In 1997 the Central Bank of Russia continuedimplementing policy of flexible maintenance of liquidity through the “discountwindow” in the framework of tight control over the increment of the moneystock. In particular, the policy of placing custody credits against securitiesgranted on GKOs on a fixed interest rate was continued. “Discount window”gradually becomes a dominant channel for maintaining the required liquidityratio of the banking system. Average weighted interest rate on custody creditsagainst securities during the first half of 1997 was substantially less thanthe CBR's refinancing rate. The latter constituted in February - April 42 percent and was decreased on April 28 down to 36 per cent, on June 16 - to 24 percent, and on October 6 - to 21er cent. On May 1, 1997, the Central Bankchanged norms for required reserve ratio for the commercial banks on rouble andcurrency deposits. In particular, the reserve ratio was lowered on roublecheckable deposits and time deposits for 30 days from 16 per cent down to 14per cent (20 per cent in June 1996), on deposits from 31 to 90 days - from 13per cent down to 11 per cent, from 91 days and longer - from 10 per cent downto 8 per cent. The reserve ratio on the banks foreign currency liabilities wasraised from 5 per cent to 6 per cent. These measures were designed to convergethe required reserve ratio on foreign exchange and rouble deposits. Note thatthe reduction in the reserve ratio was taking place simultaneously with therevision of the refinancing rate and reduction in custody creditrates.
Crisis on the international financial marketswhich broke out in October was provoked by the devaluation of currencies of thesouth-east Asia countries and led to a significant destabilisation ofRussia’s financialmarkets. In those circumstances, the Central Bank of Russia imposed a number ofmeasures designed to avert speculative runs on the rouble and support the statesecurities market. A decision was taken to raise the refinancing rate from 11November 1997 from 21 per cent to 28 per cent (Fig. 6). Moreover, the requiredreserve ratio on foreign currency deposits was raised from 6 per cent to 9 percent and rates on custody credits were reduced down to 22 per cent annual forthe period of up to 7 days, to 25 per cent for the period of between 8– 14 days, and to 28per cent for a period of between 15 – 30 days.
The imposed measures allowed to avert therouble devaluation which was fraught with catastrophic consequences for thewhole Russian finance system.
External causes for the Russianfinancial markets crisis
During the whole of 1997, the situation ofthe world currency and stock markets remained quite unstable. For example,growth of Japanese stock market index from April till June 1997 led to anincrease of capital inflows to Japan which already in May resulted in thegrowth of Yen exchange rate with respect to the US dollar by 12 percent.
Dramatic for developed economy increase inthe exchange rate of the national currency considerably undermined competitiveadvantages of the majority of Japanese companies. In circumstances of theexport-oriented economy that means a decline in the average profit rate ofcompanies. That is why, in the second half-year growth of the stock marketindex changed for reverse. For example, from August to December the fall of theTokyo stock exchange Nikkei - 225 index amounted to about 30 percent.
Price movement through time for the sharesof the Japanese companies have influenced the economic outlook of the wholeAsian region. Figure 7 shows that Hong-Kong and South Korea stock exchangeindexes were behaving similarly. For example, coefficient ratio of Japanese andKorean stock exchange indexes made up 0.88 for the period from January toNovember 1997.
The change in the Hong-Kong status inmid-1997 determined a higher level of fluctuations on its stock exchange.Financial problems experienced by a number of largest local companies and bankstogether with an uncertain political outlook considerably raised the investmentrisks. Precisely the change in the status of Hong-Kong became a parting pointfor revaluation of the assets on world markets. General price decline from 7August 1997 till mid-December in the stock market of Hong-Kong made up about45per cent.
Note: here and further on, the indexrates for 1.01.1997 are taken as benchmarks. Figures 7,8 and 9 show incrementrates in absolute value.
The fall of the stock exchange index inHong-Kong, Japan and other Asian countries accompanied with the devaluation ofnational currencies put in question expectation for further economic growth inUSA which has close trade and financial ties with that region (Fig. 8).Moreover, the outflow of capital from the developing markets started, and onOctober 28 the crisis reached all stock markets world-wide. In particular, onOctober 28 the Dow Jones Industrial Average fell by 554.51 points(decline constituted 7.18 per cent) down to 7160.9.
Such sharp reaction of the US stock marketto the changes in the Asian region was unlikely half-year before theaforementioned events. However, continued from April to August growth of theDow Jones Industrial Average guaranteed mainly by price increase of thetechnology-intensive companies have already ended. By autumn 1997, manyobservers started to evaluate the existing level of quotations as overvalueddue to increased inflationary expectations in the US. Intention of the FederalReserve Board to increase the interest rate with the first signs of inflationmade many global funds risk managers to redistribute the investment portfolioin favour of an increased share of the European bonds. Demand on shares of theEuropean companies grew from the second half of 1996 till August 1997.Moreover, the fall of quotations on shares in the European stock markets wasless noticeable than in Asia and USA.
The redistribution of capitals on the worldscale was caused not only by a desire to withdraw money from the risky markets,but by the speculative interests as well. Large international investment fundswhich dominate the majority of the developing markets have organised aco-ordinated play a bull which have resulted in the fall of the stock exchangesindexes by the volumes close to the Hong-Kong volumes.
Such reaction of thelarge Western investment funds is explained, mainly, by their aspiration toavoid the Mexican variant of the financial crisis. The Mexican crisis inDecember 1994 was caused by different factors. Among them, one should identifyespecially the rapid increase in the external debt which had reached 7.4percent of the overall external debt of all countries with developingmarkets (US$1.6 trillion)3.Nevertheless, the financial crisis scheme remained unchanged: massive outflowof the external capital poses a threat for the devaluation of thenational currency and the foreign institutional investors active on theinternal market strive to sell their assets in a given country and fix obtainedprofits. That way, the crisis is spreading to all segments of the financialmarket.
Precisely this explains significantpost-crisis adjustment of the prices for shares resulting from a large numberof transactions. As an example of such situation, we can analyse dynamics ofindexes of two countries with similar credit ratings. Nevertheless, as can beseen from Figure 9, despite similar credit ratings of both countries, theRussian stock exchange is less stable and less liquid than the Brazilianone.
The measures introduced by the Central Bankwere, to a certain extent, justified and allowed to avert the development ofcrisis processes. In contrast with the majority of countries who suffered fromthe crisis, Russia managed to avoid a combination of interest rates growth anddevaluation of the national currency. When there exist macroeconomic conditionsfor undermining the currency market--inflationary money supply, negativebalance for the current transactions, low currency reserves, bank crisis,etc.--the currency crisis is inevitable. When speculative runs start which arecaused by such fundamental factors, it is impossible to change anything. Anyattempts aimed at strengthening regulation over the currency market only resultin the growth of the illegal outflows of capital.
In Russia, fortunately, these fundamentalcauses have not reached the critical mass. The macroeconomic situation inRussia in 1997 by itself could not provoke the currency crisis. The monetarypolicy was not inflationary despite a considerable growth of the money stock.The latter was dictated by an increase in demand and was supported by growinggold and currency reserves. The position of Russia in the external creditmarket has somewhat improved. The currency policy was allowing to maintain thejustified price proportions of the external trade turnover. The Central Bankmeasures aimed at prudential regulation of the banking system have contributedto a reduction of the possibility for a new banking crisis in case thestock market collapses.
Theoretically, the Central Bank of Russia hadat its disposal a rather wide choice of possible anti-crisis measures: 1)maintaining control over the currency market, refusing to take any adjustmentmeasures in the GKO market, thus allowing this market to adjust to a newequilibrium itself with a higher interest rate; 2) devaluate the rouble by20-30 per cent, thus averting a sharp increase in GKO yield; 3) increase theinterest rates, thus preserving the existing currency policy; 4) carry outpartial devaluation supplemented by an increase in the interest rates; 5)formally refusing to take any measures directed at changing the interest rateand the exchange rate, to provoke the collapse of the stock market to the levelof May 1997, thus reducing a potential demand for the currency fromnon-residents who wish to leave the stock market and strengthen, at the sametime, GKO-OFZ market.
However, all measures which envisaged anydevaluation of the rouble were politically and economically unacceptable.Attempts of direct and indirect manipulation with the rate of government andcorporate equities, being politically acceptable, were extremelyrisky.
Evaluating the CBR’s decision envisaged atincreasing the refinancing rate, one should take into consideration, on the onehand, that by that moment many countries, who were involved in the crisis, hadalready raised the interest rates, and that measure became the main instrumentin competition between the monetary authorities of different countries forinternational capital. On the other hand, the increase of the refinancing rate,which entailed the growth of the interest rate in the government securitiesmarket, has provoked a redistribution in favour of the state securities marketassets at the expense of the stock market, thus exacerbating itscollapse.
The fact that the banking system suffersconsiderable unanticipated losses becomes the main consequence of the financialcrisis4. A significant part of bank assets, which previously guaranteedhigh profits, constituted instruments which were mostly devaluated as a resultof the financial crisis: corporate shares, GKO-OFZ, European bonds, internalcurrency bonds, debts to the London club. At the same time, shortage ofliquidity which became acute during the crisis forces the banks to increase thesupply of the devaluating assets which increased the decline of thecorresponding quotations. All that has brought about the first sings of thebanking crisis: a number of banks failed to honour obligations on payment andsupply of securities. There were demands for advance payment on the contractsin the financial markets.
In relation to that, drafting of the newmonetary policy should include a higher possibility for a banking crisis. Itshould be noted, that in December 1997, the Central Bank of Russia stressed itsintention to increase the choice of the applied monetary instruments whichrefer to short-term crediting of the commercial banks. In particular, itenvisaged to start offering the banks different types of secured credits. As acollateral for the CBR’s credits, government bonds included in the Custody list areaccepted. Market value of such bonds adjusted by the correction factor set bythe Central Bank will represent a credit limit for a working day. In additionto the already existing custody credits against securities, the Central Bank ofRussia is planning to extent intraday transaction credits and day crediting oncustody of securities blocked on the DEPO bank accounts.
Inflation forecast for1998
Given forecast is based on the followingpremises. First, parameters for the growth rates of the money stockM2 (they are within thelimits of 1.7 per cent-2.2 per cent of monthly increment; 22 per cent and30 per cent annual correspondingly) fixed by the Joint Declaration of the RFGovernment and the Central Bank in Maindirections for the single state monetary policy for 1998 will be maintained. Second, increment of the real GDP isenvisaged at 1per cent.
This forecast model is based on theregressive equation of the following type:
where – polinome weight,
– weekly change of consumer pricest,
mt –decimal log of a monthly change of the money stock rate M2, evenly spread overthe weeks of a corresponding month,
Yt –monthly change rate of the real GDP, evenly spread over the weeks of acorresponding month,
c – intersept, – the residuals ofregression,
n – lag depth, equal 47 weeks, i– lagnumber.
Table 2 shows the statistical estimates ofthe given regression equation. Figure 10 gives distribution of the incrementrates of the money stock.
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