Central Bank of Russia Reserves & The Economy
Where are the Foreign Reserves & How Much? De-dollarization and Yuanization, Economy, Confiscation of CBR Foreign Reserves? Impact on Putin’s Power?
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“Barbershop Whispers….Russia” begins with “My Takeaways”on the main topic followed by the main topic discussion. The last two sections of “Barbershop Whispers…Russia” will be follow-ups from previous publications and emerging events.
In the previous issue, I discussed the Great Russian Asset Sale. This week I will focus on the Central Bank of Russia (“CBR”) foreign reserves – where are these foreign reserves, in what currency, and how much? The Russian economy, De-dollarization to Yuan-ization, and noise around the confiscation of CBR foreign reserves. How does this all this impact on Putin’s power.
My Takeaways:
Russia’s sizable foreign reserves have helped soften the short-term impact of western sanctions, but the country’s economic problems run much deeper than frozen foreign reserves. The decision to de-dollarize and Yuanize the economy will prove politically and financially costly for Putin and the country;
A perfect storm of weak economic performance - partly but not solely a function of western sanctions - and a losing war are coming to a head and raising questions about Putin’s ability to lead;
Russia’s foreign reserves will be released only when the war is settled, and part of the settlement terms will include reparations;
Should Putin find himself in need of currency devaluation and economic collapse advice, current Chief of Staff of the Presidential Administration Sergei Kirienko (AKA Kinder surprise) is an experienced sage on the subject.
Where are Russia’s Foreign Reserves, In What Currency, and How Much?
Days after Putin’s full-scale invasion in February 2022, the US, Canada, the UK, and the EU froze the foreign reserves of the Central Bank of Russia (“CBR”). This action immobilized approximately US$300B out of the US$480B of CBR foreign reserves held outside of Russia at the time. 31% of these foreign reserves are held in the EU, 13% in Japan, and 6.6% in the US, all in their respective national currencies. Meanwhile 17% of CBR reserves are held in China, but they are unencumbered.
(Source: Central Bank of Russia; Figures in US$ Billions)
Russia is one of the top five holders of gold and foreign reserves in the world. The others are China (US$3.3T), Japan (US$1.3T), Switzerland (US$924B), and India (US$563B).
The immobilization of foreign reserves seriously impacts Russia’s ability to borrow internationally, which hampers future economic growth. Constraints on borrowing and an increasingly stagnant economy become more problematic because of the ban of Russian banks from the SWIFT interbank payment system. Without SWIFT, it will be challenging and more expensive for the Russian government and businesses to make timely payments on its international debt, or borrow from international institutions. The added complication makes them unattractive clients.
Another consequence of the immobilization of foreign reserves is the CBR’s inability to effectively manage the RUB exchange rate. Since the start of the war in 2014, the RUB has weakened significantly against the USD. As illustrated in the chart below, RUB has steadily declined since the first invasion and will soon break the psychological barrier of 100RUB/1USD.
De-dollarization and Yuan-ization:
Shortly after Putin started the war against Ukraine in 2014, the CBR began replacing the USD component of its international reserves with RMB and EUR. Russia’s Finance Ministry also adopted a strategy of moving away from USD in its management of the National Wealth Fund. By the end of 2022, the RMB represented 60% of the National Wealth Fund’s currency component and the USD — zero. Today, most 2023 surplus oil & gas revenues are being in accumulated in RMB, thus substantially increasing the RMB component of reserves.
(Translation: The chrysanthemums in hell have faded long ago)
Russia’s pivot to, and reliance on, China extends to trade and manufacturing. Imported Chinese cars now account for 49% of the Russian market, compared to 7% in June 2021. The newly relaunched Moskvich 3 is in fact a JAC Sehol X4, assembled in Moscow, using kits purchased from the Chinese partner.
Russia’s reserves and payments will increasingly become influenced by the policies of the Chinese Communist Party and the People’s Bank of China. Should relations between the two countries deteriorate, Russia may face reserve losses and payment disruptions.
Other Economic Variables:
CBR Governor Nabiullina has done a remarkable job managing the RUB exchange rate as well as domestic interest rates, given the limited tools and resources she has at her disposal. However, the impact of frozen reserves is amplified when coupled with other variables directly related to the war and sanctions that continue to drain precious resources from the Russian economy.
Russia continues to face other economic challenges directly related to the war and sanctions:
Human Capital – a labor shortage in manufacturing is starting to build because of emigration and mobilization. The Russian military industrial sector is resorting to prison labor to fill the shortage. The British Defense Ministry said in January 2023:
“the Russian defense manufacturing sector is highly likely resorting to using convict labor in an effort to meet wartime production demands.”
“The prison population provides a unique human resource to Russian leaders to utilize in support of the ‘special military operation’ while willing volunteers remain in short supply.”
2. Discounted Oil Prices – Western-imposed price caps give trade partners – China and India in particular – a negotiating advantage to secure further price discounts. Embedded in the export price is the cost of transport, which is significantly more expensive because it is seaborne;
3. Transport Infrastructure – reliance on and constraints of the Black Sea, the main export route for Russian crude oil and grain exports. Ukraine has demonstrated they too can hamper Russian exports in the Black Sea, with drone attacks on Russian military ships;
4. Alternative Currency Reserves – significant buildup of RMB and INR in the Russian economy generated from crude oil sales.
Noise about the Confiscation of CBR Foreign Reserves?
Since the second invasion, there has been much discussion in the US and EU about the financial need and moral obligation to confiscate the CBR’s frozen reserves for the reconstruction of Ukraine – reparations. However, the legality of such an action today is questionable, and it could have serious negative consequences. At the G7 finance ministers meeting in Bonn last year, US Treasury Secretary Yellen said:
"I think it's very natural that given the enormous destruction in Ukraine, and huge rebuilding costs that they will face, that we will look to Russia to help pay at least a portion of the price that will be involved…While we're beginning to look at this (confiscation of CBR assets), it would not be legal now in the United States for the government to seize those assets….It's not something that is legally permissible in the United States."
One of the fundamental foundations of western economies is rule of law and the embedded sanctity of private property. Confiscation of CBR reserves without a clear legal justification would weaken western economies and their currencies — USD and EUR in particular. The absence of legal due process and justification would erode the faith and trust in the rule of law in the West, thus providing sovereigns and investors with sound reasons not to store wealth in USD, or in the US, for fear it could be confiscated. However, it is not often that a country invades its neighbor, let alone with the intent to deprive it of its sovereignty. Furthermore, the fact remains that there are few good alternatives to parking massive reserves in any currencies other than USD, EUR, CHF, etc. Some have argued that the RMB or INR represent good alternatives, but these currencies have limited market depth and global liquidity, and they are constrained by capital controls.
While there are precedents for confiscating central bank reserves, such as Iran in 1981 and Iraq in 1992, these are rare exceptions. In the US, central bank foreign reserves are protected by the Foreign Sovereign Immunities Act of 1976.
What is the impact on Putin’s power?
The weakening the RUB since 2014, and a stagnating economy as evidenced by other poor economic indicators, contributes to Putin’s eroding power with the population and the elite. Combined with the upcoming presidential election in March 2024, Putin should be worried. A perfect storm of trouble is brewing.
Putin’s decades-long civil contract with the population has been ‘Leave politics to me and I will improve your standard of living’ – and this contract has been broken. The population was told the war is a “Special Military Operation” that would be over in a few days. Two mobilizations later, the military draft service age has been expanded, a third mobilization is on the horizon, and drones are hitting Moscow. The war has gone from the television screen to the living room, with sons and and fathers drafted to fight Putin’s war.
The political elite, particularly the next generation technocrats who may one day inherit the reins of power, are increasingly concerned they will inherit a Chineses vassal. The armed forces, who had little say in the decision to invade, are becoming aware that they will be made the scapegoat for the debacle war. Even the security and intelligence services are beginning to cast an eye around, and contemplating about the post-Putin era.
Presidential elections are scheduled for March 2024 and the RUB is weakening, the economy is stagnating, and the war continues well past its first year with no victory in sight.
The Kremlin appears confident and unfazed by these growing challenges as illustrated by Kremlin spokesman Dimitri Peskov’s quote to the NYT when he said:
“Our presidential election is not really democracy, it is costly bureaucracy... Mr. Putin will be re-elected next year with more than 90% of the vote…”
To which he later claimed to have been misquoted and clarified his comment with the following:
“based on the level of consolidation around Putin….the question was about the elections and the answer was that elections are what a democracy demands and Putin himself decided to hold them, but theoretically, they don’t even have to be held. Because it’s clear that Putin will be elected. That’s completely my personal opinion. That’s how I was misquoted.”
There is no doubt Putin will win the March 2024 election, in the absence of any credible opposing candidates. The Kremlin’s task will be more about how many ballots will need to be manufactured to demonstrate respectable voter turnout to “legitimize” the election.
Follow-ups & Quick Bites:
Follow-Ups:
Saudi Host Peace Talks Success:
The Saudi-hosted peace talks were a success for Zelensky, with much credit to the last minute participation by China, adding credibility to the event. China did not attend the first summit held in Copenhagen, but their attendance at this one, and indications that they will attend a third summit, bodes very well for Zelensky controlling the narrative.
China is a powerful and influential Russian ally. Coupled with the attendance of the global south and other BRICs dependent on Ukrainian and Russia grains, Ukraine is able to focus them on aligned common interests - food and sovereignty - without the noise of Russian propaganda.
However, peace is far away and will be largely determined by battlefield results. As long as both sides have the capacity to fight, there is nothing to negotiate. Ukraine is fighting for its existence and sovereignty, while Putin is fighting for his power and life.
Quick Bites:
Declaration Against the War & US Sanctions on Russian Billionaires:
From the comfort and security of his home in Tel Aviv, Yandex co-founder Arkady Volozh publicly condemned Putin’s war nearly a year and a half into the war. Volozh, who has lived in Israel since 2014, is only the second major Russian billionaire to put out an unequivocal anti-war statement.
“I am categorically against Russia’s barbaric invasion of Ukraine. I am horrified that Ukrainian homes are being bombed every day”.
Russian billionaires Mikhail Friedman, Petr Aven, and German Khan are sanctioned by the US. These men were the founders of Alfa Bank, Russia’s biggest private commercial bank launched in the 1990s. The three have few, if any assets, left in Russia with the exception of Alfa Bank. They were never part of Putin’s inner circle and have distanced themselves from Putin’s Russia since before the first invasion.
Vol 1, No 6 - BWR 12.08.2023
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