Global News Insider

Written by Marián Šeliga

In response to the Russian invasion into Ukraine on February 24, the EU and the USA adopted a whole package of sanctions against the Kremlin. According to experts, the most unprecedented measure out of the whole package of sanctions imposed on Russia was the freezing of the Russian Central Bank’s reserves denominated in USD dollars and euros, which account for about half of all its reserves denominated in foreign currency. Another “killer” EU sanction against Russia may be a complete shutdown of Russian natural gas supplies to the EU. Based on our analysis and data taken from open sources, we anticipate that the freezing of reserves of the Central Bank and the complete shutdown of Russian gas supplies to Europe will not deliver the intended blow to Russia’s economy. Although the Russian economy is running the risk of long-term stagnation, it may weather the impact of sanctions for a sufficient period of time. At the same time, it can be assumed that cutting off Russian gas will create difficulties not only for Russia, but also for the European countries. Even the embargo on the Russian oil which is currently high on the EU agenda will not fully undermine the Russian economy, as the international statistics provided do not take into account the “grey schemes” of the oil supplies to Asian countries.

Reserves of the Russian Central Bank and the National Wealth Fund

By the time the military aggression began in Ukraine, the volume of reserves of the Russian Central Bank amounted to about 640 billion US dollars. Before the freezing of its reserves, the Russian Central Bank was gradually reducing the share of assets in US dollars and, on the contrary, increased the share of assets in Chinese Yuan. The structure of the Central Bank’s reserves according to the data of the Bank of Russia as of June 30, 2021 (they were published in January 2022 with a semi-annual lag) looked approximately as follows:

• The US dollar accounted for 16.4% of Russian reserves, the euro – 32.3%, the pound sterling – 6.5%, the yuan – 13.1%. There is no exact data on the countries in which the Central Bank holds savings. But it is reported that about 14% is located in China, and about 40% is in the jurisdiction of the EU, the USA, Canada and the UK. (However, it must be emphasized that we consider the structure of reserves according to the latest report from 30 June, and we have no information whether the latter has undergone any changes during the last six months if any).

As a result of freezing assets in dollars and euros, the Russian Central Bank lost the ability to dispose of about half of its reserves in the amount of $300 billion. Thus, Russia has about $340 billion left free, of which $132 billion is monetary gold in the form of ingots stored in Russia. As a result of the Western sanctions the Central Bank of Russia lost the opportunity to influence the market exchange rate of the ruble with the help of foreign exchange interventions (buying or selling foreign currency). This led to a temporary strong weakening of the ruble (in March, the dollar soared above ₽120, renewing its historical maximum at ₽121.5275. ), but this situation almost recovered in early April (on April 8, the dollar was worth only ₽71 on the stock exchange.) and today the ruble exchange rate reaches the pre-war level. What does it mean?

Economists may object that the current exchange rate of the ruble is artificially supported by the actions of the Russian Central Bank and relevant departments, which have taken a number of such measures as (mandatory sale of 80% of exporters’ foreign exchange earnings to the state, restrictions on the purchase / sale of foreign currency, a ban on dividends payment to foreign investors, the payment of coupons on Eurobonds in rubles and other measures). Thus, according to Wall Street, the exchange rate of the ruble against the dollar may not reflect its real purchasing power and is completely artificial. This is a technically correct description of the situation, but in fact it does not mean that the Russian economy is in danger of collapse. It is quite far from this.

Nevertheless, the ruble continues to strengthen and it is possible that the Central Bank and the Ministry of Finance will even be forced to limit this strengthening of the ruble, since a strong ruble is unprofitable for Russian exporters. In addition, some restrictions introduced by the Russian authorities to limit currency transactions are gradually being removed, such as the abolition of the 12% brokerage fee introduced earlier on the purchase / sale of euros and US dollars. It should be also said that the Russian budget for 2022 is based on a forecast of the exchange rate of 72 rubles per dollar and the price of Urals oil at about 62 dollars per barrel. (By May 2, 2022, the price of Urals oil is 79 US dollars and the ruble exchange rate is at the level of 71 rubles per 1 US dollar). Considering that Russian oil will be sold at a discount to countries such as India or China, the current stock price of Urals oil ($79) gives the authorities the opportunity to provide a discount (up to $62).

The international statistics used in the Financial Times article do not take into consideration the data on the so-called “grey schemes”, when oil or gas is loaded onto tankers, and the bill of lading does not contain information about the recipient of these goods. While Chinese state refineries are now afraid to directly import oil or gas from Russia, there are a number of private or semi-private entities that can buy Russian goods without fear of becoming subject to secondary sanctions. At the same time, China has employed multiple schemes to import oil from another country under sanctions – Iran.

National Wealth Fund

While many Western experts believe that this asset freeze dealt a devastating blow to the Russian economy, there is a strong suggestion that the Russian financial system has a strong margin of safety thanks to Russia’s National Wealth Fund. Thanks to this fund, Russia can cover the deficits from the shutdown of oil and gas supplies to the EU. At the same time, current oil and gas revenues do not take into account possible additional income from the redirection of supplies to developing countries such as India or China, even when taking into account a significant discount on the supply of these resources.

In nominal terms, the income of the NWF is huge. As of March 1, its volume amounted to almost 13 trillion rubles, of which the liquid part amounted to 9.7 trillion rubles. Plus, the Fund has not yet transferred 3.1 trillion rubles of excess income that was collected last year.

Over the four months of the current year, the volume of oil and gas excess profits amounted to:

• January: +585,9 billion
• February: +634,7 billion
• March: +537,6 billion
• April: +496,3 billion

In just four months, the Fund raised another 2.254 trillion rubles. Part of these funds will go to finance the federal budget deficit, as well as unplanned expenses. For example, for additional social payments to citizens. However, as the situation stabilizes, this type of expenditure will decrease.

It should be noted that sanctions, of course, create great difficulties for the Russian economy, namely in restricting access to foreign technologies, equipment, spare parts, hardware, chips, electronics, or relatively cheap financing. Closed access to Western innovative technologies and spare parts will create great difficulties for Russia in building an innovative economy. Scientific breakthroughs will be limited due to the termination of international scientific cooperation with Russia. However, sanctions will not be able to stifle the Russian economy. This bet is incorrect.

In summary: Russia has sufficient reserves in the National Wealth Fund that will help its economy to weather possible embargo on its oil and gas supplies to Europe for a sufficient period of time. Thus, in the short term (for the following months) sanctions even in the energy sector will not have a decisive impact on the military actions of Russia in Ukraine. A very slow and many times uncoordinated EU policy on sanctions gives Russia enough time to take retaliatory measures and even redistributes the flows of its exports. On the other hand, even without the Russian oil ban in-force yet, the countries in the Eurozone are facing the highest inflation pressure since the 1970s. According the Allianz, headline inflation in Eurozone reached 7.5% y/y in April. And the rising inflation will be fueled also by the hard lockdowns and semilockdowns in China, the consenquences of which on the global economy will be seen in the following months.