EVER INCE Russia occupied Crimea in 2014. Western sanctions have failed to bite or act as a credible deterrent against Russian aggression. The United States has announced new measures targeting Russia’s financial system. I And other allies changed it on 26 February. It is too late to stop Ukraine’s aggression but they are capable of wreaking havoc in Russia as they target its central bank and freeze its 30 630 billion foreign exchange reserves. This could trigger a race on Russian banks and currencies, shaking up world markets and pushing up energy prices further. It could also trigger Russia’s retaliation. On February 27, Russia said the sanctions were “illegal” and indicated that Russia’s nuclear forces had been given “high-level precautions” in response. The deployment of these economic weapons to the West will also be seen as pushing a loose jaw in China, which has $ 3.4 trnn of reserves and which will now reconsider how to resist Western pressure in the war against Taiwan.
So far, Western sanctions have long been a source of controversy for Russia, but with little effect. Oligarchs and fines on their offshore assets, for example, have called on some tycoons to stop the bloodshed, but the Kremlin has not changed its decision. In the meantime, it will take months or years for Western technology and industrial exports to reach Russia. Even American sanctions were announced on February 24 against Sberbank and against it VTB Banks holding together 75% of the assets of the Russian banking industry, especially since the power transaction was exempted was not a serious but fatal blow. Russia’s “fortress” financial system seemed to be able to resist the economic weapons that the West dared to use.
On February 26, Salvo went a long way. Many Russian banks, perhaps Sberbank and many headlines in America and Europe VTBFrom Swift, A global cross-border payment messaging system. Actually Swift Decisions are growing instead of a game-changer. It will warn all opponents, not just the West, to deal with these companies If they choose to do so, they need to add a layer of hassle by using email and phone to communicate.
Instead, the really big move is to target the institution located at the center of Russia’s fortress economy, the central bank. It has foreign reserves of 30 630 billion, equivalent to 38% of Russia. GDP In 2021 (sanctions may cover other government-run funds). Biden administration officials say they are working with Europe to prevent the central bank from using these reserves to reduce the impact of sanctions. As part of the fortification strategy, Russia has shifted the combination of its reserves away from the dollar: as of June 2021, it was only 16% in greenbacks, 32% in euros, 22% in gold and 13% in Chinese yuan. However, it is likely that most holdings in securities, bank deposits and other instruments, regardless of the currency they are denominated in, are subject to the authority of the financial institution’s account or to enforce Western sanctions. That means some or even more of Russia’s national war chest could be frozen.
In response to the new move, the central bank said on February 27 that it had all the necessary resources and equipment to maintain financial stability. But the effects are terrible. If the central bank does not have immediate access to reserves, it will be difficult to intervene in the currency market using foreign cash to support the ruble, as it has done in recent days. Banks under central bank sanctions may be unable to provide foreign exchange liquidity, increasing their chances of defaulting on their foreign exchange obligations to their counterparts. And it will be unable to act as a middle-man for such national banks, giving or receiving foreign money on their behalf with foreign counterparts, which is a theoretical way to avoid sanctions.
All of this points to a deep panic in Russia’s financial system. So far the damage from the war is serious but tolerable. Currency fell 10% year-on-year, the stock market 35% and the share price of the largest banks fell more than 50%. As of February 25, the cost of insuring against the default of the Russian government was equal to that of Turkey. Now the pressure is likely to intensify. Ordinary Russians may lose confidence in the banking system, although their withdrawal could be offset by the ruble lending to central banks in rubles. Thanks to its oil revenues, Russia runs a current-account surplus, which earns more from abroad than it buys from abroad. But if there is panic and a flight of capital, without access to its reserves, it may be forced to introduce strict capital controls to prevent the currency from falling. It may also choose to temporarily close financial markets (short-selling of shares has already been banned).
So far, although there have been some signs that Chinese banks are moving away from dollar-directed transactions with Russian companies, there are no signs that China or other Asian countries are seeking to enforce Western sanctions. But now, with the high risk of Russian banks, corporations and the government defaulting on foreign exchange obligations, not only the West, but all their opponents will be wary of them.
The new measures are serious enough that they could be seen by Russia as something close to war and could lead to retaliation. On February 26, it said it had placed its nuclear forces on “special responsibility”, meaning a high level of caution. It is designed to signal that the Kremlin does not believe there is a clear boundary between economic and conventional warfare. The West may now have to change its nuclear stance in response. Russia has other options. One way is to intensify cyber-attacks on Western institutions. Another is to limit gas supplies to Europe. According to Bloomberg, gas supplies from Gazprom through Ukraine have been restored to normal levels by February 25. But Russia could now cut supplies. This will only have a moderate financial impact on Russia (oil exports are much more important for its economy) but will also lead to higher energy prices and consumer bills in Europe. Under the circumstances, the West will still have other economic weapons to help it grow, including blocking consumer Internet services or banning Russian oil.
It remains to be seen whether the West’s new resolve succeeds in dealing a devastating blow to Russia’s economy before Russia launches a devastating military strike on Ukraine. However, the new measures will cause huge damage to Russia. And they represent a Rubicon that will fundamentally change how sanctions and the world economy work. This is because of the large number of other countries that follow foreign policy that do not agree with the US reserves of large sums. The largest is China, whose vast savings are held mostly by Western financial instruments or through Western institutions. It will look at and learn from Russia’s financial pressures, and how Russia will retaliate, and try to assess how it can avoid being crushed by the West’s financial woes. 3
Our latest coverage of the Ukraine crisis can be found here
For more expert analysis of the biggest stories in economics, business and markets, sign up for our weekly newsletter Money Talks