Russias financial markets boom, crisis and recovery 1995-2001, Lessons for Emerging Markets Investors

From 1995 to 2001 Russia witnessed an asset market boom, a deep financial crisis, and a surprisingly forceful recovery. This paper analyzes economic policy and data of the time to explain why fluctuations were so violent and to draw lessons for Emerging Markets investors as well as for policymakers. The evidence suggests that the boom in Russian asset prices in 1995-1997 resulted from a highly ambitious monetary stabilization program amidst favourable global conditions. Inflation was compressed faster than in advanced transition economies, at the expense of rapid real appreciation and a persistent need for capital inflows. Weak economic structures and the lack of broad political support hampered fiscal consolidation and structural reforms, however. This made the monetary stabilization program vulnerable. Moreover, the program did not provide a politically viable exit option. Therefore, after external shocks had eroded the sustainability of the exchange rate target in 1998, the authorities felt compelled to defend it as long as possible. The ultimate crisis escalation resulted in a partial government default and steep devaluation. However, the economy responded with relief to the crisis-related easing of monetary conditions. The latter outweighed the drag from a collapse in capital imports. Also, the crisis escalation united the political spectrum around a new fundamental consensus on economic policy. Post- crisis governments prioritized fiscal consolidation over disinflation. This reduced dependence on foreign capital and made overall stabilization robust to external shocks. The more stable political and economic environment spurred economic reform in 2000-2001, particularly in the areas of public finances and investment conditions. Together with persistent commitment towards international integration this heralds a convergence of Russia’s economic structures with those in Central and Western Europe.