Targeting Russia’s central bank reserves might be the most effective weapon in the West’s financial armoury, as it strikes at the heart of the country’s financial system. It’s an unprecedented measure that enhances previous Western restrictions while also posing hazards.
In a joint statement released Saturday, the US, Europe, and Canada promised to prohibit the Bank of Russia from using its $630 billion international reserve stockpile “in ways that undermine the impact of our sanctions.” The action is aimed squarely at President Vladimir Putin’s war chest, which he has amassed in recent years to help protect Russia’s economy from external threats.
According to analysts and central bank officials, the decision may be a hammer blow to Russia’s financial system, reducing the government’s capacity to defend the ruble in currency markets, make foreign acquisitions, and guarantee banks affected by international sanctions.
Russia has spent years accumulating reserves, transforming money from oil and gas sales abroad into a large pile of securities, bank deposits, and gold. Foreign reserves are, by definition, stored overseas, frequently in foreign government bonds and accounts with commercial banks and central banks.
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According to a recent study by Russia’s central bank, the changes announced Saturday would affect about 40% of Russia’s reserves stored in North America and Europe as of last June.
According to the statistics, the plan has gaps and potential loopholes, particularly the lack of involvement by China, a significant Russian trading partner that controls approximately 14% of the country’s foreign reserves. Experts have noted that it also goes against a long-standing practise of recognising central banks’ sovereign immunity.
“In the realm of global finance, it’s a nuclear bomb,” said Sony Kapoor, a finance professor and CEO of the Nordic Institute for Finance, Technology, and Sustainability, an Oslo-based think tank.
“Any form of financial transaction will be subject to a significant Russia discount and risk premium.” Mr. Kapoor predicted that the event would be “macro important” and “very unpleasant.”
According to those acquainted with the situation, Russia may have already depleted a significant portion of its European stockpiles in recent months.
According to Russian central bank figures, Germany and France combined accounted for nearly 22% of Russia’s international reserves in June. According to a French official, those figures have altered dramatically since then.
In the immediate term, the action constitutes a huge blow to the Russian banking system’s survival. In the long run, it “opens a huge Pandora’s box” that might hasten the construction of a global financial infrastructure that is immune to the West’s capacity to disrupt it, according to Mr. Kapoor.
There are just a few precedents, all of which target economies that are far smaller and less integrated than Russia’s, such as Iran, Venezuela, and North Korea.
“Normally, it’s difficult to explain something like this under international law and the idea of sovereign immunity without a United Nations Security Council resolution,” Mr. Kapoor said.
China is the big unknown. Given the size of China’s foreign reserves and banking sector, if Beijing chooses to back Russia, the sanctions’ impact will be significantly reduced.
While the specifics of the move have yet to be revealed, it is likely to limit Russia’s ability to provide foreign currency backstopping to the country’s banks, which have recently been weakened by Western sanctions, including removal from the Swift messaging system, which has harmed their ability to operate globally.
Foreign investors face new monetary and commercial risks as a result of the shift. Previously, investors might have counted on the central bank to intervene if something went wrong in Russia. Because the central bank would not allow it, the ruble would never fall in value. This will almost certainly result in financial outflows.
Stefan Gerlach, a former deputy governor of Ireland’s central bank, stated, “It tremendously complicates the management of the Russian economy.”
Mr. Gerlach stated, “Financial systems require one thing to function: confidence.” “If you do business, you must trust your counterparty. Dealing with them becomes a lot riskier when you understand they won’t be able to obtain support from their government if they need it. You’ve basically yanked the rug out from beneath the banking system.”
The judgement carries legal ramifications. Russia’s Central bank assets being frozen might set a precedent for targeting government finances for various reasons.
Someone may, for example, sue Norway’s $1.3 trillion Oil Fund, which is controlled by the central bank and invests earnings from oil sales, over the country’s influence on climate change, according to Mr. Kapoor. Around half of the fund’s assets are located in the United States.
Some nations may respond by shifting their reserves out of the West, resulting in a global financial system split.