Sanctions and dollar dependency in Russia: resilience, vulnerability, and financial integration

ABSTRACT

What are the long-term effects of the financial sanctions against Russia? We provide a time-sensitive analysis of the sanctions impact on certain Russian financial markets and highlight how Russia has responded strategically. Our analysis also captures the effect of the threat of sanctions and informs the debate on sanctions effectiveness. Thus, our study indicates how financial sanctions can be incorporated into theories of deterrence and conflict resolution. We also provide some policy implications that can be generalized and reinforce previous research. Russia’s banking system is highly dependent on dollar transactions, and in response to sanctions, Russia has systematically undertaken measures to promote its economic sovereignty under conditions of continued financial integration. We argue that sanctions put some pressure on the Russian budget, and that this effect has been exacerbated by the Covid-19 crisis, but also that Russia has used debt placements strategically in order to deter sanctions escalation.

KEYWORDS:

• Sanctions
• Russia
• interbank market
• government bonds
• dedollarization
• Ukraine

Notes

1. Some Russian observers have even argued recently that a sudden removal of sanctions would cause bigger problems for the Russian economy – due to rapid capital inflows that could destabilize the currency – than would further sanctions (Foy 2020). Concise summaries of all US and EU legislation in relation to the Ukraine-related sanctions against Russia as of early 2018 are provided by Welt, Nelson, and Rennack (2018) and Archick, Rennack, and Welt (2018). Others have argued that sanctions have had almost no economic effect at all; for example, Movchan (2017) claims that “all sanctioned companies can easily borrow as much as they need from Russian banks.” Even if this argument were true, it ignores the issue of how high the interest rate would be on such loans.

2. A few Russian studies emphasize the positive effects of the sanctions, arguing that it is rather the Western economies that will suffer the costs (e.g. (Loginova, Titarenko, and Sayapin 2015; Sokolov, Larin, and Khrustalev 2016;; Nureev (2017)). As noted above, Putin is using a similar argument.

3. The studies by Stone (2016) and Ahn and Ludema (2016) were published by the Office of the Chief Economist of the US State Department, while the report by Crozet and Hinz (2016) represents a working paper by the Kiel Institute for the World Economy in Germany.

4. For a European perspective on the policy debate, see Moret et al. (2016), who argue that policymakers should improve the coordination of sanctions with other tools of statecraft, and also make more strategic use of the threat of sanctions. This report was commissioned by consultancy firm Rasmussen Global, founded by former NATO Secretary General Anders Fogh Rasmussen.

5. Financial restrictions in general are not a new phenomenon. For example, around the turn of the twentieth century, when the German Empire banned credits to the Russian Empire, Russian Finance Minister Sergei Witte expressed his bewilderment to the tsar that foreign countries were at all inclined to provide capital to a competing power (Nove [1969] 1984, 18).

6. The quick response by the Duma can be understood in light of the fact that the deputy who proposed the legislation, Vladislav Reznik, First Deputy Chair of the Financial Markets Committee, had lobbied for such measures to be included already in 2011 when the law on a national payments system was adopted (RBC 2014b).

7. The US Treasury imposed restrictions on credits with maturities longer than 90 days on 16 July (one day before the shooting down of flight MH17), while the EU did so on 31 July. On 12 September, both the US and EU amended the restrictions to 30 days. The Countering America’s Adversaries Through Sanctions Act (CAATSA) legislation of August 2017 reduced the period further to 14 days for the American sanctions.

8. The definitions of “resident” and “non-resident” are found in the first paragraph of Federal Law No. 173-FZ “On Currency Regulation and Currency Control” (O valyutnom regulirovanii i valyutnom kontrole). The definitions of the terms “internal” and “external” debt for budget purposes (subchapters 1301 and 1302) are found in the Finance Ministry’s instructions for the classification of budget codes (Andermo and Kragh 2020).

9. Yields did indeed come down in early 2013 for a short period before the Ukraine crisis erupted, as discussed further below. In 2010, Russia placed its first eurobond since the aftermath of the 1998 crisis, and this was followed by annual placements until 2013. The crisis of 1998 marked a fork in the road for the nascent Russian bond market. In the run-up to the crisis, Russia was running persistent budget deficits for political reasons, and there was significant trading in short-term debt, so called GKOs (“short-term government bonds,” gosudarstvennye kratkosrochnye obligatsii). Well-connected investors could borrow cheap money in the Central Bank and invest in GKOs with real returns of over 100%, an arbitrage situation that Åslund (2019, 71) has likened to a legal Ponzi scheme. In 1998, the government defaulted on that debt. In the early 2000s, Russia was instead running sustained budget surpluses, partly thanks to increasing oil prices, and the Finance Ministry issued only limited amounts of OFZs with an unattractive yield below the inflation rate, which were bought almost exclusively by banks and state-owned pension funds that needed the securities for regulatory purposes. This situation meant that OFZs were not useful as a pricing reference; instead, bonds issued by the City of Moscow served the role as benchmark for corporate bonds. OFZ issuance increased gradually throughout the 2000s, as Russia followed its strategy to liberalize its debt market to attract foreign investors and promote longer-term maturities that would improve financial stability (Noel et al. 2006; Lu and Yakovlev 2017). For a more general discussion of the evolution of government bonds in emerging markets and the utility of market liquidity, see Borio (2000) and McCauley and Remolona (2000).

10. The annual policy guidelines for government debt from the Finance Ministry also represent a useful source for this history.

11. The reports to congress were not published by the US Treasury but made public via the news agency Bloomberg (Wasson and Mohsin 2018). One of the reports, in turn, mentions Bloomberg as the source of some of the data used in the analysis (US Treasury 2018a).

12. Spicer (2017) also reports that Russia removed as much as 115 USD billion from its account with the New York branch of the Federal Reserve in March 2014, but that the funds were returned after only a few weeks.

13. The term “de-dollarization” has been used in the literature to describe efforts in emerging markets to reduce the role of the dollar in domestic transactions (Kokenyne, Ley, and Veyrune 2010). The priority of Russian authorities using this term is rather to reduce the dependency on the dollar in international transactions.

14. An indirect effect of sanctions that affected the entire Russian economy, sometimes referred to as “soft” or “undeclared” sanctions, concerns the fact that all international transactions are now subject to increased scrutiny, and that the time necessary to settle payments increased for all actors in the Russian economy, from 1–2 days before sanctions to 2–6 days after sanctions were introduced (Orlova 2014).

15. The share can be measured by converting the volume of the ruble segment of the interbank market to a corresponding dollar value according to the current exchange rate and comparing it to the dollar segment.

16. Orlova (2014) reported that the average daily dollar turnover in the Russian interbank market was 1–2 USD billion before sectoral sanctions were introduced. Unfortunately, the Central Bank dataset on MIACR dollar transactions starts only in January 2015, so we cannot compare this data series with the numbers reported by Orlova (2014).

17. Only the most creditworthy Russian banks are included in MosPrime, as decided by the National Finance Association, and the calculation is performed by the media company Thomson-Reuters. In practice, however, on many days there are no interbank transactions with durations longer than overnight (especially after the 2014 ruble crisis), in which case the corresponding MIACR indicator cannot be calculated. Since MosPrime is a forward-looking estimate not based on actual transactions, it is reported for all durations every banking day, which means that it has the advantage of not having any gaps in the data.

18. Karber’s (2015) analysis is based on field observations in the conflict area throughout 2014 and 2015, including interviews with most Ukrainian battlefield commanders. Zabrodskyi was later promoted to general and made commander of Ukraine’s Air Assault Forces. The raid was reportedly inspired by his studies of a cavalry raid during the US Civil War.