The financial turmoil originating from the U.S. subprime mortgage crisis hit Russia by early September 2008, prompting the Russian government and the Central Bank of Russia to undertake a set of speedy and concerted measures to soften the impact of the crisis. These initial measures supported the value of the ruble as ruble holders, domestic and foreign, switched to dollars. They also provided hard currency to major Russian banks and Russian big business (the so-called oligarchs) which had borrowed heavily from foreign banks for their expanding operations from 2000 to 2007. (1)
As the crisis unfolded, the Russian central bank's policy choices for unlocking the credit crunch and reviving the declining economy were constrained by a double-digit inflation rate in 2008. At the same time, the Ministry of Finance faced a high budget deficit as tax revenues from oil export earnings steeply declined from the end of 2008. In short, the Russian economy faced a negative growth rate and a significant budget deficit in 2009, a sharp reversal from their sustained positive record from 2000 to 2007.
SYMPTOMS OF THE CRISIS
The initial severity of the crisis was underlined by a series of indicators. By mid-October 2008, the Russian stock market (Fig. l) had plummeted by 70 percent from its May peak. Its fall was accelerated by nervous foreigners discarding their ruble-denominated assets following the Russian-Georgian war of early August.') The Russian ruble had also declined by 14 percent against a combined dollar/ euro basket since mid-July (Fig. 2). The foreign exchange reserves of the Russian central bank had dropped to $484 billion from approximately $600 billion (Fig. 2) although they still remained the third largest in the world after those of the central banks of China and Japan. (3)
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The plunging stocks severely threatened the financial fortunes of Russian oligarchs who had borrowed heavily from western banks to expanding their businesses, offering their company stock as collateral. (4) The plummeting stock market, however, had not affected ordinary Russians because they did not hold stocks as American households do (although labor layoffs by the troubled companies had begun to have an effect). But the declining ruble had the Russian populace worried. Toward the end of the year, currency exchange booths in Moscow began facing demands from Russians wanting to convert their rubles into dollars and euros. Marketing surveys of the period also report that the Russian middle class, including those who could afford to buy household appliances and mobile phones, had shrunk for the first time in a decade, from 25 percent to 18 percent of the population. (5) According to a report by Russia's Interior Ministry, 5.5 million Russians had demonstrated in 30,000 protests during 2009. (6)
INITIAL REMEDIAL MEASURES
By the middle of October 2008, the Russian central bank and government sources had earmarked up to $200 billion to stabilize the situation and contain the outflow of dollars from the economy. The stabilization measures included out right purchases of plunging stocks (in the amount of $20 billion), capitalization of selected banks, and financial support (of up to $50 billion) to companies owned by Russian oligarchs who had scrambled to raise cash in order to meet margin calls. (7) A significant amount of cash had been assigned (about $36 billion) to the two largest state-owned banks, Sberbank (the savings bank) and Vneshekonombank (the foreign economic bank). (8) The total proposed bailout, estimated at 13 percent of GDP, was the largest bail out among the G-8 member countries. (9) It was substantially higher in terms of national GDP than the U.S. stimulus package (amounting to $787 billion) adopted by Congress, which was 5.5 percent of U.S. GDP.
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The Central Bank of Russia continued offering dollars in exchange for the continuing flood of rubles in the foreign exchange market (as rubles earned from the sale of ruble-denominated assets were converted into dollars which were then whisked out of Russia). …