You know, it’s all too easy to dismiss Russia’s economy as a retreating one with stagnant GDP and a rapidly aging population. However, if that is the case, then how is it possible that Putin is so confident in his geopolitical adventures? After all, he is risking the same economic sanctions of Western powers that have devastated the economy of his ally Iran. Well, in this post we will tell you why Russia’s economy is immune to western sanctions?
Well, one reason why Putin cares less about these sanctions is that, unlike Iran, Russia’s economy is self-sufficient where it matters. It has:
- Massive agricultural sector
- Plenty of raw materials
- Advanced Information Technology sector
- State of the art-defense and aerospace industries
But, you know what, this is not the most important reason that Putin is just not that afraid of Western economic sanctions. Let us present to you the one thing standing between Russia and Western economic sanctions.
Foreign Reserves in Russia’s central bank
The central bank of the world’s 11th biggest economy has amassed the fifth largest pile of foreign currencies in the world. So, how do these, central bank-owned, foreign exchange reserves protect mother Russia?
Well, imagine the West cuts of both Russian firms and banks from its massive financial markets. No problem, they just turn to the Russian government for a share of that foreign exchange pile. Or, now imagine that these sanctions lead to a speculative run on the Russian Ruble. Again, no problem. The Russian central bank can just use its vast reserves. It can use it to buy back Rubbles on foreign exchange markets, stopping the fall.
But, hold on, you could now credibly argue that, while a bit smaller, Russia also had a significant war chest of foreign reserves when it was hit by economic sanctions after annexing Crimea in 2014.
Concretely, these sanctions meant preventing many Western companies from doing business with Russian firms in the energy & defense sector. But, more importantly, it meant that Russian banks were suddenly shut off from Western capital markets.
As a consequence, the Russian economy was faced with a financial crisis, a run on the Russian rubble. And, as a result, inflation shooting up to 16%. For comparison, inflation is 7% today in the USA and people are already losing their freak in minds. And all of this happened despite Russia’s impressive war chest of foreign reserves.
What did Russia learn from this experience?
First of all, it learned that it needed even more reserves to take away any doubt that Russia wouldn’t be able to defend the Rubble against speculative attacks. So, instead of investing their oil and gas money in the local economy, Russia invested it in foreign exchange reserves instead. Second, Russia’s private sector learned to depend less on foreign finance.
Did all of this lead to economic hardship for ordinary Russians over the last few years?
Sure. However, Corporate Russia has cut foreign lending all but in half, compared to 2014. On top of that, Russia’s war chest has expanded by roughly 70 percent since late 2015.
Finally, most countries hold their foreign exchange reserves as Dollars. On average 60%. Russia has recognized that such assets can easily be blocked or frozen by the U.S. To counter that, it has successfully diversified its war chest. It now only holds 16% of its reserve in Dollar assets. For the rest, it holds roughly 32% Euro assets, 13% Chinese Yuan, 6.5% in British Pounds, 10% in other currencies, and almost 22% in Gold.
Doesn’t that large share of Euro & British pound denominated assets still make Russia vulnerable to the West?
Well, not really, since while Russia has reduced its financial exposure to the West, European politicians have once again, failed to think strategically. You see, while in 2014, 37% of gas imported to Europe came from Russia, that number has now increased to almost 47%. And surprisingly even though Russian gas production has remained roughly constant, gas supplies to Europe have fallen drastically as tensions increased.
And sure, poor Europeans have no issue turning off the heater and just sitting out this little winter. But, the other Europeans, like their houses warm and cozy. And with energy prices already sky-high, Europe is just in no position to risk losing access to that cheap Russian gas.
Sure, as is often the case in economics, the long run works differently. We can assure you that, right now, European nations are scrambling to shift from gas-based energy to renewables. But, just to give you an idea, the Netherlands has set itself the goal of getting gas by 2050. We don’t think Putin has boots with such a deadline.
And even if European countries can speed that up somehow, China is currently switching from coal to gas as we speak. Because China is so big, this pushes up gas prices like crazy and will likely ensure the Russian economy will remain insulated from Western sanctions for the foreseeable future unless the Chinese economy slows down due to a property downturn.