Russia and the IMF: A sordid tale of moral hazard

Given all the hype about Russia simply being too big for the world to allow it to fail, and all the scary, overblown scenarios about a possible communist or nationalist backlash, or even civil war in a nuclear superpower, that had accompanied speculation about a possible ruble devaluation, it was rather logical that investors held out. After all, following the run on the ruble that took place in May-June 1998, the IMF did come through with a giant rescue package. So, based on the expectation that further bailouts would be undertaken if needed, who wanted to forego the seemingly guaranteed fantasy returns on Russian paper? When offered in July 1998 to trade ruble-denominated GKO debt for lower yielding dollar-denominated Eurobonds, most investors logically refused.

In August, however, the IMF made an abrupt about-face. Having failed for years to raise even a warning finger about the long-term viability of Russia's slash-and-burn economic reforms, the Fund suddenly decided to let everything go. The costs to those involved (including the Russians) were substantial, putting it mildly.

The most obvious reason for directing anger at the IMF is linked not to the fact that it got tough in August 1998, but to its role in causing faulty expectations. One may recall, for example, the standard rituals at the frequent Moscow meetings between the Fund's managing director, Michel Camdessus, and Russian president Boris Yeltsin, where the two men heaped praise on each other. Being courteous is one thing. But there is also a distinct risk that by overdoing the courtesy bystanders may be lured into believing that at least some of the praise does have some foundation in fact. Rather than joining in the chorus of praise for a coming Russian boom, the IMF would have been well advised to keep a low profile, to stay out of the limelight, and to adhere to its main task of financial rule enforcement.

Following the August collapse, it seemed for a while that the myth of Russia's being "too big to fail" had been effectively killed and was not likely to be resurrected. By spring, however, pressures for renewed financial support were mounting and the arguments were strikingly familiar. The consequences of allowing Russia to declare a full sovereign default would simply not be acceptable. The main problem with this type of attitude lies in the influence it has had over the way in which the money games have been played. In particular, it served to reinforce the complacency with which the Russian players reacted to the first phases of the Asian crisis. Let us therefore take a closer look at the string of events that were played out during the fateful year between the outbreak of the Asian crisis and the final Moscow meltdown.

Prelude

The prelude to the Russian crash began, as mentioned above, in Thailand, in summer 1997. The collapse of the Thai baht triggered a regionwide financial crisis, which for Indonesia in particular would have dire consequences indeed, and which soon would begin to infect more distant economies such as Hong Kong, Japan, and South Korea. Although the situation in Asia was deteriorating at a pace that was fueling fears of a global recession, on the Russian front all was quiet. Expectations were that the reform process had reached such a degree of stability that the Russian markets would be able to withstand contamination from Asia.