Russian Bank Squeeze Lacks Punch --- While blocking currency reserves puts pressure on the ruble and the economy, commodity exports still offer support

"It is hard to conceive a complete collapse of Russia's economy as long as it can keep selling its oil to Western nations at almost $100 a barrel.

Over the weekend, the U.S., the European Union, the U.K. and Canada made the unprecedented announcement that they would stop the Russian central bank from using its foreign-currency reserves, diminishing the country's ability to protect the ruble, which plummeted on Monday. They are also seeking to cut off some Russian banks from the ubiquitous Swift messaging system.

Ever since invading Crimea in 2014, Moscow has sought to reduce its foreign dependency. Imports have been partly replaced by domestic products, the Russian central bank beefed up its reserve pot, linkages with foreign banks were reduced and a Russian alternative to Swift was developed.

The blow remains painful: Of the $630 billion held in reserve by the central bank, more than half is probably blocked. Gold held domestically made up less than a quarter of the pot in mid-2021, and it won't be easy to sell quickly. Most reserves were liquid foreign deposits and securities, but less than 15% were in China. Almost all the rest is invested in Western markets.

Yet Russia suffered a serious recession in 2015 and the Russian central bank managed to avoid a currency-led inflationary spiral by aggressively raising interest rates. It did the same on Monday by pushing them to 20% from 9.5%.

Moreover, the post-2014 woes happened as the price of crude oil fell off a cliff. This time, Brent futures are hovering around $100, boosting Russia's current-account surplus, which is forecast to be around $20 billion a month.

As Sofya Donets at emerging markets-focused Renaissance Capital pointed out Monday, this is likely to grind closer to $30 billion when Russian economic growth wobbles and imports decrease. This means a lot of dollars and euros coming in to pay for goods, services and debt interest. And the central bank's gold and yuan still pay for eight months worth of Russia's estimated imports for 2022.

Investors shouldn't fall for the trope that nations with current-account surpluses can't suffer currency and financial crises. They can, and Russian banks will experience both. Swift exclusion will cause big disruptions, given persistent linkages with Western financial systems.

On Monday, the European Central Bank said the European arm of Sberbank, Russia's biggest lender, is likely to fail because of a run on its deposits.

Still, Russian officials can provide infinite liquidity in rubles, and have other foreign-exchange tools. On Monday, they mandated firms to convert 80% of their revenues from abroad into rubles, and stopped foreigners from selling domestic securities. Nonresidents held 20% of ruble-denominated sovereign debt in January, S&P Global Ratings data shows. Admittedly, short-term gyrations say little about where the ruble is headed, but it was down about 15% against the U.S. dollar in the European afternoon, compared with more than 30% initially.

The bottom line is that the magnitude of Russia's energy sector is so disproportionate -- half of its exports and a fifth of the economy -- that its rude health probably puts a floor under how bad things can get for the ruble.

The question then is whether Western nations are prepared to undermine it in ways that would also be painful for them.

The sanctions on Russia announced since it invaded Ukraine last Thursday have been carefully designed to exclude commodity imports. The West buys about $350 million worth of Russian crude daily and Europe spends another $300 million on gas.

European-Russian energy interdependence was intentionally built up in recent decades, a mainly German-led effort to align interests and avoid conflict that has aged very badly.

Europeans could go cold turkey. It would be painful and costly for a few years. Existing gas inventories could probably see it through this winter, but the following two or three years would need industrial rationing and have "profound economic consequences" such as higher prices for energy, fertilizers and steel, according to an analysis by think tank Bruegel.

European gas needs can be reduced over time with measures like replacing gas-fired boilers with heat pumps, renovating buildings to use less energy, extending the life of nuclear power plants, and increasing renewable-energy generation and power storage. Shares in companies that serve the renewables sector soared on Monday, with those of wind-turbine giant Vestas up 15%.

Europe could also agree long-term contracts for liquefied natural gas (LNG) from suppliers such as the U.S. and Qatar, though they would likely take between one and three years to start delivering. It isn't quick or cheap but it is possible.

A Western oil embargo is another option. However, it can be difficult to hit Russia's crude sales as it doesn't face the shipping bottlenecks of natural gas and can sell its oil around the globe to other international buyers. Banking sanctions targeting oil cash flows could make others wary of buying.

Even comprehensive sanctions don't have a great track record. Those levied against the regimes in Iran and Myanmar increased the power of the existing regimes and enabled them to pass the pain on to their citizens, says Lee Jones, professor of international politics at Queen Mary, University of London.

The flagship example of success remains the fall of South Africa's apartheid regime some 30 years ago, where a strong opposition and very weak economy also played crucial parts.

German foreign policy moved with astonishing speed over the weekend, underlining the growing appetite for tough decisions.

As long as sanctions spare oil and gas, Moscow may be able to endure its growing isolation." [1]

The analysis of political component in this story is weak. Germans just had their elections. They can afford to make a little show of their power. Americans are approaching elections. Too much inflation could be very tough for ruling Democrats there.

1. Russian Bank Squeeze Lacks Punch --- While blocking currency reserves puts pressure on the ruble and the economy, commodity exports still offer support
Sindreu, Jon; Toplensky, Rochelle. Wall Street Journal, Eastern edition; New York, N.Y. [New York, N.Y]. 01 Mar 2022: B.12.