“Friendly” Currencies Are Becoming a New Reality for Investors
“Since the 90s, various gurus have taught the Russian business world and population to distribute assets between the three main currencies – rubles, dollars and euros. Sometimes there was interest in more exotic world reserve currencies – for example, the British pound or the Swiss franc. The military conflict with Ukraine – the sharpest confrontation between Russia and the West since the end of the Cold War, leading to unprecedented sanctions that limited external payments in major world currencies and blocked about half of the international reserves of the Bank of Russia – significantly changed the situation,” describes Olga Belenkaya, an analyst at Finam, one of Russia’s largest investment groups.
The dollars and euros familiar to the whole world, which account for about 80% of global international reserves and more than 75% of international settlements in the SWIFT system, have become “toxic” for the Central Bank, the Ministry of Finance, Russian banks and a number of companies. For the population, the acquisition, withdrawal and export of cash dollars and euros is still limited by the Central Bank due to the US and EU ban on supplying these banknotes to Russia, and the storage of these currencies in Russian banks is becoming increasingly burdensome due to the commissions and restrictions imposed on currency transfers. There are also examples of forced conversion by banks and brokers of client accounts in the currencies of “unfriendly” countries. There are fears of expanding sanctions, including on the National Clearing Center and National Settlement Depository – which threatens to stop exchange trading in the dollar and the euro in Russia, in which case the exchange rate could become even less transparent.
The Central Bank defines the ongoing processes as a “structural transformation” of the Russian economy – logistics chains are being rebuilt, and the transition of external payments into national currencies is accelerating. Against this background, interest in the currencies of countries that have not yet joined the Western (in the broad sense) sanctions – the currencies of so-called “friendly countries” – is naturally growing. In fact, the motives of the population and business may be different – use for trade, investment, tourism, relocation, or as a means of saving.
What factors should be paid attention to here?
The first factor is the liquidity of a currency, the ability quickly and with minimal losses to carry out its purchase and sale, exchanging it for other currencies. This characteristic depends on its popularity in international payments. Ideally, the greatest liquidity is with the world’s main reserve currencies, in which the IMF includes the US dollar, the euro, the Chinese yuan, the Japanese yen, the British pound, the Australian and Canadian dollars, and the Swiss franc – as mentioned above, the US dollar and the euro lead by a significant margin. Of the “friendly” or neutral countries, only the Chinese yuan meets this criterion.
The second factor is the convertibility of the currency, that is, the absence of restrictions on residents and/or non-residents owning and/or performing operations with this currency. Unfortunately, the yuan is not a completely freely convertible currency at the moment.
The third is the stability of the exchange rate (primarily against the dollar, in which most of the goods of Russian commodity exports and goods imported to Russia are denominated). Unfortunately, most “friendly” currencies are not known for being stable. For example, the Turkish lira depreciated by 96% against the dollar over the year, and by 378%(!) over five years. The Indian rupee is more stable – for the year the loss is under 10%, and 26% for 5 years – but this instrument is not yet represented on the Moscow Exchange. Perhaps this is due to currency control restrictions in India. And even the yuan is near a 15-year low against the dollar amid weakening Chinese economic growth and divergence of monetary policy (the Fed is actively raising interest rates to curb inflation, while the Bank of China is lowering them to support the economy).
Therefore, currencies with an explicit peg to the dollar exchange rate have a significant advantage – for example, the Hong Kong dollar, the exchange rate formation of which takes place using the currency board approach, in a narrow range of 7.75-7.85 per US dollar. That is, this is actually a proxy for the dollar, but with significantly less risk of the blocking of assets. Also pegged to the dollar are the currencies of a number of countries in the Middle East, including the UAE dirham (1 dollar = 3.6725 dirhams). At the same time, there have been many cases in history when countries, due to a sharp deterioration in the balance of payments, were forced to abandon an exchange rate peg and devalue their currencies. This has often happened in commodity-oriented economies, but not only. For example, in 2015 the Swiss National Bank (SNB) abolished the rigid peg of the franc to the euro and abandoned the policy of protecting the weighted average exchange rate of the two currencies at the level of 1:1.20.
Therefore, macroeconomic and political stability are necessary for the stability of the exchange rate. In the case of the Hong Kong dollar, support for the corridor in the face of a weakening yuan is now more difficult for the Monetary Authority (which performs the function of a central bank). It has to intervene in foreign exchange, selling dollars to local banks and buying the national currency – which leads to a decrease in foreign exchange reserves and at the same time to a reduction in the liquidity of the national currency and to an increase in interest rates, increasing pressure on the real estate market. Nevertheless, Hong Kong has sufficient resources to protect the exchange rate: foreign exchange reserves exceed $400 billion, and if necessary, the reserves of mainland China (already measuring trillions of dollars) can be used. The UAE has a low public debt (about 30% of GDP), and a very high current account surplus (according to the IMF, this year it will be more than 14% of GDP), but long-term risks are connected to a possible decline in oil prices and to potential political changes.
The fourth is the ability to easily buy/sell currency on the Russian market. According to the Moscow Exchange, the US dollar, the euro, the British pound, the Japanese yen, the Swiss franc, the Hong Kong dollar, the Chinese yuan, the Belarusian ruble, the Kazakh tenge, the Turkish lira, the South African rand, the Armenian dram, and the Uzbek sum are all traded for rubles. Dollars can buy euros, British pounds, Japanese yen, Swiss franc, Chinese yuan, Kazakh tenge, Turkish lira, South African rand, and Armenian dram. However, due to problems with settlements that arose as a result of sanctions, the Moscow Exchange has indefinitely suspended trading in the British pound, Japanese yen, and Swiss franc.
From October 31, the Moscow Exchange has launched trading in the Kyrgyz som and Tajik somoni. Also, a representative of the Moscow Exchange has reported that the site is working on launching trading in rupees, but due to difficulties on the side of India, the currency will not be able to be brought to trading this year. Since the beginning of the year, the share of operations with currencies of the EAEU countries and the Asian region in the total volume of spot operations has increased from 0.5% to 25%. However, in fact, the main contribution to this was made by the Chinese yuan. Thus, according to the Bank of Russia, the share in the volume of exchange trading of currency pairs with the yuan reached 26% in August (as opposed to 6% in April), while the share of the dollar/ruble currency pair decreased from 58% to 43%, and the euro/ruble – from 32% to 23%.
The yuan is the absolute leader in popularity among “friendly” currencies. Thus from October 1 to October 28, the average daily trading volume for the yuan in settlements “tomorrow” amounted to 75 billion rubles. For the Kazakh tenge it was 400 million rubles, the Belarusian ruble – 261 million rubles, the Hong Kong dollar – 195 million rubles, the Turkish lira – 124 million rubles, and the Armenian dram – 1 million rubles. For the South African rand, trading volumes are zero, and one transaction for 5.6 thousand rubles took place with the Uzbek sum. The Arab dirham is not yet traded on the stock exchange, but some banks are already actively offering operations buying and selling cash in this currency.
The fifth is the possibility of using the currency for foreign trade operations and tourism. Other than the dollar and the euro, the absolute leader here is the yuan. The trade turnover between Russia and China for the first nine months of this year increased by 32.5% and amounted to $136 billion, and for the year, according to the Ministry of Economic Development, it can reach $165–170 billion. The importance of India in foreign trade with Russia is growing: in the first six months of this year, the trade turnover between the two countries increased by 120% and reached $11.5 billion. However, the country has quite strict currency restrictions – foreign trade operations are carried out mainly in dollars, pounds sterling, euros, or yuan. In July, however, the Reserve Bank of India proposed a new mechanism for international trade transactions in rupees, which will facilitate settlements with countries under sanctions (Russia, Iran). Against the background of the forced withdrawal of Russian companies from Western markets, Dubai is becoming one of the most important hubs for trade, transport, and financial flows. Turkey is interesting both from the point of view of trade turnover with Russia ($33 billion in 2021, and this year obviously will be more), and from the point of view of tourism – but a serious minus is that the Turkish lira is an extremely weak currency, as mentioned above, and inflation in the country this year exceeds 80%.
The sixth is the availability of instruments for investing/saving in the foreign currency. And here the yuan is quickly gaining popularity – according to banki.ru, deposits and savings accounts in yuan are offered by dozens of banks in Moscow at rates (for deposits) of 1-2% on average. Deposits in other “friendly” currencies are still exotic. In addition, yuan can be placed in bonds of Russian corporate issuers (Rosneft, Rusal, Polyus), which later may be joined by the Ministry of Finance (its representatives have said that they were considering such a possibility). Hong Kong dollars can, for example, be invested in shares of Hong Kong (Chinese) companies traded on the St. Petersburg Stock Exchange.
Thus at the moment, in fact the only real competitor to the dollar and the euro in the Russian market is the Chinese yuan. This is recognized in practice by the Ministry of Finance of the Russian Federation, since only this currency can be purchased for the NWF within the framework of the budget rule. The currencies of the CIS countries are still too risky – small, usually poorly diversified economies, and poorly developed financial markets. From the point of view of investment, the Hong Kong dollar may be interesting in the future, and from the point of view of transactions – the Kazakh tenge (the largest and most developed economy in Central Asia) and the Arab dirham. But we must remember that economically these currencies are much more risky than the dollar and the euro. One should not rely so recklessly on the eternal “friendliness” of the issuing countries. After all, when decisions were made to get rid of the dollar in the structures of the NWF and reduce its share in the international currency reserves of the Russian Federation, this was largely done through an increase in the share of the euro – as it was believed that Europe would not join the toughest sanctions. Those hopes were dashed, however; even neutral Switzerland has joined several packages of EU sanctions against Russia.