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Thursday, December 31, 1998 Published at 18:34 GMT

Business: The Economy

Red-letter year for Russia

Russia's 1998 financial meltdown hit the people hard

Russia stands at the crossroads as it enters 1999, its conversion to a capitalist economy under a cloud after the country's financial system went to the brink during 1998.

And in turn, the near-financial collapse of Russia's economy in 1998 helped push the world economy as close to the brink as it has been since the Great Depression.

When the Asian crisis spread to Russian markets, it appeared Latin America might follow and plunge the whole world into financial meltdown. However, concerted action by leading industrialised nations and the International Monetary Fund stopped the rot.

But it's the Russians that have felt the brunt of 1998's market mayhem. Inflation was 84% over the year, the economy contracted by 5% while 29% of the whole population - that is 42m people - now live below the poverty line, earning $28 a month or less.

[ image: Primakov: PM no.3 in 1998]
Primakov: PM no.3 in 1998
Seven out of ten Russians don't expect their lives to improve in 1999, despite the government's pledge to resurrect the economy.

Prime minister Yevgeny Primakov has conceded that little has improved since he assumed office in September but he has pledged that the economy will be turned around in the coming year. "We are not magicians. We cannot make the country economically prosperous in only a few months. But we must do it."

The declining health of President Boris Yeltsin has not helped with many believing he has surrendered much of the responsibility for running the country to the prime minister.

Anatomy of a meltdown

The Asian crisis had spilled over to Russia by March '98 as exports fell and the government ran out of money. President Yeltsin responded by sacking prime minister Viktor Chernomyrdin and his cabinet and appointed Sergei Kiriyenko - a 36 year-old unknown.

The new government failed to halt the slide, unable to win the confidence of the markets. The stockmarket fell and the state-controlled rouble exchange rate came under pressure as Western investors pulled out. But the worst was yet to come.

In July, the IMF outlined a $22bn loan package to bail out the government - but only if Russia agreed to tough austerity measures.

Soros speaks, Russia shakes

Alarm turned to crisis when the billionaire financier George Soros warned that the turmoil in Russia's financial markets had "reached a terminal phase." His prophecy became self-fulfilling as the markets crashed in August.

[ image: Soros: Prophet of doom]
Soros: Prophet of doom
Drained of hard currency reserves, the government was forced to abandon the rouble's pegged trading range around 6.3 to the US dollar - effectively allowing it to devalue at the mercy of market forces.

And devalue it did, rapidly losing 70% of its value against the dollar, despite the fact that trade on the currency exchange was halted several times. For a while there were just no buyers.

Street panic

On the streets the real exchange rate went well above the official rate with some paying 25 roubles or more for one US dollar and flocking to the banks to withdraw their rouble savings. Meanwhile, inflation ran rampant as buyers and sellers lost confidence in the rouble.

[ image: The rouble loses 70% of its value]
The rouble loses 70% of its value
Russia's main stock exchange hit an all-time low at around 50 points in September. Only a year before the RTS index had stood at around 570.

An early casualty was central bank chief Sergei Dubinin who stepped down because of the Communist-dominated parliament's frustration over his efforts to tackle the crisis.

Adding to those problems, the IMF withheld the first tranches of its loan package, saying there was not yet clear proof that the new government was trying to cut spending and raise revenues to balance its books.

Yeltsin sacks prime minister - again

In late August, President Boris Yeltsin reacted by sacking the Kiriyenko government in favour of former prime minister Viktor Chernomyrdin. But parliament refused to endorse him and the political stand-off was only resolved when former foreign minister Yevgeny Primakov emerged as a compromise candidate.

Mr Primakov said he would resort to printing money in order to pay state workers, some of whom hadn't been paid on more than a year. He said the government planned to pay off its wage debts to state workers before the end of 1998 and to the military by the end of January 1999.

He said the debts owed to pensioners could not be paid until the end of 1999 and admitted the government might need to print even more money to cover those debts. In a bid to ease fears of ensuing hyperinflation, he insisted the amount of new roubles would be "very insignificant" and a "controlled emission".

Banking crisis

1999 will see an enormous shakeout of the Russian banking system, with half the country's 1,500 institutions expected to slide into bankruptcy, according to the Russian central bank.

Russia's central bank has already revoked the license of Inkombank after it effectively went into liquidation as a result of the financial crisis. Oneximbank and Tokobank have since suffered the same fate.

The pressure on banks is immense. Much of the foreign debt of banks, as well as the government and private firms, was denominated in hard currency. As the rouble fell, buying the dollars and Deutschmarks to service the debt got ever more expensive. The price of foreign currency commitments sky-rocketed.

The government tried to protect those hit hardest, buying them time by announcing a unilateral 90-day moratorium on debt repayments. The freeze has now expired and those creditors want their money back and may well go to court to get it.

Meanwhile, the government also defaulted on its own debt, refusing to honour its repayment commitments on GKO treasury bonds to both foreign and domestic bond holders.

This hurt Russian banks as much as anyone else, because they are large holders of these bonds too. The government's action wiped out a large share of their assets.

The prognosis

The passing of a tough austerity budget just before Christmas holds hopes of bringing the economy back under control in coming months and securing further emergency funding from the IMF.

The government's hopes of resurrecting the economy also depend on the success of the central bank's plan to rehabilitate the banking system. It plans to bail-out the biggest and most important of the troubled banks while allowing up to 700 to go bankrupt.

But this is a high-risk strategy. Such wholesale collapses may result in a further crisis of confidence in the financial system.

The New Year begins with fingers crossed - among the Russians themselves as well as thousands of Western bankers and investors.

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