Strict Currency Control: Reasons and results

Strict currency control was not imposed in Russia by chance. The reason for it was the unprecedented sanctions imposed by the West immediately after the beginning of the special military operation in Ukraine. As a result Moscow was forced to take a range of measures limiting currency operations in the country. What will this lead to? Will Russia prohibit the circulation of the dollar and the euro? And if so, what will take their place: the Chinese yuan, the Indian rupee, the Iranian rial, or the Turkish lira? These questions are answered by Alexander Potavin, analyst at one of the largest investment groups in Russia, Finam.

 

Step by Step

The troubling news of the start of military operations in Ukraine, and the imposition for it of sanctions on Russia by the west, led in the beginning of March 2022 to the ruble losing 45% of its value compared to the dollar, with the USD/RUB rate jumping to 100–125 rubles. Our currency had not seen this kind of sudden collapse in the last decades.

In order to stabilize the ruble exchange rate, the Central Bank of Russia then took a range of emergency steps: raised the key rate from 9.5% to 20%, imposed mandatory sales of 80% of foreign currency receipts by exporters, prohibited the sale of securities to nonresidents, introduced a commission of 12% on currency market transactions by private individuals, and also imposed restrictions on the expatriation of capital from Russia. All of these steps were taken in order to maintain calm on the financial and currency markets of Russia, as the western sanctions imposed indeed turned out to be quite severe.

Also, from March 9 the CB imposed a ban until September 9 on the sale of foreign currency cash to private individuals. A short time later, from March 18, they allowed the sale to citizens of foreign currency cash  – but only that which was received by the credit organization after April 9, 2022, and with an overall limit of $10,000 or the equivalent in euros. Foreign currency can be exchanged for rubles with no limitations. There is also an exception for legal entities and individual entrepreneurs who are legal residents of the RF, who during this period are allowed to receive cash US dollars, Japanese yen, British pounds, and euros  – but only up to $5000, and only for the payment of expenses for foreign business travel. From March 2, it is prohibited to take out of the country foreign currency cash and monetary instruments totaling more than the equivalent of $10,000 (calculated at the official CB rate on the date of travel).

In August, the Central Bank of the RF announced that in September it would extend these limitations on the sale of foreign currency cash to private individuals. In essence, this means that for now the ruble remains a partially-convertible currency. That is, having purchased hard currency on the currency market at the current low rate, it remains impossible to receive it in cash at a bank. The reason for this is completely banal: since February 24, it has been forbidden to bring into the country foreign currency cash from Europe and the USA. The population is forced to buy the foreign currency cash remaining in the country at an inflated rate, which at currency exchange points is about 10–15% higher than the market rate.

This spring the CB also limited the transfer of money abroad. In the course of a month, a private citizen had the right to transfer to their accounts abroad (or to other persons) no more than $5000, or the equivalent in another currency. Later this sum was increased to $10,000, then $50,000, and later to $1,000,000. However, these transfers are allowed only to legal residents or foreign citizens of so-called “friendly” countries. Citizens and legal entities from “unfriendly” countries are prohibited from making transfers at least until October 1.

In their July overview, the CB RF showed that essentially the only category of participants in the domestic market acting as sellers of foreign currency between April and June 2022 were the largest banks. In this period, they sold dollars and euros on the currency market totaling 2 trillion rubles, mostly the funds of their clients from the export field. The other categories of participants in the currency market mostly purchased foreign currency. During this period, citizens of the RF purchased 400 billion rubles of foreign currency  – that is, twice as much as two years ago (200 billion), and 30% more than last year.

Traditionally the dynamics of the market rate of the ruble depends a great deal on the flows of foreign currency in and out of Russia. According to the CB RF, the current account surplus of the balance of payments of the RF in the first half of the year totaled $138.5 billion rubles  – as compared to $39.7 billion a year earlier. The surplus of the RF of foreign trade in goods and services in the 1st half of the year came to $158.4 billion, versus $60.5 billion in the previous year. This shows a continuing unbalance in the foreign trade of Russia: the import of goods and services has fallen sharply, while inflows of foreign currency, from the sale of oil at increased prices, have grown.

 

There Is No Ban Yet

There is hope that in the coming months Russian business will be able to establish full-fledged commodity flows for the import of goods and services to Russia. In that case, the domestic demand for foreign currency would grow. On the other hand, the introduction of a ceiling price for Russian oil exports is expected by December. At about the same time should begin to take effect both the ban of the EU on insurance of tankers with Russian oil, and the abandonment of its delivery to European consumers by pipeline. This should reduce the flow of money from export sales of Russian oil and gas, which will negatively impact the exchange rate of the ruble. It appears that by the end of the year, the dollar exchange rate may rise to about 70–75 rubles.

Officially the Russian government is not currently planning to forbid the circulation of American and European cash in our country. It is difficult to change quickly the stereotypes in the attitudes of ordinary citizens to these world currencies, as this process has been going on in Russia for decades. According to the CB, our population is holding about $85 billion of dollar and euro cash. Banks are still able to buy and sell these currencies, and open deposits. Yet it is not possible to say this about the Chinese yuan, Indian rupee, or Turkish lira, banknotes of which are indeed difficult to purchase even in Moscow.

 

What’s next?

However there are a series of problematic issues which indicate that the situation in the RF with so-called “unfriendly” currencies will soon become quite difficult. Citizens and legal entities will not be prohibited from using American dollars, euros, Swiss francs, or Japanese yen (the key reserve currencies of the world). Yet such unbearable conditions will be created that the holders of these currencies will themselves decide to give up holding and performing transactions using them.

At the beginning of August the President of the RF signed a decree which allows Russian banks which have come under sanctions to freeze for legal entities and individual entrepreneurs certain operations with the currencies of those countries which imposed the sanctions on the bank. That is, if the USA imposed sanctions on a Russian bank, then it has the right for an unspecified time not to pay in dollars the funds of the deposits of companies and individual entrepreneurs. However, the bank is granted this right only if the obligation to the client appeared after the publication of the decree, on August 8.

So previously, if a bank came under sanctions, then a legal entity client (or individual entrepreneur, who is treated the same way) could try to:

• transfer their foreign currency funds to another bank which is not under sanctions  – but this option was widely blocked by banks;

• exchange their foreign currency for rubles, transfer the rubles to another bank, and there once again buy foreign currency.

Now it appears from what is written in the decree that if a bank is under sanctions, on new currency obligations in the corresponding currencies (including transfers and issuance), its obligations to legal entities are simply suspended indefinitely. That is, even the option of transferring to rubles is not prescribed.

If a bank decided to suspend payments in a foreign currency, then for the period of this suspension interest would not accrue on those funds which the bank received on deposit after the presidential decree came into force, nor would measures of responsibility for the bank’s failure to fulfill its obligations on deposits in foreign currency be applied. But at the same time, the bank’s client would get the right to claim his foreign currency obligations from a foreign counterparty.

Since the spring, the number of banks which are able to conduct transfers under the SWIFT system has declined sharply, and the reserves of the CB itself in the main world reserve currencies have been frozen. Thus, the bank of Russia has no choice but to declare western currencies “toxic” and contribute to the “acceleration of the process of uncoupling from foreign currencies” by deliberately squeezing them out of circulation, and reducing the number of banking operations in these currencies within the Russian Federation.

 

The Yuan and the Rupee Instead of the Dollar and the Euro?

The absence of the CB RF from the foreign currency trading of the Moscow Exchange over the last two months (due to the suspension of the budget rule) has already led the ruble to be the most volatile currency in the world, beating out even the Turkish lira in this category. Predicting and hedging such large price swings is extremely difficult. This creates uncertainty, both for importers and exporter, and also for ordinary citizens.

In light of this situation, the CB RF is not looking at the possibility of introducing new premiums to risk ratios for foreign currency loans and securities, which will depend on the issuer of the currency and their status as “friendly” or “unfriendly” to the Russian state. In addition, the regulator will assess the feasibility of applying an increased reserve ratio requirement for banks’ liabilities in so-called “toxic currencies.”

In connection with this, at the start of August the Moscow Exchange sharply increased the security requirements of fixed-term contracts for the euro and the dollar, and lowered them for the yuan, reflecting the general trend of moving away from the currencies of “unfriendly countries” under the auspices of the Bank of Russia. As a result, Russian companies have no choice but to wrap up operations in “unfriendly” currencies, reducing assets and liabilities in them, and move to the currencies of “friendly” countries, such as the Chinese yuan, the Hong Kong dollar, the Indian rupee, the Iranian rial, and the Turkish lira.

The Moscow Exchange ended trade in the Japanese yen on August 8. This restriction affects spot and swap instruments for the currency pairs of the yen with the ruble (JPY/RUB) and dollar (USD/JPY), in both the exchange and over-the-counter regimes. The exchange justifies this suspension of operations by the risks of difficulties in conducting settlements in the Japanese currency. The JPY/RUB currency pair previously held the 11th place in the volume of transactions in the currency department of the Moscow Exchange. In June, the Exchange temporarily suspended trade in the Swiss franc, also due to difficulties in conducting settlements because of sanctions.

Thus a unique situation has appeared in Russia, where the use of various exchange-traded assets and currencies is limited  – causing their prices to become more distant from the market, operations with them to become problematic, and holding them to become unprofitable. Since the majority of international transactions are conducted in the dollar or the euro, the forced acceleration of the decoupling of Russia from these currencies has made the international operations of local importers and exporters more difficult  – especially importers, as exporters retain the right not to repatriate to Russia a large portion of their foreign currency earnings.

The population will continue to acquire foreign currency only when absolutely necessary (such as foreign travel, purchasing foreign real estate, medical treatment abroad, or help for relatives living outside Russia). The external isolation of Russia and the strict sanctions will end up meaning that purchasing and maintaining savings in foreign currency, particularly in “toxic” currencies, will become unprofitable for the citizens of Russia.