Financial report

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Case Study

financial report1.1 RUSSIA 

financial report 11.2 EXCHANGE RATE BACKGROUND: 

Bretton Woods system was developed by John Maynard Keynes to respond towords economy instability and inflexibility through IMF. The systems did well till the 1960s. In the 1970s, Russia was a member of Soviet Union with an economy that was centrally planned with fixed interest rates. According to Rabobank (2013) after the breakdown of the Bretton Woods system, Russia continued to use the fixed rate in interests despite the majority of other countries adopting a free-floating exchange rate. In 1991, Russia experienced a breakdown of Soviet Union due to external debt buildup, concentration on the public sector and the failure of reform policies. In 1993, the external debt/export ratio was 36% and continued to rise in the coming year. According to Shapiro (2014), the high inflation rate led Russia to adopt crawling peg regime to cab this problem. In 1997, there was Asia financial crisis, and Russia decided to sell foreign reserves to defend Ruble value. As a result, Russia experienced significance decrease of the foreign exchange reserve. Also, drop in the oil prices and domestic fundamentals such as reduced tax collection further worsened Russia budget causing the country to rely on exports to gain foreign currency earnings. The outcome was slow depreciation of exchange rate causing overvaluing of the currency.

According to Weisbrot (2001), the IMF helped Russia by giving them large loans with high-interest rates to sustain overvalued currency. Due to this, the Central Bank of Russia devalued its currency. As a result, currency markets broke down due to the fears of investors that Ruble would devalue. As the figure below shows between 1997 -1998, Russia experienced a sharp drop in the stock market.

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In 1998, Russia adopted free-floating exchange rate causing a steady depreciation of currency as the figure below shows.

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The reason for the depreciation is due to the declaration of a moratorium on the foreign debts and defaulting on domestic debt. According to Robobank (2014), the prices increased from 27.6% to 85.7 between 1998 -1999 due to a sharp decline in the currency. The fall of rumble led to a restructuring of monetary policy by implementing tax returns, privatization and restructuring of international trade policy (The World Bank 2010).

According to Shapiro (2014), Russia experienced greater capital flow due to the price increase of oil, and low Ruble value resulted to high production and export of oil in 2005-2008. Russia increased the money supply due to currency appreciation causing inflation and high exchange rate leading to the less competitive environment. In 2008, Russia experienced less export revenue while the oil prices decreased leading to account deficit. Therefore,
Bank of Russia decided to control the currency depreciation and at the same time raise interest rates.

In 2011, the central bank reserves growth declined that meant there was no adequate demand for Russian currency from investors and exporters. Also, in 2012-2013 Russian banks and companies borrowing rate from abroad increased.

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In 2014, the investors sold their assets causing a decline ruble value. Russian rubble collapse in 2014 was due to fall of oil process. Russia major export is crude oil which fell by almost 50% from June to December 2014 as the figure below shows. The Russian debt increased significantly and as the figure below shows, investors do not have faith in the economy.

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Also, the economic sanctions due to Russia military involvement in Ukraine and annexation of Crimea further contributed to the breakdown of Russian Rubble. The crisis affects companies, consumers, and regional financial markets. The stock market declined by 30% from December 1st to 16th in the RTS index. According to Kitroeff &Weisenthal (2014), the liquidity trap and central bank unconventional events have caused investors to pursue greater interest regarding debt they are holding within the emerging market. The result has
caused Russian companies increase debt issuance in the foreign currency-denominated terms. The debt payment issued in strengthened foreign currencies
creates added costs to Russian companies while repaying the debt. As the figure below shows Russian ruble devalued by more than 50% from July 2014 to March 2016.

Official exchange rates RUB/USD and RUB/EUR established by the Bank of Russia

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financial report 81.3 ISSUES ARISEN IN THE IMPOSSIBLE TRINITY 

Russia tried to accomplish the three- policy objectives concurrently while ignoring principles of the trilemma. Russia has not been able to accomplish its aims as of flexible currency due to the frequent crash of currency. Russia adopted crawling peg system that entailed fixed interest rates. Crawling peg system results to slow appreciation and depreciation of exchange rates. The method enhanced monetary independence as Russia controlled currency and interest rates in favor of investors hence attracting investments in the country (Shapiro 2014).

Russia focus was to accomplish capital market integration through the removal of controls on the purchase of securities that limited investors who did not belong in the country. However, the IMF borrowing restrictions and the overvaluation of Russian currency caused hindrance on buying government securities. Therefore, Russia instead removed capital restrictions and increased interest rates to invite foreign investments. The results were not pleasing as short-term and not long-term investors dominated the market. Short term investors left on the reduction of liquidity (University of Essex, 2014).

financial report 91.4 RUSSIAN CURRENCY CRISIS: 

In 1991, the high buildup of debt and policy failures led to a weakening of the economy. The results were high inflation causing Ruble to lose value. In 1997 when there was a financial crisis in Asia, Russia decided to sell foreign resolve to defend Ruble but instead worsened the overall budget leading to an overreliance on exports. In 1998, Russia experienced financial crisis where the country failed to restructure its economy leading to high government debts and overvaluation of Ruble. Due to uncertainty, residents resulted in capital savings using foreign currency due to more favorable conditions. The Russian government collected less tax due to IMF restrictions while running bureaucracy taxation that led to corruption. The overreliance of oil export which its prices fluctuated regularly led to the vulnerability of the Russian currency (Kitroeff &Weisenthal, 2014).

The increase in interest rates due to IMF restrictions and alternation of country restrictions to suit non-residence shows the overreliance of Russia on foreign investors. The increase in interest rates invited short term investors instead of long-term investors leading to liquidation of companies at unfavorable times. This led to deteriorating of fiscal consolidation and slow economy recovery. The overreliance of capital inflows significantly contributed to the currency crash as investors investments and withdraw of capital investment determined Russian economy (Kitroeff &Weisenthal, 2014).

The liquidity trap and Central Bank
unconventional events which resulted in investors’ interest in holding debt led to foreign currency dominated terms hence strengthening foreign currency and adding cost to Russian companies. This resulted to the devaluation of Russian currency and increased in volatility due to foreign currency dominated conditions (Kitroeff &Weisenthal, 2014).

financial report 101.5 Conclusion

In conclusion, IMF provided Russia with structural reform program to restructure domestic debt during the financial crisis. The IMF acted by suspending its payments forecasted in the damaged agreement. However, IMF agreed to collaborate with Russia as soon as the government started reforming the economy. Currently, Russia is using managed float exchange process where Central bank role is to intervene on excess instability in the exchange rate. It is evident that Russia is trying to increase the flexibility of currency in recent years to achieve a free-floating exchange rate possibly.

financial report 11REFERENCES 

Eiteman, D., Daly, K., Rath, S., Stonehill, A., and Moffett, M., (2011) Multinational Business Finance, Pearson Addison-Wesley, NSW. Ch 2.

Kitroeff, Natalie; Weisenthal, Joe (16 December 2014). Collapsing»«Here’s Why the Russian Ruble Is .Businessweek (Bloomberg). Retrieved 17 December 2014.

Rabobank,
 (2013).
 The
 Russian
 Crisis
 1998.
 [online]
 Available
 at:  https://economics.rabobank.com/publications/2013/september/the-­‐russian-­‐crisis-­‐1998/  [Accessed
 11  Sep.
 2014].  

Shapiro, A., (2014) Multinational Financial Management, 10th edition, John Wiley & Sons, New Jersey. Ch 3.

Weisbrot,
 M.
 (2001).
 International
 Herald
 Tribune.
 [online]
 Available
 at:  lmthf.miveih/arcmo.cxatrimndaagaoprp.www://ptth
 [Accessed  2

 Sep.
 2014].  

Case study