes:
The Analytical Report & Macroeconomic Analysis by short-term forecasting institute of economic forecasting of the Russian Academy of Science; describes bank system of Russia per 1996-2000 and presents models of functioning, the tendency, prospect of development
The World Economic Outlook Review (1998) presents the IMF staff’s analysis and projections of economic developments at the global level, in major country groups (classified by region, stage of development, etc.), and in many individual countries. It focuses on major economic policy issues as well as on the analysis of economic developments and prospects. It is usually prepared twice a year, as documentation for meetings of the International Monetary and Financial Committee, and forms the main instrument of the IMF’s global surveillance activities.
Financial Stability Review Financial Crisis Management Articles 1998 (1999). The Financial Stability Review is essentially aimed at financial sector players and observers, such as decision makers, academics and market participants. It reviews developments affecting financial institutions, markets and their infrastructures from a cyclical and structural perspective.
The annual report of the Central Bank of Russia (1998).
The transformation of financial systems has highlighted several potential sources of instability, such as financial bubbles, bouts of market volatility and changes in the allocation of risk between participants. At the very heart of the financial system, central banks play a decisive role in preserving its stability. For this reason, they carry out a thorough analysis of the soundness of the financial systems various components, based on a close dialogue with its main relevant players.
Aimed at encouraging analysis and exchanges of views, the Financial Stability Review is divided into two parts. The overview provides a detailed account of recent developments in the international environment and the financial system addresses financial vulnerabilities and sheds light on the initiatives designed to enhance financial stability.
Hypothesis of research: Can we state that political crisis in complex with macroeconomical factors initiated the financial crisis in Russia of 1998? What factor was more essential?
Structure of Research. The given research includes presentation, introduction, two chapters (theoretical and analytical ones), conclusion, list of references and appendix.
Analysis part was devoted to studying of all the questions enlightened the main characteristics of the financial crisis in economics; the basic features of financial crisis of Russian economy in 1998; the state of the Russian economy in 1998, of the bank system and inner market state.
The research examined the default identifications in 1998 in bank system and causes of financial crisis of Russian economy in 1998.
In Conclusion the lessons from the situation of Russian default of 1998 will be identified.


Methodology

Methodology of research embraces the following stages:
1. Statement of theory of hypothesis.
2. Obtaining the data:
a) Primary data (interviews, periodical materials); (Appendix 2)
b) Analytical foundation (statistics, analytical reports). (List of resources)
The tested 10 indicators are selected on the basis of currency crisis theories and further empirical literature. In addition to the traditional macroeconomic variables, we include several indicators describing the vulnerability of domestic banks. These indicators include the growth of bank deposits, the ratio of the lending rate to the deposit rate, and the ratio of bank reserves to assets.
We also employ variables that indicate vulnerability to a sudden stop of capital inflows. These variables are public debt, broad money to reserves, and private sector liabilities.
3. Estimation of the parameters of the data. The basic tool for this purpose is served by the financial analysis, through which it is possible objectively to estimate the internal and external attitudes of analyzed object.
As it was mentioned earlier, the recent efforts at devising an early warning system for an impending financial crisis have taken the form of two related approaches.
The first approach estimates a probit or logit model of the occurrence of a crisis with lagged values of early warning indicators as explanatory variables. This approach requires the construction of a crisis dummy variable that serves as the endogenous variable in the probit or logit regression. Classification of each sample time point as being in crisis or not depends on whether or not a specific index of vulnerability exceeds an arbitrarily chosen threshold.
For example, for currency crises, the index of vulnerability is sometimes based on a weighted average of percentage changes in nominal exchange rates, gross international reserves and short-term interest rate differentials (e.g. local versus US rates when dealing with crises in the Philippines).
Explanatory variables typically would be variables in the real sector of the economy, financial variables, external sector and fiscal variables. This approach has the advantage of providing a framework for statistically measuring the magnitude and significance of the effects of various potential explanatory variables on the onset of a crisis. The estimated model also allows the estimation of the probability of occurrence of a crisis in the future given projected or anticipated values of the explanatory variables.
Negative aspects of the approach partly derive from the following:
1. The model does not address the independence of crisis occurrence from period to period - except indirectly through serial correlations that exist in the explanatory variables.
2. Additional serial correlations may even be introduced inadvertently through the explicit manner in which the crisis dummy variable is constructed. For example, the use of exclusion windows (where the crisis variable automatically is set to zero for k periods immediately following a time point rated to be in crisis) establishes perfect correlation between a crisis time point, and the next k periods following it. In general, any serial correlation in the crisis dummy variable which is not taken into account in the probit or logit regression would cause the estimates of the model to be inconsistent.
3. Another source of inconsistency: errors in the construction of the crisis dummy variable leading to misclassification of time points - either a false signal of a crisis or a missed reading of a crisis.
4. The method does not provide a direct measure of the weakness or intensity of the signal of each explanatory variable regarding the onset of a crisis.
The second method uses a signaling approach to get a more direct measure of the importance of each candidate explanatory variable. The approach constructs a similar binary variable from each explanatory variable - thus imputing a one (for crisis) or a zero (no crisis) signal from each explanatory variable at each point in time in the sample. A signal-to-noise is then computed for each explanatory variable over the whole sample period - as a quantitative assessment of the value of the variable as a crisis indicator.
This signal-tonoise ratio is defined as the ratio of the success rate of crisis predictions relative to the false alarm rate. More specifically, this approach allows a direct ranking of variables as crisis indicators and provides a quick focus on the source of the crisis (assuming an encompassing set of indicators). But the approach does not take into account strong correlations among indicators, provides no framework for statistical testing or calculation of crisis probabilities in the future, and is still open to misclassification errors that can bias the conclusions of the analysis.
Probit and logit models, pioneered by Frankel and Rose (1996), use limited dependent variable models known as probit or logit regressions to identify the causes of crises and to predict future crises. This approach defines a crisis indicator equal to one or zero depending on whether a currency crisis does or does not occur within the specified time period.
Frankel and Rose (1996) attempted to find out how international debt structure and external factors affected the probability of currency crises. They used a number of external, internal and foreign macroeconomic variables in a multivariate probit model specified for 105 developing countries, covering annual data from 1971 to 1992.
They defined a crisis as at least 25% depreciation of the nominal exchange rate that also exceeds the previous years depreciation level by at least 10% and constructed a dummy crisis variable according to that rule. Results of their model indicate that the significant variables are output growth, foreign direct investment/total debt, reserves, domestic credit growth, external debt and foreign interest rates. Sachs, Tornell and Velasco (1996) also used a probit model to analyze currency crises, particularly the Mexican Tequila Crisis of 1995, using a sample of 20 emerging countries that were vulnerable to contagion effect.
They used the weighted sum of the percent decrease in reserves and the percent depreciation of the exchange rate as their crisis index. (International Journal of Applied Econometrics and Quantitative Studies Vol.1-4(2004)
They found that crises happened only in the countries with weak fundamentals such as low reserves, fragile banking systems and overvalued exchange rate. They also found evidence showing that short-term capital inflows do not matter when reserves and fundamentals are strong whilst government consumption and current account deficits matter only in the countries with weak fundamentals and weak reserves.
Berg and Pattillo (1999) tested models offered by Kaminsky, Lizondo and Reinhart (1998), Frankel and Rose (1996) and Sachs, Tornell, Velasco (1996) to see if these models could predict the Asian Crisis using information available at the end of 1996. They found out that the models offered by Sachs, Tornell, Velasco (1996) and Frankel and Rose (1996) were ineffective in forecasting the Asian Crisis. The Kaminsky, Lizondo and Reinhart (1998) model, on the other hand, proved to be successful.
Crisis probabilities generated by this model for the period between May 1995 and December 1996 were statistically significant predictors of actual crisis occurrence over the following 24 months. Berg and Pattillo (1999) also found out that in all three approaches, the probability of a currency crisis increases when domestic credit growth is high, the real exchange rate is overvalued relative to trend, and the ratio of M2 to reserves is high.
In a recent study, Komulainen and Lukkarila (2003) examined the causes of financial crises in 31 emerging market countries during 1980-2001 using a probit model based on 23 variables.
Their findings show that financial crises occur together with banking crises and an increase in private sector liabilities, public debt, and foreign liabilities of banks, unemployment, inflation, and US interest rates raises the probability of a crisis.
Feridun (2004) summarizes the empirical literature on financial crises. According his work, the probit model is estimated for a set of 20 monthly observations spanning the period 1988:1 – 1998:8. Most data are gathered from DataStream. The data for government debt figures come from several sources, including International Financial Statistics, the World Bank’s WDI and IMF country reports.
The used probit model assumes that the probability distribution function corresponds to normal distribution. Since in currency crisis situation a successful attack leads to sharp currency depreciation and substantial reserve losses, both the signal approach and limited dependent models traditionally define a currency crisis as a discrete event. One common technique is to construct an index of exchange market pressure as a weighted average of exchange rate changes and reserves changes (as well as interest rates in some cases). The crisis is said to occur when the index exceeds a certain threshold level.
At this point, we’ll calculate an exchange market pressure index (EMP) for Russia. The index includes exchange rate depreciation and loss of reserves, which are weighted to influence equally. The exchange market pressure index takes the form:
EMP = ?e – (s e/s r)*?r (2)
where ?e denotes the change in exchange rate and ?r in international reserves,
se and sr denote the standard deviation of exchange rate alteration and reserves, respectively.
We’ll determine the values of the EMP index more than two standard deviations above the mean as a crisis. Since macroeconomic variables often worsen prior to the actual crisis, we define as a crisis not only the crisis month but also the eleven months before. In other words, we use a one-year window for our variables.
4. Stating of the conclusions.


Analysis/findings

1. What are the characteristics of financial crisis situations?

A currency crisis is defined as a speculative attack on country A’s currency, brought about by agents attempting to alter their portfolio by buying another currency with the currency of country A.
The speculative attack need not be successful to be dubbed a currency crisis. This might occur because investors fear that the government will finance its high prospective deficit through seigniorage (printing money) or attempt to reduce its nonindexed debt (debt indexed to neither another currency nor inflation) through devaluation.
A devaluation occurs when there is market pressure to increase the exchange rate (as measured by domestic currency over foreign currency) because the country either cannot or will not bear the cost of supporting its currency. In order to maintain a lower exchange rate peg, the central bank must buy up its currency with foreign reserves. If the central bank’s foreign reserves are depleted, the government must allow the exchange rate to float up  a devaluation of the currency. This causes domestic goods and services to become cheaper relative to foreign goods and services. The devaluation associated with a successful speculative attack can cause a decrease in output, possible inflation, and a disruption in both domestic and foreign financial markets.
Burnside, Eichenbaum, and Rebelo (2001) show that the government has at its disposal a number of mechanisms to finance the fiscal costs of the devaluation. Which policy is chosen determines the inflationary effect of the currency crisis.
The standard macroeconomic framework applied by Fleming (1962) and Mundell (1963) to international issues is unable to explain currency crises. In this framework with perfect capital mobility, a fixed exchange rate regime results in capital flight when the central bank lowers interest rates and results in capital inflows when the central bank raises interest rates.
Consequently, the efforts of the monetary authority to change the interest rate are undone by the private sector. In a flexible exchange rate regime, the central bank does not intervene in the foreign exchange market and all balance of payment surpluses or deficits must be financed by private capital outflows or inflows, respectively.
The need to explain the symptoms and remedies of a currency crisis has spawned a number of models designed to incorporate fiscal deficits, expectations, and financial markets into models with purchasing power parity. These models can be grouped into three generations, each of which is intended to explain specific aspects that lead to a currency crisis.
The valid state of affairs at crisis historical periods of any human community is presented in diagram (See figure 1).

Figure 1. The state of affairs at crisis historical periods
Basically there are two kinds of economic crises:
1. The stagflation crisis (or underproduction crisis) is the final effect of government-stimulated growth (or the war, which is no more that a special kind of government investment). Just before the crisis (in the hidden phase) we can observe: shortage of goods, government regulation of the market (like rationing coupons or fixed prices), and the black market.
These are signals of the increasing market unbalance. When the crisis starts (in the evident phase) we can observe: unemployment, decline of the production, and inflation (or even hyperinflation), because publicity no longer believe in money offered by the government.
2. The overproduction crisis (or deflation crisis) is the final effect of growth stimulated by private financial institutions (like banks or investment funds).
Just before the crisis (in the hidden phase) we can observe: rocketing increase of prices on the stock market, and a periodical increase of inflation. These are signals of the increasing market unbalance. When the crisis starts (in the evident phase) we can observe: sharp fall of the stock prices, unemployment, decline of the production, problems with selling goods (overproduction), and thus deflation. (See economic tools // Access: www.geocities.com)
Of course in the real world things are more complicated, and sometimes crisis is some combination of two basic kinds of crises mentioned above.
For example, when a country with government-stimulated economy borrows money from an external and free financial market (i.e. from abroad financial institutions abroad), the crisis usually begins with a drastic fall of the national currency.
Mexican crisis of 1994 is a good example here. The reasons for the crisis are the same like in stagflation crisis but the course of the crisis resembles rather an overproduction crisis - because of free financial markets involved.
The preliminary research has shown that literature on financial crises is categorized into three mainstream models, namely first-generation models, second-generation models, and third-generation models. (See the list of bibliography)
The representative study that uses the logit/probit framework (Kindleberger 2001, 90) deals with predicting banking crises. Based on observations for 1980-94 for a large sample of developed and developing countries, it reports that banking crises tend to occur when the macroeconomic environment is weak especially when growth rate of GDP is low and inflation is high.
Considering the question of currency crisis’ origin we tend to focus on the role of economic and financial fundamentals such as the unsustainable fiscal policies in the face of the fixed exchange rate as the major cause of an eventual currency crisis. Given a fixed exchange rate regime, the persistent need to finance government budget deficits through monetization would surely lead to a reduction in the international reserves held by the Central Bank. Since such reserves are finite the speculative attack on the currency is the eventual outcome of this scenario.
This rather simple model suggests certain fundamental imbalances such as the gradual decline in international reserves, growing budget and current account deficits, domestic credit growth, and gradual exchange rate overvaluation as the potential early warning indicators of speculative attacks.
Also, high real interest rates, balance of payment deficits and presence of deposit insurance scheme were found to be significant precursors of banking crises.

FINDINGS.
- A currency crisis is defined as a speculative attack on country A’s currency, brought about by agents attempting to alter their portfolio by buying another currency with the currency of country A.
- The speculative attack need not be successful to be dubbed a currency crisis. This might occur because investors fear that the government will finance its high prospective deficit through seigniorage (printing money) or attempt to reduce its nonindexed debt (debt indexed to neither another currency nor inflation) through devaluation.
- A devaluation occurs when there is market pressure to increase the exchange rate (as measured by domestic currency over foreign currency) because the country either cannot or will not bear the cost of supporting its currency.
- In order to maintain a lower exchange rate peg, the central bank must buy up its currency with foreign reserves. If the central bank’s foreign reserves are depleted, the government must allow the exchange rate to float up  a devaluation of the currency. This causes domestic goods and services to become cheaper relative to foreign goods and services.
- The devaluation associated with a successful speculative attack can cause a decrease in output, possible inflation, and a disruption in both domestic and foreign financial markets.
2. What are the IDENTIFICATORS OF currency crisis?

Given the fact, that the currency crises may be preceded by multiple economic and even political problems, the modeling of currency crisis prediction should involve a relatively broad range of indicators. The variables that receive ample support as useful predictors of currency crises include:
1. M2/International reserves - official foreign currency reserves in the central bank, in financial bodies of the country or in the international currency - credit organizations. Currency reserves are intended for international payments, on a case of unforeseen situations, for the purposes of reception of the income and regulation of the currency market. In the balance of payments of the country currency reserves are an active. (Economic tools // [E-resource])
2. The real exchange rate which is defined as RER, where P is the domestic price level and P * the foreign price level. P and P * must have the same arbitrary value in some chosen base year. Hence in the base year, RER = e.
The RER is only a theoretical ideal. In practice, there are many foreign currencies and price level values to take into consideration. Correspondingly, the model calculations become increasingly more complex. Furthermore, the model is based on purchasing power parity (PPP), which implies a constant RER. The empirical determination of a constant RER value could never be realized, due to limitations on data collection. PPP would imply that the RER is the rate at which an organization can trade goods and services of one economy (e.g. country) for those of another. (Kaminsky, Lizondo, Reinhart 1998, 34)
For example, if the price of good increases 10% in the UK, and the Japanese currency simultaneously appreciates 10% against the UK currency, then the price of the good remains constant for someone in Japan. The people in the UK, however, would still have to deal with the 10% increase in domestic prices. It is also worth mentioning that government-enacted tariffs can affect the actual rate of exchange, helping to reduce price pressures. PPP appears to hold only in the long term (3–5 years) when prices eventually correct towards parity.
More recent approaches in modeling the RER employ a set of macroeconomic variables, such as relative productivity and the real interest rate differential.
3. Domestic inflation in classical economics is an increase in the total stock of money. As the consequence of that, so called price inflation occurs and is revealed in a rise in general level of prices of goods and services over time. Although "inflation" is sometimes used to refer to a rise in the price of a specific set of goods or services, a rise in price of one set (such as food) without a rise in others (such as wages) is not included in the original meaning of the word. Increases in the price of financial assets (stocks, bonds, etc.) are not included in the calculation of inflation by governmental or banking agencies. (Bustelo Paper. No.16)
4. Trade Balance is one of the key indicators. It is the value of the goods and services sold to other countries and bought from them, it forms part of the balance of payment (Current Account).
The balance of trade is a correlation between the sum of money gained by some country economy by exporting goods and services to other countries and the cost of goods and services imported to the country that is the difference between export and import. At first export is analyzed as it has direct impact on the economic acceleration. Whereas import reflects demands for goods within the country (import increase reflects stocks forming, which may signify possible further slow increase in selling).
Rate of exchange affects trade balance as it corrects the nominal value of the imported goods and services. In case the sum of exported goods and services exceeds the price of imported ones Trade Balance is positive (surplus), in case import surpasses export it is negative (deficit). Surplus (or decrease of deficit) is favorable for the national currency rate of exchange advance. Trade balance volatility may be significant for GDP forecasts, as import volume is subtracted from GDP (See below) whereas export volume is added to it. (Berg 1999, 567)
5. Export performance which is the relative success or failure of the efforts of a firm or nation to sell domestically-produced goods and services in other nations. (Lages 2005, 80)
6. Real GDP growth - the gross domestic product (GDP) or gross domestic income (GDI) is one of the measures of national income and output for a given countrys economy. GDP is defined as the total market value of all final goods and services produced within the country in a given period of time (usually a calendar year). It is also considered the sum of value added at every stage of production (the intermediate stages) of all final goods and services produced within a country in a given period of time, and it is given a money value.
The most common approach to measuring and understanding GDP is the expenditure method: GDP = consumption + gross investment + government spending + (exports − imports), or, GDP = C + I + G + (X-M);
- and the fiscal deficit as potential early warning indicators. (Dooley 1997, Working Paper Number 6300)
On the other hand, the variables associated with the external debt profile or the current account balance did not fare well.

Findings.
- Summing up the theoretical survey the following indicators at crisis period in economy can be stated in Table 1.
Table 1 Interrelating indicators under a stress classification
Macroeconomic stress
External stress
Financial stress
Fiscal deficit
International reserves
Composition of foreign capital flows
Inflation rate
Foreign investment
Interest rates
Real GDP growth or level
Exchange rate
Credit growth
Savings-investment gap
Trade balance
Money supply
Employment/unemployment
Terms of trade
M2/international reserves
Financial market indices

Parallel financial market premium
Government consumption
OECD growth
Central bank credit to banks/public sector


Private sector debt



3. what is the essence of financial crisisies of 1997-1998?

Wall Street Journal in August, 1998 has written about the financial firestorm that has been scorching economies around the globe is intensifying into one of the worlds worst and most baffling currency crises since the system of fixed exchange rates crumbled a quarter of a century ago. (Wall Street Journal - Aug. 24, 1998)
Frightened investors and quick-moving speculators in markets as far apart and different as Brazil and Hong Kong, Canada and Russia, Japan and Venezuela were scurrying to exchange local currencies for the U.S. dollar.
Selling those currencies means selling stocks and bonds in their respective markets, pushing down stock prices and pushing up interest rates in emerging-market economies and even in some that emerged long ago, such as Hong Kong.
We can mark the strict connection between the Asian financial crisis of 1997 and the Russian currency crisis of 1998. Cooper (1999) has established, that «the Asian financial problems, and other factors have created uncertainty in the appearing markets of the capital on the part of investors " and as sharply falling prices for oil have made firm currency incomes insufficient, aggravating crisis.
Before the Russian financial crisis of August, 1998, Russia experienced a shortage of foreign investments into the country and as consequence a shortage of trust, leading to falling of the Total National Product, the high inflation, raising unemployment and high interest rates.
Hence, it has affected external economic indicators which included the exchange rate between the American dollar and the Russian ruble and reduction in foreign reserves in Russia.
There are a handful of studies which try to predict economic and/or financial crises, see Ozmucur & Shabbir (1999); Onis & Ozmucur (1989a, 1989b) used logit and probit models to predict "need for IMF programs" and "bottlenecks" in the economy.
Real exchange rate, real interest, external terms of trade, excess demand (money supply growth- real GDP growth), and share of current account balance in GNP, all with one or two lags, are used as explanatory variables in their model.
As the crisis mounts, so does the number of explanations many of them deriving from ominous combinations of domestic and international factors:
Plunging commodity prices, such as the drop in oil prices that has pummeled Russia, Mexico and Venezuela;
Political instability in several pivotal countries, highlighted just Sunday by Russian President Boris Yeltsins abrupt dismissal of his cabinet and the appointment of Viktor Chernomyrdin as prime minister; 
Doubts about the financial wherewithal and willingness of the International Monetary Fund to respond to the next big economy in need of aid;
A spreading nervousness among global investors about being exposed to emerging markets;
And a deeply intermeshed global financial market that, with increasing speed, transmits one markets weakness to others. (Berg, Pattillo 1999, 570)
What made the crisis so unnerving is that there was no clear solution in sight - no financial firebreak that governments or international financial institutions can construct to slow the spread. Hopes that the crisis, ignited by the July 1997 devaluation of the Thai baht, would soon burn itself out have been dashed by this months devaluation and default in Russia and the side effects that flared Friday, including record lows for the Mexican peso and the Canadian dollar, and the Venezuelan central banks decision to give the bolivar more room to fall.

Findings.
There are combinations of domestic and international factors which caused the crisis situations of 1997-1998:
Plunging commodity prices, such a


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