SIKAKROM with Gideon DONKOR: Fragile stability: Lessons from Russia’s 1998 financial crisis

People say you never forget your first major experience. The first financial crisis I encountered in my professional life was the 1998 Russian debt default, which subsequently led to the bailout of Long-Term Capital Management. This event taught me that apparent stability founded on short-term borrowing and an overvalued currency is inherently fragile. Such situations represent a precarious balance, akin to walking a tightrope.

Following the collapse of the Soviet Union, Russia rapidly transitioned to a market economy. Moscow’s reformers introduced sweeping changes that attracted significant foreign investment, and for a short time, optimism among investors seemed justified. However, in August 1998, crisis struck: the government defaulted on its debts, the currency rapidly lost value, and the banking sector unraveled. Suddenly, the party was over.

Many investors incurred heavy losses, and ordinary Russians saw their savings wiped out for the second time in ten years. The situation powerfully illustrated how fragile stability can be. Many people view money as something physical, but it is just a shared story that everyone agrees with. Debt translates this shared story into future commitments, while exchange rates reflect ongoing discussions about the relative value of one story versus another. In Russia during the 1990s, all these narratives—money, debt, and the currency—were completely redefined at the same time.

The story begins in 1991 with free-market reforms that removed price controls and involved printing money to cover government deficits. This development resulted in hyperinflation, which significantly eroded personal savings as the ruble depreciated rapidly. In 1993 alone, the inflation rate exceeded 840%. To mitigate this problem, the government ceased financing deficits through excessive money printing and shifted to issuing short-term bonds (GKOs) in 1993 and medium-term bonds (OFZs) in 1995.

The policy change proved effective, reducing the inflation rate to 11% by 1997. However, due to inadequate domestic savings, the government had to rely on foreign investment to finance its debt obligations. This it did by offering high interest rates and promise of currency stability.

To back up this promise, Russia fixed the ruble’s exchange rate to the US dollar within a set band. While this stability promise made Russian bonds appealing, defending the currency peg forced the central bank to use its limited foreign reserves whenever the ruble weakened. Additionally, using short-term bonds to cover deficits meant constantly seeking new investors to replace those whose bonds were about to mature.

This strategy made the system highly dependent on continuous foreign investment, strong commodity prices, and sustained confidence in the ruble. Consequently, this created a cycle: high interest rates attracted speculators, which boosted the ruble and reinforced trust in its fixed value, drawing in even more investment and fostering a brief period of stability. Yet, underneath it all, the financial system was becoming increasingly fragile.

While the debt market grew significantly, the broader economy struggled due to low tax revenues that undermined government finances. The costly war in Chechnya further increased financial pressure, causing budget deficits to rise to 10% of GDP. Following the onset of the 1997 Asian financial crisis, investors reevaluated their positions and withdrew funds from high-risk markets like Russia.

At the same time, falling prices for oil and metals further stressed Russia’s budget, increasing deficits and reducing reserves needed to keep the ruble pegged to the dollar. Between October 1997 and August 1998, the Central Bank reportedly spent about $27 billion in U.S. dollars trying to uphold this currency peg.

Early in 1998, Russia received a $22.6 billion emergency loan from the IMF to help stabilize its economy. Nevertheless, persistent challenges such as reliance on short-term borrowing, stagnant incomes, and declining commodity profits continued to trouble the nation. The IMF’s intervention ultimately failed to resolve these deep-rooted problems, resulting in widespread panic and triggering Russia’s financial crisis on August 17, 1998.

On that day, the government and central bank issued a joint statement containing three major announcements that shook any remaining confidence in the market and triggered the crisis. The first action involved devaluing the ruble and broadening the exchange rate band, thereby formally acknowledging the inability to sustain the previous rate.

The second directive introduced a temporary 90-day moratorium on payments for specified bank obligations, including certain debts and forward currency contracts, indicating to creditors that these repayments would be deferred. The final action entailed the restructuring of domestic debt, specifically targeting GKOs and OFZs held by Russian banks and foreign investors, which amounted to an effective default.

The concurrent implementation of debt restructuring and currency devaluation led to immediate and significant consequences. Within weeks, the ruble dropped sharply, losing more than two-thirds of its value against the dollar, while prices for imported goods soared, rendering many items inaccessible to average households.

Banks with substantial GKO and OFZ portfolios suffered significant losses, resulting in widespread bank failures; numerous depositors experienced frozen or diminished accounts due to institutional insolvencies and inflation. Corporations encountered difficulties meeting wage obligations and servicing debts, and trading activity contracted substantially amidst ongoing uncertainty and price volatility.

Already burdened by hyperinflation earlier in the decade, Russian citizens witnessed another erosion of financial trust. The consequences of the crisis extended internationally, as Russia’s default reverberated through global financial markets.

Banker’s Trust, a venerable Wall Street firm, suffered substantial losses in the crisis and was eventually acquired by Deutsche Bank. Similarly, Long-Term Capital Management (LTCM), a prominent American hedge fund, became one of the most well-known victims of the 1998 Russian financial crisis. When Russia defaulted on its debt and devalued the ruble, global markets were shaken, and LTCM, which had taken on massive leveraged positions assuming continued market stability, suffered catastrophic losses.

With liabilities amounting to $100 billion, a coordinated bailout by major banks and the Federal Reserve was done to prevent systemic contagion. The crisis also exposed the vulnerabilities of emerging market economies that rely heavily on foreign capital and short-term borrowing to fund fiscal deficits. When investor sentiment shifts, these countries can experience rapid capital outflows, currency collapses, and severe economic contractions. Russia’s experience demonstrated that without adequate structural reforms and resilient financial institutions, external shocks can quickly unravel seemingly stable systems.

Russia financial crisis stands out for its dramatic atmosphere and distinct circumstances—a period marked by post-Soviet privatization turmoil, ‘mafia-style’ violence among executives, rising oligarchs, IMF interventions, and the plummeting ruble. Yet, when you look past specific names and dates, the core narrative is strikingly common: a government accumulates chronic deficits that it finances with short-term borrowing and maintains an overvalued currency to signal stability and gain public confidence.

Then, an external shock occurs, debt spirals out of control, reserves are depleted, and confidence wanes. Difficult decisions are unavoidable. Central banks rarely concede failure, so the usual outcome is currency depreciation, debt renegotiation, and relying on inflation and time to address the consequences. A default signals that existing commitments can no longer be honored as promised, while devaluation determines who bears the cost—be it domestic savers, foreign investors, or taxpayers.

Why is a crisis in a country so different from Ghana still relevant today? It is because the underlying issues remain the same. Whenever a government consistently spends more than it earns, piles up short-term debt to cover the gap, props up a currency that seems too strong for its real economy, and insists that everything is fine, you are witnessing a scenario like Russia in 1998.

At the time of its default, Russia’s short-term debt was roughly 13% of its GDP—a figure not far from our current level of 10%. Like Russia, our central bank seeks to maintain the currency within a certain range, backed by high commodity prices. The key takeaway is not that we are destined to collapse but that apparent stability based on short-term debt and an overvalued currency, is fragile at best.

Governments consistently assert that their promises are reliable, and central banks trust in their ability to handle financial challenges, yet each crisis ultimately exposes these beliefs as illusory. On August 17th, 1998; the illusion met arithmetic.

A country, hoping to escape its troubled past through borrowing and a defended exchange rate, found out just how fast trust disappears when the economic numbers no longer add up. For most people, the lesson is stark but straightforward: trust in government promises can disappear overnight. Currency pegs may break suddenly, and what once seemed stable can quickly become unstable. What endure is personal character and the ability to see through the illusion a little earlier than the crowd. But what do I know?

Gideon Donkor, an avid reader, dog lover, foodie, closet sports genius but a non-financial expert

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