This is THE question of the hour: will Westerners’ weapon of massive deterrence, financial suffocation, end up making Vladimir Putin bend?
In the immediate future, the strategy will not force the dictator to withdraw his troops from Ukraine. The financial bomb did its first major damage, however. It forced the Moscow Stock Exchange to close to halt the rout of its securities, in addition to dropping the Russian ruble by 21% on Monday and boosting interest rates.
Who knows, therefore, if the financial suffocation will not play a central role in resolving the crisis?
What exactly does it consist of? Essentially, Westerners want to prevent Russian companies and individuals from trading with foreigners or, in other words, using the Russian ruble to acquire goods, services and foreign currency.
To do this, the United States and its allies – and even the historically neutral Switzerland – have agreed that several of the major Russian banks will no longer have access to the Swift system, which is a global platform for banking communications, a kind from Interac. About 70% of the Russian banking sector would be affected.
The Russian financial system could find an alternative, but it will be much more expensive and it will take time.
With the freezing of access to the Swift system, the demand for the ruble suddenly dried up, companies could no longer use this monetary unit to make imports and exports.
This downward pressure on the ruble against other currencies is accentuated by the crisis of confidence among the population, who are starting to queue up to withdraw their bank deposits in rubles.
Normally, the Russian Central Bank could have dipped into its enormous reserves to contain the situation, that is to say, to support the ruble and thus finance the daily activities of the Russian economy, in particular the war. Since the invasion of Crimea in 2014, it should be noted, Russian reserves have gone from the equivalent of 499 billion US to 630 billion US.
But the Central Bank is handcuffed: the Western countries have agreed to refuse all transactions of the Bank, therefore those denominated in “Western” currency.
According to the 2022 report of the Central Bank of Russia, two-thirds of the Bank’s reserves were denominated in “Western” currencies (euros, US dollars, pounds sterling, etc.) as of June 30, 2021. And only 13.1% were in renminbi, the currency of the only major country that did not denounce the invasion, China, while 21.7% is made up of gold.
In short, most of the bank’s reserves cannot be used to halt the collapse of the rouble. “The goal is to cut off the Russian financial system,” explains Hendrix Vachon, a Desjardins Group economist specializing in currencies.
To cope with the situation, the bank is forced to boost its reference interest rate. On Monday, it went from 9.5% to 20%. This jump, the Bank hopes, will have the effect of encouraging savers to leave their assets in the banks, rather than rushing to withdraw them. It also aims to curb the flight of Russian capital abroad.
Another tool to stimulate demand for the ruble and curb its collapse is the requirement for Russian exporting companies to convert 80% of their cash on hand into rubles in the future. Ordering won’t be easy, given the frozen access to the Swift system.
In the medium term, the backlash will be major for the Russian population. With an interest rate of 20%, the Russian economy will be hit hard, probably more than with the 2014 Western sanctions on imported goods. In addition to these high interest rates, there will be a highly inflationary context.
“The strategy of financial suffocation could resolve the crisis. In any case, it gives the desired effect for the moment,” says Hendrix Vachon.
HEC Montréal professor Jean Roy, an expert on the financial system, is not so sure.
Not all Russian banks have been excluded from the Swift system. There will therefore be a possible circumvention. It makes international financial transactions difficult, but not impossible.
Jean Roy, professor at HEC Montreal
Banks not excluded are those used for natural gas transactions between Russia and Germany, among others.
China can play a big role in the stability of the Russian financial system. “If China looks elsewhere, it could work, if not, Russia will have a lot of support,” said Mr. Roy.
The expert believes that it is perhaps the oligarchs, who see their fortunes collapsing and their stays in Europe prohibited, which are likely to have more effect, by putting pressure on Putin.
The National Bank’s chief economist, Stéfane Marion, believes that the suffocation of the Russian financial system may cause Putin to reconsider his options. However, he fears “the effects of contagion elsewhere in the global financial system”.
In fact, if Russian companies can no longer make transactions, many international suppliers will be deprived of payments, past and future. And these ramifications will particularly affect emerging countries, including China, he believes, with its indirect effects on the G20 countries.
“We are entering totally uncharted territory,” says the economist.