Can Russia's 'De-Dollarisation' Protect its Economy From US Sanctions?

Of the total reserves in Russia's central bank, US dollars constitute 16.4%, which is down from 22.2% in 2020.

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Edited By :Saundarya Talwar

If you have been following the Russia-Ukraine crisis, you will already be familiar with the term "sanctions".

On Monday, 21 February, after Russian President Vladimir Putin recognised the independence of two rebel-held areas of the Donetsk and Lugansk in Ukraine, the US announced sanctions, with the White House saying Joe Biden will issue an executive order to "prohibit new investment, trade, and financing by US persons to, from, or in" the two rebel regions.

A better understanding of why Eastern Europe is on the edge of war can be found here.

In this article, we shall try to understand how sanctions work and how Russia might resist them.

What would US sanctions target? Will they crush the Russian economy? What role do Russia's massive foreign reserves play in this situation?

Can its 'de-dollarisation', that is, its attempts to replace the share of US dollars in its foreign reserves with gold and the Chinese renminbi, save the economy from collapse?


How Will Sanctions Work?

There are more than a few ways in which sanctions might hurt Russia.

One of the more effective strategies, according to analysts, is to target Russian banks.

Most transactions of global trade are carried out in US dollars and Russia's top banks are deeply integrated within the international financial system.

If the US blacklists these banks from its financial system, then transacting with them would become extremely difficult, if not impossible.

US President Joe Biden warned about this one month ago, when he said that if Russia invades Ukraine, it "will not be able to deal in dollars."

Sberbank, VTB, and Gazprombank are Russia's three largest banks.

Of the total reserves in Russia's central bank, US dollars constitute 16.4%, which is down from 22.2% in 2020.

Important Russian banks and their total assets at the end of the third quarter in FY'21. 

(Data Courtesy: S&P Global Market Intelligence/Russian Central Bank)

The US has imposed sanctions on foreign banks in the past, especially against Iranian banks.

"Such blacklisting could have a devastating impact on the Russian economy," Caroline Brown, a partner at the law firm Crowell & Moring whose work primarily constitutes economic sanctions compliance and enforcement, told S&P Global.

If these sanctions are slapped on Russia, the government would have bail out the banks, while investing companies would start walking out.

Shares of Sberbank and VTB Bank already fell by more than 30 percent between October 2021 and January 2022 as the likelihood of sanctions kept increasing.

Some of those losses were recovered in February, but the looming threat of war-induced sanctions means that investors could cash out anytime.

The Russian Ruble would plummet against the US dollar, making it financially catastrophic for Russia to hold US dollars in its foreign reserves.

A related option available to the US and to Western European countries is to kick Russia out of the SWIFT financial system.

SWIFT stands for the Society for Worldwide Interbank Financial Telecommunications, and it carries out the shifting of money from one bank to another.

Activating this option would cut off Russia from most international financial transactions.

That means that it won't be able to collect its profits from its oil and gas exports, which accounts for more than 40 percent of Russia's revenue.

The US has used the SWIFT option in the past – with Iran.

Iranian banks were thrown out of the network due its nuclear programme, resulting in Iran losing more than 50 percent of its oil export revenues and 30 percent of foreign trade.

Another much pondered sanctions option concerns Russian oil and energy.

The US has been considering ways to reduce Russia's export revenues, especially with respect to oil and gas.

In the case of Iran, the US had ensured that the former's oil customers reduce purchases over time and switch to other exporters.

A similar strategy could be used against Russian exports, but the costs of that move would be really high.

Global oil prices would spike until other countries can increase production to compensate for the shortage, a process that could take a long time.

Targeting Russia's natural gas exports could also prove to be problematic for the whole word, especially for Europe, which has already been facing natural gas shortages for the past one year.

The economies and the daily lives of people belonging to Scandinavian countries like Austria and Finland, along with other countries like Germany and Poland, could be uprooted if Russia halts its natural gas supplies.


Putin's Plan to Resist Sanctions – De-Dollarisation

The problem with the above-mentioned sanction strategies is that Putin seems to have a backup plan in place already.

In the centre of that plan lies the "de-dollarisation" of Russia's foreign reserves, a process that has created what analysts called "Fortress Russia".

The Russian central bank's reserves have increased more than 70 percent since 2015, according to The Financial Times.

The reserves are now worth approximately $640 billion, which is equal to almost one-and-a half years of its export revenues.

Being the fourth-largest foreign reserve in the world, "This is what gives Putin his freedom of strategic manoeuvre," says Adam Tooze, a Columbia University economic historian, the New York Times reported.

The question is, how much of it is in US dollars?

Of the total reserves in Russia's central bank, dollars constitute about 16.4 percent, which is down from 22.2 percent in June 2020.

Over 30 percent of the reserves are in euros, almost 22 percent are in gold, and about 13 percent are in renminbi.

It is no secret that Putin and President Xi Jinping of China are uniting against the US.

On the opening day of the Beijing Winter Olympics, Putin and Xi announced, with a joint statement, a new strategic partnership between Russia and China.

Xi even supported Putin's demand that NATO must not expand eastwards and that it must not give membership to Ukraine.

Therefore, in case a war does erupt, and US sanctions are imposed, Moscow will have economic support from Beijing.

What the US could do, in order to make their sanctions on Russia more effective, is impose secondary sanctions on China, according to Aaron Arnold in his article for Foreign Policy titled "If Russia Invades Ukraine, Sanction China."

"The simple truth is that the U.S. dollar accounts for nearly 60 percent of global foreign currency reserves—and the Chinese renminbi does not. That is a big stick to wield", he wrote.

Talking about gold, a BloombergQuint report said that "a multi-year drive to reduce exposure to US assets has pushed the share of gold" in Russia's foreign reserves above dollars for the first time.

With more gold than US dollars in its foreign reserves, Russia should be able to hold on (at least for a while) even if it is barred from dealing in dollars, as Biden had warned.

Finally, due to its experience with the 2014 sanctions after the annexation of Crimea, the Russia economy has reduced its reliance on foreign investors.

Additionally, according to FT, the foreign ownership of Russian government bonds has reduced to 20 percent since last year.

Therefore, while foreign investment in the country has dropped, it has also made Russia resilient to future external shocks that could be catalysed by sanctions.

Corporate loans from foreign lenders used to be at $150 billion dollars in 2014. That number has been halved in 2021.

Therefore, on one hand, even if the US doesn't send troops to Ukraine in the case of a Russian invasion, there are ways in which it can hurt the Russian economy.

On the other hand, Putin's "Fortress Russia" may be able to absorb some costs without the economy falling to its knees.

How long it can manage to do that will depend on numerous factors, some of them being the length of the sanctions, the outcome of the war, and the level of Chinese support to the Russian economy.

(With inputs from The Economist, Foreign Policy, the Financial Times, and The New York Times)

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