APPENDIX

On numerous occasions throughout history, exceptional monetary strategies have been implemented in times of conflict. In the current context of its invasion of Ukraine, Russia is no exception to this rule. To prevent the Russian Central Bank (CBR) from countering the heavy economic sanctions imposed by the United States and its allies, the later have resorted to an unprecedented asset freeze. However, despite the heavy burden of international sanctions on its reserves, Russia’s economy is, to this day, holding up far better than expected. The CBR has successfully prevented a bank run, inflation has eased to 13.7 percent and the ruble is currently worth more than it has since 2015[1]. But to what extent can this seemingly insolent success last?

Although the use of financial weapons has become a common facet of international conflicts, Russia is now in an unprecedented situation due to the magnitude of these sanctions and the number of countries imposing them. A first series of restrictions had been adopted in response to the 2014 annexation of Crimea. As a result, over $124 billions of capital left the country, leading to a significant devaluation of the ruble and a severe economic crisis[2]. Consequently, Russia enhanced its resilience by amassing over $640 billion in official reserves made up of cash, gold, and government bonds from other countries[3]. The nation thus effectively doubled its hoard in the space of five years (Appendix 1)[4]. This strategy, known as “Fortress Russia”, ambitioned to make the country’s economy immune to economic sanctions.

However, the full-scale invasion of Ukraine last February signed the advent of a new paradigm. The resulting sanctions enacted by the United States and its allies have been described as “a nonviolent nuclear attack on Russia’s economic system”[5]. They include, among numerous individual and sectorial designations, a ban on all transactions related to the management of reserves and assets of the Central Bank of Russia. This encompasses all direct and indirect transactions involving the purchase, sale, investment services or assistance in the issuance of securities and money market instruments issued since April 12, 2022[6].

Accordingly, over half of the assets held by the Bank of Russia have been frozen[7]. The country is therefore impotent to use its reserves in order to limit the impact of sanctions on its economy, either by keeping the ruble exchange rate stable or by providing funds to its banks to limit the rise of inflation. The measure is not limited to cash, as various commodities fall under the yoke of these international sanctions. This includes gold, which has recently emerged as a central element of the “Fortress Russia” strategy, and now exceeds the weight of the dollar in Russian reserves (Appendix 2).

In order to effectively analyze the monetary consequences of the CBR’s asset freeze, it is first necessary to place our assessment in a threefold context: the structural slowdown of the Russian GDP which pre-dated the invasion of Ukraine; the primary impact of the war on Russia’s economy; and finally, the weight of western economic sanctions along with the countermeasures taken by Russia. These three dimensions are not entirely separable, which is why it is important to take a multi-dimensional approach in order to provide a coherent quantitative and qualitative analysis[8].

At first, the Bank of Russia’s reserve freeze proved devastating. It caused the value of the ruble to fall by 22 percent, thus increasing the price of imported goods and leading to a 14 percent climb of the inflation rate. In addition, Russia’s GDP was first expected to fall by 9.6 percent in 2022[9]. The move thus led the deputy chief economist of the Institute of International Finance to predict that “Sanctioning Russia’s central bank is likely to have a dramatic effect on the Russian economy and its banking system, similar to what we saw in 1991. This would likely lead to massive bank runs and dollarization, with a sharp sell-off, drain on reserves — and, possibly, a full-on collapse of Russia’s financial system”[10].

However, it now appears that none of these conspicuous predictions have come true, most notably on the monetary level. If the ruble has since recovered, it is above all through the action of Elvira Nabioullina at the head of the Central Bank of Russia. The latter has guided the extraordinary rebound of the Russian currency through the drastic increase of its key rate from 9.5 percent to 20 percent. The institution subsequently enacted a gradual decline in order to minimize the prolonged impact of sanctions on households and businesses (appendix 3)[11]. In her latest press conference, Nabiullina announced the upkeep of her institution’s benchmark interest rate at 7.5 percent: “We had a very broad consensus on the decision that the rate should be left unchanged. As for our further actions, we believe that monetary policy is now in the neutral zone and in doing so we have given a neutral signal[12]”. Such action can be interpreted as the result of the observed slowdown in the price growth rates, and an overall easing of inflationary pressure. Additionally, The International Monetary Fund reduced its earlier prediction of an 8 percent drop in Russian GDP for 2022 to a 6 percent contraction, noting that crude oil and non-energy exports were stronger than anticipated[13].

This undoubtedly raises the question of the asset freeze’s true effectiveness. The initial intent of the move was to cause a crisis in Russia’s liquidity and balance of payments, which would have considerably complexified the financing of the invasion. On this precise point, the measure has yet to increase the cost of the war to the point of making Vladimir Putin give up. However, Russia’s unviable spending spree has led to the nation’s first budget deficit in years, despite high energy prices. In addition to the dramatic increases in military expenditure, Vladimir Putin is thus turning to manifestly unsustainable fiscal and monetary policy measures[14].

In conclusion, it appears that the CBR has so far managed to limit the monetary implications of the 2022 freezing of its foreign held assets, thanks in part to its “Fortress Russia” strategy. However, this has come at the hefty price of drastic fiscal and monetary action which will undoubtedly prove unsustainable in the long run[15].

Whatever the timeline turns out to be, the move has most certainly created a valuable monetary precedent, which will serve as a warning to all aggressive nations in the future.

[6] See: Council Regulation (EU) 2022/334 of 28 February 2022 amending Council Regulation (EU) No 833/2014 concerning restrictive measures in view of Russia’s actions destabilising the situation in Ukraine.

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