Russia’s foreign exchange reserves spiraling out of control
The substantial reserves of the Central Bank of Russia are intended to maintain the stability of the currency amid market panic.
Reserves – worth $630 billion, up to the end of January – is made up of assets and deposits in the major world currencies (that is, the dollar, euro, pound sterling and yuan). As well as nearly 2,300 tons of gold.
The reserve is there so that the central bank can intervene in the foreign exchange market, selling the ruble in case of volatility. There’s a little Jedi side to building reserves – if the market knows you have a large stock of them, they’ll be less likely to challenge you to use them.
The US, EU and UK sanctions against the central bank has the potential to render many, if not completely, of these reserves useless. To understand what CBR is, and is not, likely to use when the banks open tomorrow morning, you should take a close look at what is known as the “Data Sample for International Reserves and Foreign Currency Liquidity.”
The snapshot below is taken from Twitter account by former Alphavillain Matthew Klein. We tried to find the official data on the central bank’s website, but it’s not available anymore.
Securities account for more than half ($311 billion) of what the CBR is worth. According to the annual report, these properties are mostly appreciated, with only 6.8% of them having a lower A rating.
With high ratings, most of them will likely be highly liquid and easy to sell in times of panic. But how does the Central Bank of Russia turn these securities into cash in case they need quick access to dollars or euros? Yes, it needs to rely on global finance.
Here’s how Ousmène Mandeng, a visiting fellow at the London School of Economics and Political Science, who has spent decades working in central bank reserve management, explains to us:
Foreign exchange reserves are not held by central banks. Stocks and money never move, everything is external. . .
In the case of securities, central banks will require their brokers to sell the asset in question. . . In the case of, for example, a German government bond [that the CBR owns], the broker in Frankfurt would call other brokers to announce the sale and, once a price had been agreed, they would instruct the custodian of the securities to pass on to the buyer. Upon receipt of payment to a bank account, usually in Frankfurt, the custodian instructs the central securities depository to designate the buyer as the new owner. The central bank then credits the proceeds to their account with the broker.
The proceeds can then be used to instruct brokers or forex traders, most of them in London, to buy rubles at a specific rate. The seller will usually be a Russian commercial bank. Buyer and seller can share the same correspondent bank. Once a purchase is made, the Central Bank of Russia instructs its correspondent bank to credit the seller’s account in euros.
Therefore, preventing the central bank from using its securities to stabilize the ruble would involve instructing the financial intermediaries present on this chain – brokers, custodians, securities depository central bank, foreign exchange dealer and correspondent bank – to freeze assets and cease operations on behalf of the central bank.
Judging by their recent behavior, there is much to suggest that the United States would be willing to do just that. In recent years, Washington has often stepped up its foreign policy through what has come to be known as “financial weaponization.” That makes sense given the practice of using the dollar’s global dominance to cut the monetary authorities of Iran, Venezuela and (most recently and controversially) Afghanistan from access. their own reserves.
There is a paradox at play here, between what the US is willing to do with its political enemies and the rules for the private sector. State immunity typically protects foreign central bank assets, typically held at the New York Fed, if they are “held for its own account.” However, that balm has been tested over the years in various U.S. lawsuits against defaulting governments, as bondholders watched the rich cash flow of their foreign exchange reserves. . However, none of those lawsuits go as far as the US government’s frequent targeting of enemy central banks.
In targeting central banks, authorities have invoked anti-terrorism and human rights laws, along with the United States’ International Emergency Economic Powers Act. In particular, the latter has proven an effective measure.
The most direct way to penalize the CBR would be to include it in the so-called SDN lists of individuals and organizations that prohibit US entities from dealing with them. When it comes to dollar access, that stops every step of the process outlined by Mandeng.
The second part of the reserve that the CBR holds is in the form of currency and deposits. These are worth $152 billion. Of this $152 billion, about two-thirds are held in formal institutions. That includes other central banks, the Bank for International Settlements and the IMF.
Central banks in the Eurosystem, which hold about a quarter of CBR assets, have frozen central bank accounts. The European Central Bank said it would implement 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 are now in place and have been lobbied for them”.
BIS said: “[Our] It is the organization’s policy not to acknowledge or discuss banking relationships. BIS will follow sanctions, if any. “
It is not clear how other authorities will behave. Notably China. According to CBR’s annual report, as of early 2021, 14% of foreign exchange reserves are held in China – the largest share for any country. Nearly 13% of reserves are in yuan or yuan-denominated assets.
Mandeng says China could provide a means for Russia to continue trading with at least some parts of the world:
Russia could accept payment for its exports in renminbi and increase its imports paid in yuan from China and possibly other countries that accept renminbi. Since renminbi-based payments will most likely be made by institutions outside of the direct Western sphere of influence, this should work. I’m not sure if China is willing to sabotage the West’s attempt to isolate Russia, but it might. It means a reorganization of Russia’s international economic and financial relations, but that may be what the country is pursuing in any case.
Another third of CBR’s deposits are held in private banks. Again, it is impossible to say which part of this $57 billion is held in the US, UK or EU. But since nearly 60% of CBR’s reserves are in dollars, euros or pounds, it’s fair to guess that more than half.
Financial intermediaries in the rest of the world may also be reluctant to deal with the CBR, even if they are not directly subject to the sanctions. When the US blacklists you, it can have a chilling effect. Famously, Carrie Lam, the leader of Hong Kong, used “piles of cash” after local institutions were reluctant to bank her and other city officials, who were sanctioned by the US.
And then there’s gold, the historical favorite of central banks around the world. Including Russia’s currency protector. CBR’s assets are huge – the fifth largest in the world – and according to industry trade body the World Gold Council, they have among the latest buyers. According to the annual report, the entire amount of gold bullion worth 130 billion USD is stored in vaults in the Russian Federation.
Keeping all your gold close to home is unusual. Most of the world’s central banks keep a large portion of vaults beneath the Bank of England headquarters in Threadneedle Street, or near Wall Street, in the coffers of the New York Federal Reserve. The reason is that the City of London and New York are the two hubs of the global gold market, making it easier to buy and sell bars.
Keeping gold in Russia, not in London or New York, would make it more difficult for the central bank to handle large amounts. At the same time, its proximity to home makes it very difficult for the US, UK and EU to successfully impose sanctions on Russian gold. Financial pariah may be so, but those who know the market believe that it would be foolish to assume that Russia would be completely frozen. The appeal of gold has been present throughout history – especially during times of geopolitical uncertainty. If Russia is selling below the market rate, then we think someone, somewhere will be willing to take the risk.
We won’t pay too much attention to what else the CBR may, or may not, be able to handle in the morning. SDRs or several billion banknotes will not prevent the currency’s collapse.
Thinking differently? Think in a common place. Along with any predictions about where the ruble will end up tomorrow.