V The Initial Impact of the Asian Crisis on the Baltics, Russia, and Other Countries of the Former Soviet Union
- Luis Valdivieso
- Published Date:
- January 1999
Financial and Foreign Exchange Markets
Financial and foreign exchange markets in a number of the countries comprising this group have been significantly affected by the Asian crisis.16 The impact has differed widely, however, across individual countries, depending on such factors as the development and degree of international integration of domestic financial markets, preexisting economic weaknesses and policy problems, and the importance of economic links with the countries in crisis. Spillover effects from the Asian crisis have been felt in the financial and foreign exchange markets of a number of these countries, but most clearly in Estonia, Russia, and Ukraine. It was clear that in some cases, the short-term growth and inflation outlook may be adversely affected by the crisis. The extent of the deterioration, however, was expected to be contained, leaving growth in the group on a rising trend.
International Bond and Credit Markets
The Asian financial crisis has also had initial adverse consequences’ for the countries access to international bond and credit markets. In the early fall of 1997, there were several mandated international bond issues waiting to come to market from these countries. The cost of issuing international bonds after turmoil hit the markets in the early fall increased substantially. As a result, some borrowers in these countries postponed their issues or switched to the syndicated loan market. Despite these changes, however, the Baltics, Russia, and other countries of the former Soviet Union are expected to continue to be able to finance moderate current account deficits.
The ruble came under attack in late October and November 1997 as the Asian crisis intensified, and again in late January 1998.17 The pressures arose in spite of an external current account close to balance; they reflected a persistently weak fiscal position characterized by poor revenue collection, and also concerns about how the external position might evolve if the fiscal imbalance is not dealt with and about financial sector weaknesses. The authorities successfully defended the exchange rate by raising interest rates sharply, increasing reserve requirements on foreign exchange deposits, and intervening in the foreign exchange market, as well as the treasury bill market. And, as planned earlier, a new exchange rate policy was announced.18 Once the Central Bank of Russia demonstrated its willingness to raise interest rates to defend the ruble, pressures subsided allowing the rates to move to more sustainable levels. Nevertheless, there were associated steep declines in stock market prices which, despite some recovery in early February 1998. remained about 30 percent lower than in early 1997.
While 1997 appears to have brought single-digit inflation and positive growth within reach, inadequate fiscal adjustment led to increased reliance on official short-term foreign borrowing. This, combined with structural weaknesses in the banking system, heightened Ukraine’s vulnerability to adverse developments, and when the Asian crisis intensified late last year, exchange market pressures built up from the end of October, particularly as nonresidents began to reduce their holdings of treasury bills. This forced the authorities to take measures to defend the exchange rate, including a widening of the exchange rate band: increases in the refinance rate: lighter monetary conditions, which included increasing the required reserve ratio: and a shorter maturity for treasury bills offered for sale. All these measures were insufficient to stem the pressures, however, and the central bank had to intervene heavily in the foreign exchange market.19
In Estonia, where international financial integration has progressed the furthest, domestic pressures on financial markets, which had been associated with a burgeoning current account deficit as well as a steep rise in equity prices, were exacerbated by contagion from the Asian crisis. The three-month inter bank rate more than doubled during the last quarter of 1997, while the stock market, also reflecting in part domestic factors, slid more than 60 percent from its summer high by the middle of November. In mid-February 1997, interest rates remained high, and equity prices had only recovered modestly.
In the other countries, the contagion effects of the Asian crisis on domestic financial markets were limited, despite their openness to international markets and relatively large current account deficits, because domestic financial market development and integration into international financial markets are still at early stages. In Kazakhstan, however, international financial turbulence created unfavorable conditions for the launching of the stock exchange in September 1997.20
Although the Asian financial crisis has had a significant impact on some members of this group of countries, several factors appear to have contributed to the containment of spillover effects. First, these countries on the whole have accumulated relatively little foreign currency debt, and. for many of them. most foreign currency borrowing is centralized by the government. Second, the size of banking systems, capital markets, and financial systems as a whole are relatively small. At the same time, differences among these countries in the severity of interest rate and equity price movements illustrate the importance of appropriate domestic macroeconomic and structural policies to limit vulnerability to worsening conditions in international financial markets. In Russia and Ukraine, remaining weaknesses in structural and financial sector reforms: a high dependence on short-term government borrowing: and. in Russia, chronic revenue collection problems largely explain why these two countries were more severely affected by the Asian turmoil than oilier members of the group. Ii should be noted, however, that both Russia and Ukraine allowed rates to rise to defend their currencies. The Asian financial crisis exposed more fully some of these underlying problems and made more apparent the need to address them.21 In Estonia, domestic pressures, which had been reflected in a burgeoning current account deficit, and a steep rise in equity prices were exacerbated by the spillover from the Asian crisis.22