The United States and its Western allies have unveiled the most punitive sanctions yet against Russia, the latest in a series of sanctions rolled out in response to the country’s full-scale invasion of Ukraine.
The measures announced on Saturday directly target Russia’s central bank and seek to hamper the country’s connectivity to the global financial system. They aim to destabilize the Russian economy, building on the sanctions imposed in recent days that target the oligarchs as well as its banks, high-tech companies and aircraft manufacturers.
“It is becoming increasingly clear that Russia is following the path of Cuba and Iran in terms of the significance of the sanctions imposed,” said Daniel Tannebaum, a former US Treasury sanctions official who is now a partner at Oliver. Wyman, a consulting firm.
A senior US administration official added that the new measures amounted to Russia “getting kicked out of the international financial system” and becoming a “global economic and financial pariah”.
Here’s how the new restrictions may work in practice:
What was announced?
The United States, United Kingdom, Canada, France, Germany, Italy and the European Commission said on Saturday they would block Russia’s central bank from using its stockpile of around $630 billion. of foreign exchange reserves, harming its ability to consolidate its economy and protect it from costs. associated with its attacks on Ukraine.
The sanctions were announced alongside plans to kick some Russian lenders out of the Swift financial messaging system, which is used to communicate details of billions of dollars in daily payments between banks.
Their main goal is to hamper Russia’s ability to circumvent the broad sanctions that have so far been imposed on the country.
“This is a direct attempt to hit Russia’s ability to overcome sanctions, because the way it would resist sanctions would be to rely on its reservations,” said Daniel Glaser, who served as deputy secretary. for terrorist financing and financial crimes at the US Treasury. department from 2011 to 2017 and now works at K2 Integrity, a risk consulting firm.
“The less control they have over their reserves or the less they can do with their reserves, the more vulnerable they become to the second round of pressure,” he added.
The United States and its allies have not yet specified how the new regime will work against the Russian central bank. Glaser said the ‘simplest’ US method would be to add it to the Treasury’s ‘specially designated nationals’ list – where personal and corporate assets are blocked and US individuals and commercial banks have no no right to deal with them.
How harmful could these restrictions be for Russia?
The country’s foreign exchange reserves are a key pillar of its economic power, and Western allies are trying to undermine its ability to tap into the stock. While Russia has aggressively reduced its dollar reserves, a notable share of its currency stock is held overseas in the United States, Germany, France, the United Kingdom, Austria and Japan.
If it were unable to sell large swaths of its foreign assets in exchange for local currency, Russia would be crippled in its ability to defend the rouble. Elina Ribakova, deputy chief economist at the Institute of International Finance, said sanctioning the central bank could eventually lead to bank runs. Russians have already flocked to banks to withdraw cash, fearing the country’s financial system could crash.
“I am confident that the effects of these measures will be felt immediately in Russian financial markets,” said a senior US official. “Market participants understand that if Russia doesn’t have the ability to defend its currency, it will go into a tailspin.”
The country’s record $19 billion current account surplus, built up from its large energy exports, will provide some protection. Russia continues to earn large amounts of foreign currency from oil and gas sales, which should support the economy and help pay for imports. And the Russian central bank said it was supporting domestic lenders by offering them ruble liquidity.
How is the Russian central bank likely to react?
Without access to reserves to hedge against the ruble’s collapse, the central bank would have only two clear options: raise interest rates and control capital.
The central bank could seek help from China, where more than 14% of its foreign exchange reserves are held – the largest foreign share. It’s unclear, however, if China will want to provide it. While rushing to help from Russia would undermine US dominance over global finance, Chinese banks could fear secondary sanctions that would cut off access to dollars and euros.
The central bank could also try to sell some of its 2,299 tonnes of gold, the world’s fifth-largest stockpile, to more supportive governments. This gold is held in locations in the Russian Federation, according to the central bank.
But Sergei Guriev, an economist at Sciences Po University in Paris, said selling those reserves would also be difficult.
“Anyone who says it will be easy to sell gold or yuan must be kidding – Chinese state banks are already blocking funding for Russian oil sales. China is rightly afraid of secondary sanctions. really a game-changer,” he said.
How exposed are foreign investors?
Western financial institutions’ direct exposure to Russia is modest, in part due to sanctions imposed after its annexation of Crimea in 2014, as well as the rise of more investor-friendly economies in Asia.
Foreign investors held $20 billion of Russia’s dollar debt and ruble-denominated bonds worth $37 billion at the end of 2021, according to Russian central bank data.
Russian bonds make up about 6% of JPMorgan’s widely tracked index of emerging market local-currency debt and about 3% of the foreign-currency version. Russia makes up just 3.4% of the widely followed MSCI index of emerging market stocks, less than Saudi Arabia or South Africa.
The measures could leave Russian securities listed on foreign markets in the cold, as banks become reluctant to allow intermediary transactions and investors are wary of adding exposure.
The local impact will be severe, according to Peter Williams, analyst at Evercore ISI. “Russian banks and financial markets are likely to face significant stress when they open, given memories of the 1990s,” he said.
In terms of banks’ exposure to Russia, the Bank for International Settlements estimates that foreign banks’ claims on Russian banks amount to only $29.3 billion, and overall claims on Russian entities s amount to about $89 billion, notes JPMorgan.
That said, Europe in particular is heavily exposed to Russia’s huge energy sector. “Russia accounts for well over 10% of global oil and natural gas production and plays an important role in European natural gas markets,” the U.S. bank said in a report over the weekend.
What about cutting Russian banks from Swift?
The proposal to separate a number of Russian banks from the Swift network aims to ensure that these lenders are “disconnected from the international financial system”, according to the allies.
This would come on top of existing, more targeted, individual sanctions against Russian banks. The move follows calls by Ukrainian President Volodymyr Zelensky for banks to be barred from the network, making it harder for Russians to transact across borders.
Again, specifics have not been worked out, but officials say they don’t want to undermine Western economies’ ability to buy Russian fossil fuels, which means there will be significant exclusions from the Swift ban. One way to do this would be to allow Russian energy-focused banks to stay on the grid.
Has the United States done anything like this in the past?
Yes. The United States has frozen central bank assets of hostile regimes, including Venezuela, Iran and, most recently, Afghanistan. Iranian banks were also kicked out of the Swift network by President Donald Trump in 2018.
Iranian sanctions could provide a model for banning the Russian central bank. The sanctions, imposed by the Trump administration in 2019 after the relaxation of earlier measures imposed by Barack Obama in 2012, froze central bank assets held in deposit accounts in the United States.
In addition, sanctions against Iran have prevented financial institutions from engaging in transactions on behalf of the central bank or offering other services to it.
“I believe we’re on a treadmill toward Iran-style sanctions, which included this action against their central bank,” Edward Fishman of the Center for a New American Security think tank said before the latest measures were announced.
Reporting by Colby Smith, Claire Jones, Sam Fleming, Demetri Sevastopulo, Max Seddon, Tommy Stubbington and Robin Wigglesworth