Russia's Domestic Debt Default - What Greece Can Learn

 

Martin Gilman, author of the forthcoming No Precedent, No Plan shares some of his thoughts on the recent financial crisis in Greece. 

The economic turmoil unfolding in Greece, as financial markets turn against the sovereign debt issued by the Greek Government, seems unprecedented.  Of course Carmen M. Reinhart, Kenneth 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.

Greece is different though in at least one key respect – the sovereign debt in question is not foreign debt or foreign-currency debt, but rather domestic debt issued in its domestic currency.  Countries rarely default on domestic currency debt since they usually have the option of printing more money.  In fact, with minor exceptions, you would need to seek analogies harking back to the 1930s.

However, one such example happened in our recent past.  Twelve years ago this summer the Russian Federation defaulted on its domestic debt obligations denominated in domestic currency.  The parallels are striking.  Both Russia and Greece took advantage of a benign global environment to issue large amounts of debt in the local market on the assumption that it could always be rolled-over; the issues were in local currency; among the largest buyers of the sovereign securities were local and foreign banks; the International Monetary Fund was called in to do the heavy lifting once trouble developed; larger and more extensive “bail-out” packages were announced to an ever skeptical market in the absence of convincing austerity policies to restore financial discipline; and the markets persisted in the belief that politics would never allow a default until the inevitable actually happened.

Of course, Greece has two advantages over Russia in 1998: it is a member of the Eurozone and can benefit, however reluctantly, from massive support of its partner countries; and the world has a generally positive disposition toward the country.  However, Greece also has the Euro as an albatross – devaluation is not an option as it turned out to be for Russia (Greece can only act in conjunction with the other 15 members of the Eurozone) . 

As described in my forthcoming 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 Greece is more stark.  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, unlike Russia, would be advised to use it well.