Déjà Vu All Over Again

by Martin Gilman

From my perch in Moscow, the inimitable words of Yogi Berra come to mind as I watch the economic turmoil in Ireland and the contagion effects on others that constitute the soft underside of the eurozone currency area. The sense of déjà vu is palpable.  No, I am not thinking about Greece when international bond markets turned against the sovereign debt issued by the Greek Government last May, as unprecedented as it may have seemed at the time.

Rather my thoughts turn to Russia and its now infamous default in 1998.

Of course Carmen Reinhart and Ken Rogoff in their 2009 book This Time is Different analyze cases of financial crisis in 66 countries stretching back some 800 years including problems with locally-issued foreign-currency debt.  However, countries rarely default on domestic currency debt for the simple reason that they usually have the option of printing the money needed to repay.  In fact, with minor exceptions, you would need to seek analogies harking back to the 1930s.

Russia was – until the latest attack by the bond vigilantes on peripheral eurozone members – the exception.  Twelve years ago last summer the Russian Federation defaulted on its domestic debt obligations denominated in domestic currency. The slowly unfolding financial meltdown in Greece and Ireland was not inevitable any more than the 1998 economic crisis in Russia. But a combination of an unsustainable budget policy, weak government and some bad luck – including the contagion from the Asian crisis — was enough to provoke the financial markets to abandon Russia in droves in 1998. A slightly different combination of circumstances seems to be conspiring to erupt in a financial collapse on the fringes of Europe in the near future.

The parallels with Ireland and Greece are striking.  As in the case of Russia, they and their banks took advantage of a benign global environment to issue large amounts of debt on the local market on the assumption that it could always be rolled-over; the securities were issued in local currency; among the largest buyers of the sovereign securities were domestic and foreign banks; and the International Monetary Fund was called in to do the heavy lifting once trouble developed.  The next steps in the drama, if the Russian script is followed, would be larger and more extensive “bail-out” packages announced to an ever more skeptical bond market in the absence of sufficiently convincing austerity policies to restore financial discipline.  Even then it is likely that the bond markets will persist in the belief that European politics would never allow a default until it actually happens – whatever it is actually called.

Although Russia’s default on its domestic ruble-denominated debt in August 1998 may differ in some respects from what is happening in Greece and Ireland — every debt crisis has its own unique characteristics — they share some key features that warrant attention. The critical point is that their debt dynamics, as with Russian GKOs, or treasury bonds, in the early summer of 1998, are probably beyond the point of no return. If the Russian precedent is valid, then the latest European bailout packages, announced with much pomp, in conjunction with resources from the International Monetary Fund, will only postpone their default.

In the Russian case, access to easy credit quickly led to an unmanageable pile of debt. As debt grew, the credibility of fiscal policy to generate tax income was increasingly put in doubt. For Russia, the use of financing from the GKO market was intended to sustain economic growth while a proper tax system was created. But that didn’t happen — at least not until after the crisis forced a strong dose of reality upon the country. As one London-based investment banker told me in July 1998, after a $22 billion IMF-coordinated bailout had been approved, “Investors no longer believe that they are bridging [their loans] to future tax receipts.”  

Back in 1998, Russia already had an IMF program that was seen by many market participants as an implicit guarantee that the major powers would not let the country fail, especially considering its large territory and nuclear arsenal. Under that program, the Russian government was supposed to reduce its budget deficit in exchange for financing to cushion the shock of economic adjustment. But political reality impeded the implementation of the agreed-upon program, and revenue targets were consistently missed.

Of course, Greece and Ireland have two advantages over Russia in 1998: they are members of the eurozone and can benefit, however reluctantly, from massive support of their partner countries; and the world has a generally positive disposition toward them.  However, they also have the euro as an albatross – devaluation is not an option as it turned out to be for Russia (they can only act in conjunction with the other 14 members of the eurozone).

All of this is reminiscent of Russia in 1998. As described in my book, No Precedent, No Plan, in August 1998, the Russian Government chose default as presumably the lesser of two evils (the other being monetization of the debt) because it did not want to risk an inflationary explosion.  The devaluation of the ruble that followed in the aftermath was not immediate, but effective by the end of 1998 in helping the economy to recover its competitiveness.

The choice faced by the eurozone periphery members is more stark.  They can either default or deflate. In both cases a critical role is played by the IMF, often behind the scenes.  As we learned the hard way in the case of Russia, the IMF can help with money, advice, and public confidence, but in the end it can only help to buy time.  Greece and Ireland, unlike Russia, would be advised to use it well if it is not already too late.


About the Author:

Martin Gilman is Professor of Economics at the National Research University — Higher School of Economics and the Director of its Centre for Advanced Studies, in conjunction with the New Economic School, in Moscow. Previously he was with the International Monetary Fund for 24 years where he was assistant director in the IMF’s policy department.  His extensive experience with Russia began as the adviser from the policy department on the negotiating missions from June 1993, and then he moved to Russia in November 1996 as the director of the IMF’s Moscow Office.  Along with his close involvement in the Russian economy and policy issues for well over 14 years, he is married to Tatiana Malkina. They have two children.

In addition to his Ph.D from the London School of Economics, Gilman attended the Institut d’Etudes Politiques, Paris, the School of Advanced International Studies of the John Hopkins University, and the Wharton School of the University of Pennsylvania.