Question

Russia and South Korea experienced exchange rate crises in the late 1990s, but their response was markedly different. First, Russia experienced a dramatic decrease in the value of the Russian ruble relative to the U.S. dollar in 1998. The Russian government responded by suspending payments on foreign debt. Similarly, South Korea experienced a decrease in the value of the won in 1997. In contrast, South Korea did not default on its debt.

Why might these two countries have behaved differently in response to their respective crises? What are the benefits of default? What are the drawbacks?

Answer 1

The Russian financial crisis also known as Ruble crisis had struck Russia on 17 August 1998 and it resulted in the Russian government and the Russian Central Bank defaulting on its debt and devaluing the ruble. The crisis also impacted the economies of many neighboring countries.The reasons which led to this crisis were declining productivity, a high fixed exchange rate between the ruble and foreign currencies, and a chronic fiscal deficit. The Russian government declared a moratorium on repayment of foreign debt.

Russia recovered from the August 1998 financial crash with surprising speed since the world oil prices rapidly increased during 1999–2000 and Russia ran a large trade surplus in 1999 and 2000. Moreover, the domestic industries, such as food processing, had benefited due to devaluation, which caused a sharp increase in the prices of imported goods.The economy had been helped due to infusion of cash. Since the enterprises were able to pay off debts in back wages and taxes, so the consumer demand for goods and services produced by the Russian industry began to increase.

The Korean crisis started with a number of insolvent businesses and these failures resulted in non-performing loans for banks which depended heavily on short-term foreign borrowings.As a result, some banks became insolvent.Thus, the foreign investors and creditors started to withdraw their investment in the securities market of Korea and cut back their short-term loans to Korea. The Bank of Korea attempted in disguise to maintain the value of the won, thus depleting its foreign reserves drastically.

Emerging economies have to repay the debt since it creates a solid reputation and goodwill that investors can use while evaluating the investment opportunities in future. The impact of the default can be more far-reaching, both in terms of its impact on international markets and also on the country's population. A government which is in default can easily become a government in chaos and this can be disastrous for other types of investments in the issuing country.

After the war, North Korea required massive investment so as to start economic development. But in the year 1980 it defaulted on many of  its newly-restructured foreign debt, and thus owed nearly $3 billion by 1987. The mismanagement of Industries and significant military spending caused a decline in GNP and the ability to repay outstanding loans.
A large portion of Russian exports came from the commodity sale, leaving it vulnerable to price fluctuations. Russia's default sent a negative sentiment all over the international markets since people became shocked that an international power could also default. This disastrous event resulted in the well documented collapse of the capital management especially long term capital management. The devaluation of currency can help exporters and makes it cheaper for foreign countries to buy its products and services. It helps its economy to grow because the current account deficit declines.