Sanctions prevent Bank of Russia FX interventions

Sanctions are preventing the Bank of Russia from deploying its foreign exchange reserves in order to stabilise the falling ruble, governor Elvira Nabiullina acknowledged today (February 28).

“Considering the restrictions on using the gold and foreign currency reserves in dollars and euros, we have not carried out interventions today,” Nabiullina said in a press conference. The central bank carried out FX interventions amounting to $1 billion on February 24 and “in a smaller amount” on February 25, added the governor.

Instead of intervening today, the Bank of Russia increased interest rates from 9.5% to 20%. The ruble plummeted around 30% and now hovers close to 100 per $1. This is likely to boost already high inflation. In January, inflation reached 8.7%, more than double the 4% target.

“The dynamics of the exchange rate is an additional pro-inflationary factor that affects the current product prices and causes a drastic rise in devaluation expectations and inflation expectations,” said Nabiullina. “In order to support the attractiveness of deposits and protect households’ savings against depreciation, we need to raise interest rates to the levels that would compensate for higher inflation risks for people.”

In stark contrast to the propaganda communicated by the Kremlin in the weeks leading up to the Russian invasion of Ukraine on February 24, the governor gave a frank assessment of the financial situation Russia faces.

“The conditions for the Russian economy have altered dramatically,” said Nabiullina. “The new sanctions imposed by foreign states have entailed a considerable increase in the ruble exchange rate and limited the opportunities for Russia to use its gold and foreign currency reserves.”

A limited buffer

In the weeks leading up to the Russian aggression, analysts highlighted how Putin’s regime counted on a hefty reserves portfolio to withstand economic sanctions. Additionally, Russia had taken steps to reduce its exposure to US sanctions.

At the end of January, the Bank of Russia’s international reserves amounted to $630 billion. Monetary gold accounted for over $132 billion, special drawing rights $24 billion, other positions in the International Monetary Fund over $5 billion. Foreign exchange reserves amounted to over $468 billion.

“The first and most obvious way to think of Russia’s reserves is as a national strategic buffer,” wrote economic historian Adam Tooze on his blog Chartbook today. “When Russia’s financial system and currency come under pressure, dollars and euros from the reserve can be sold for rubles, thus propping up the value of the currency and slowing the process of devaluation.”

However, this is being impeded by “the unprecedented step to sanction the Russian central bank”, added Tooze, which “will likely make a large part of Russia’s reserves unavailable to Russian policy-makers”.

Over the last decade, and especially following the annexation of Crimea and the occupation of Ukraine’s eastern region of Donbass, Russia has progressively reduced its US Treasury holdings from $164.4 billion in January 2013 to below $2.5 billion now.

This diversification away from the dollar continued over the last two years. According to the Bank of Russia’s foreign exchange and gold asset management report, dollar-denominated assets declined from 22.2% of the foreign exchange assets in June 2020 to 16.4% in June 2021.

Over the same period, renminbi holdings increased from 12.2% to 13.1%, and gold declined from 22.9% to 21.7%. In 2020–21, the Russian central bank reinforced the role of the euro as its main reserve currency. It increased from 29.5% to 32.3%.

According to the report, assorted Nato countries, Japan, international financial institutions and Austria held 53.6% of Russia’s foreign exchange.

In contrast, China has 13.8%. The biggest Nato holders are France (12.2%), Germany (9.5%), the US (6.6%) and the UK (4.5%). Other unspecified institutions accounted for 10.7% of these assets.

The central bank’s latest available annual report, for 2020, says its gold is stored in Russia.