August marks the 25th anniversary of the baptism of fire that the economy of the young Russia’s went through: the 1998 economic crisis. Invest Foresight talked to Alexander Abramov, Head of the Laboratory for Analysis of Institutions and Financial Markets at the Russian Presidential Academy of National Economy and Public Administration, about what is a default today, whether it can happen in Russia, why it is bad and – however strange this may seem – whether there are positive aspects of a financial crisis.
– August marks the 25th anniversary of the 1998 sovereign debt default. What lessons has Russia learned from it?
– The 1998 default was caused by the unbalanced budget. Since then, Russia has established the Stabilization Fund and then the National Wealth Fund as its successor.
The first thing that Russia learned after that memorable crisis was that under any circumstances, the finances, especially the budget, must be stable. This was the first thing.
Second, a budget rule was developed to that end as the main mechanism of ensuring budget stability by putting restrictions on unscheduled expenditures.
I believe that another very important conclusion that Russia made then was that the currency exchange rate should not be fixed or even partly fixed but must fluctuate depending on the market demand and supply. That is, the transition to the floating exchange rate of the ruble, which actually happened only in 2014, was a major and important lesson that Russia and its financial regulator learned from the 1998 default.
– Since February 2022, Russia has been repeatedly told that it would face a financial crisis due to various reasons. Is this scenario real?
– This is an open question, so to say. It would be wrong to say for sure that a currency crisis in Russia is unreal. The attitude to it has changed; at least we see that Russia, as regards foreign debt due to the sanctions and due to the fact that banks stopped transferring currency, could have announced the default on the Eurobond debt as far back as June 2022.
However, Russia has made huge efforts to avoid the crisis. Everyone who is supposed to receive money, do so. It shows that the level of Russia’s responsibility as a state has grown a lot, and even the mildest suggestions that the country might fail to fulfill its obligations are not accepted.
So I think that obviously neither sovereign nor foreign debt default is currently possible. Yet, this should in no way let our guard down as regards financial stability as we see financial issues accumulate in the country, regardless of the current developments. These include budget expenses, low and insufficient incomes as well as restrictions in the production of goods required for covering money supply. So I’d say we should stay alert to the risks.
– Are there any reliable ways to avoid a default?
– First, the government should manage budget through strict methods. Second, the government should borrow mostly in the national currency – that is, the one that would make a default essentially impossible. In case the government borrows in foreign currency, the national currency exchange rate should be free-floating to avoid accumulated contradictions that could suddenly spill out onto the market causing its imbalance.
– Is default really that bad? What about a saying, “I forgive my debt”?
– Default is bad. Just to recall, with the 2001 international sovereign debt default in Argentina, it took roughly 12 or 13 years for the country to return to the borrowing market.
– But is it bad living on your own finances?
– Living on your own is not bad, it is simply not very reasonable. If you are willing to grow and do it in consistently, you should still aim to borrow at reasonable interest rates. In other words, any growth is associated, to a certain extent, with increased borrowings and financing these efforts through debt obligations. In this case, it is essential both for business and for the government: you cannot develop through insufficient finance.
If someone is seeking to purchase a home or an apartment, they do borrow money. If we had no mortgages, would we have much housing built in Russia?
– So, a default is ultimately a bad thing?
– At the national level it definitely is, because it leads to worse borrowing conditions for all businesses. And yet, particularly in the foreign market, investors have a very long memory – which results in the general lack of opportunities for borrowing at good interest rates and under good conditions.
Domestically, a default obviously produces a lot of negativity. The 1998 sovereign debt default in Russia caused a loss of trust in finance and banks one way or another; people would rather choose to deposit money only under government-provided safety guarantees. 25 years later, people still remember about this crisis. To recall, prior to 2002, banks had much difficulty in attracting deposits. Today, we can make deposits with ease, which directly results from government guarantees. So, any default is bad domestically as well: this simple example shows that it cost a lot of effort for the economy to restore citizens’ trust in the banking system and the domestic financial system.