Russia’s foreign exchange reserves escape it
The Russian Central Bank’s large stock of reserves was supposed to keep the currency stable in the face of market panic.
Reserves – worth $630 billion at the end of January – are made up of assets and deposits denominated in the world’s major currencies (i.e. the dollar, euro, pound sterling and yuan ). As well as nearly 2,300 tons of gold.
The stock was there so that the central bank could intervene in the foreign exchange markets, supporting the ruble in the event of volatility. There’s also a Jedi trick aspect to stockpiling – if the markets know you have plenty of them, they’re less likely to challenge you to use them.
Sanctions imposed by the US, EU and UK on the central bank risk rendering much, if not all, of these reserves useless. To understand what the CBR is, and isn’t, likely to have at its disposal when banks open tomorrow morning, it’s worth taking a close look at what’s known as the “Data Model for international reserves and foreign currency liquidity”.
The snapshot below was taken from former Alphavillain Matthew Klein’s Twitter account. We tried to find the official data on the central bank’s website, but it was no longer available.
The securities represent just over half ($311 billion) of what the CBR had at its disposal. According to its annual report, these assets were mostly highly rated, with only 6.8% of them holding a rating below A.
Given their high odds, most of them are likely to be very liquid and easy to sell in times of panic. But how does the Russian central bank turn these securities into cash in case it needs quick access to dollars or euros? Well, it has to rely on global finance.
Here’s how Ousmene Mandeng, a visiting scholar at the London School of Economics and Political Science who has spent decades working in central bank reserve management, told us:
Foreign exchange reserves are not held by central banks. Securities and money never move, everything is external. . .
In the case of securities, central banks would instruct their brokers to sell the asset in question. . . In the case, for example, of a German government bond [that the CBR owns], the Frankfurt broker will call other brokers to advertise the sale and, once the price has been agreed, will instruct the custodian of title to transfer it to the buyer. Upon receipt of payment in a bank account, usually in Frankfurt, the custodian will instruct the central securities depository to appoint the buyer as the new owner. The central bank then credited the proceeds to its account with the broker.
The proceeds could then be used to instruct the broker or currency traders, most of whom are in London, to buy the ruble at a specific rate. The seller will usually be a Russian commercial bank. The seller and the buyer may very well share the same correspondent bank. Once the purchase is made, the Bank of Russia would instruct its correspondent bank to credit the seller’s account with euros.
To prevent the central bank from using its securities to stabilize the ruble would therefore be tantamount to ordering the financial intermediaries that are part of this chain – brokers, depositories, central securities depositories, foreign exchange traders and correspondent banks – to freeze the assets and cease act on behalf of the central bank.
Judging by its recent behavior, there is every reason to believe that the United States will be prepared to do just that. In recent years, Washington has often reinforced its foreign policy by what is called “the armament of finance”. In practice, this means using the global dominance of the dollar to cut off the monetary authorities of Iran, Venezuela and (more recently and very controversially) Afghanistan from access to their own reserves.
There is a paradox at play here, between what the United States is prepared to do to its political enemies and the rules of the private sector. Sovereign immunity normally protects the assets of a foreign central bank, usually held at the New York Fed, if they are “held for its own account”. That balm, however, has been tested over the years in various US lawsuits against failing governments, as bondholders spied on rich drawdowns from their foreign exchange reserves. Yet none of these lawsuits have gone as far as the US government’s increasingly frequent targeting of its enemies’ central banks.
In targeting central banks, authorities invoked anti-terrorism and human rights legislation, alongside the US International Emergency Economic Powers Act. The latter in particular has proven to be a powerful measure.
The most direct way to sanction CBR will be to put it on the so-called SDN list of individuals and institutions that prohibit US entities from doing business with them. With regard to access to the dollar, this would put an end to each step of the process described by Mandeng.
The second part of the reserves held by the CBR is in the form of foreign exchange and deposits. These are worth $152 billion. Of that $152 billion, about two-thirds are held by official institutions. This includes other central banks, the Bank for International Settlements and the IMF.
The central banks of the Eurosystem, where about a quarter of the CBR’s assets are held, have already frozen the central bank’s accounts. The European Central Bank said it would apply all sanctions decided by the EU and European governments. Joachim Nagel, President of the Bundesbank, said earlier today that he “welcomes the fact that comprehensive financial sanctions have been imposed and that he has campaigned for them”.
The BRI said: “[Our] policy is that the institution does not recognize or discuss banking relationships. The BRI will follow up on sanctions, if any.
It is unclear how other authorities will behave. Especially China. According to the CBR annual report, at the beginning of 2021, 14% of foreign exchange reserves were held in China – the largest share for any state. Nearly 13% of reserves are in yuan or in assets denominated in yuan.
Mandeng says China could offer Russia a way to continue trading with at least some parts of the world:
Russia could accept payments for its renminbi exports and increase renminbi-paid imports from China and possibly other renminbi-accepting countries. As renminbi-based payments will most likely be made by institutions outside of the West’s immediate sphere of influence, this would work. I don’t know if China is ready to undermine Western efforts to isolate Russia, but it is possible. It would mean revamping Russia’s international financial and economic relations, but it may be something it pursues anyway.
The other third of CBR’s deposits are held in private banks. Again, it’s impossible to say how much of that $57 billion is held in the US, UK or EU. But since almost 60% of the CBR’s reserves are in dollars, euros or pounds sterling, it’s fair to assume that it’s more than half.
Financial intermediaries from the rest of the world may also be unwilling to deal with the CBR, even if they are not directly targeted by the sanctions. When the United States blacklists you, it can have a chilling effect. Famously, Hong Kong leader Carrie Lam resorted to ‘stacks of cash’ after local institutions balked at banking her and other city officials who were on the hook. US sanctions.
And then there’s gold, the historic favorite of central banks around the world. Including Russia’s monetary guardian. CBR’s holdings are large – the fifth largest in the world – and, according to the industry trade body, the World Gold Council, they have been among the biggest buyers of late. According to its annual report, all of the $130 billion worth of bullion is stored in vaults within the Russian Federation.
Having all your gold so close to home is unusual. Most central banks around the world keep much of it in vaults under the Bank of England headquarters on Threadneedle Street, or near Wall Street in the vaults of the Federal Reserve Bank of New York. The reason for this is that the City of London and New York are the twin centers of the global gold market, making it easy to buy and sell bullion.
Holding the gold in Russia, not London or New York, will make it more difficult for the central bank to dispose of it in large quantities. At the same time, having it close to home makes it very difficult for the US, UK and EU to successfully impose sanctions on Russian bullion. He may be a financial pariah, but people who know the market think it would be foolish to assume that Russia will be ruled out entirely. The allure of gold has always been present throughout history, especially in times of geopolitical uncertainty. If Russia is selling below market rates, then we think someone, somewhere will be willing to take the risk.
We’re not going to pay too much attention to what CBR may, or may not, have available tomorrow morning. It is not SDRs or a few billion banknotes that will stop the collapse of a currency.
Think differently? Thoughts in the usual place. With all the guesses about where the ruble will end the day tomorrow.