Washington introduced yet another package of sanctions against Russia’s financial, energy, and technological infrastructure on June 12. Two years after Russia’s central bank was banned from using dollars, the Moscow Exchange and its subsidiaries the National Clearing Center and the National Settlement Depository were added to the sanctions list.
The latest measures effectively isolate the sanctioned companies from the global dollar system and forced the Moscow Exchange to stop trading U.S. dollars and euros, followed the next day by the Hong Kong dollar. Of the ten currencies that the exchange traded for rubles before the war, only four remain: the Turkish lira, the Belarusian ruble, the Kazakhstani tenge, and the main beneficiary of these changes, the Chinese yuan.
The idea of slapping U.S. sanctions on the Moscow Exchange and the National Clearing Center had been under discussion for two years. The Russian government had tried to protect the exchange by making it a mandatory part of the infrastructure used for the sale of gas for rubles, but that didn’t help. Now trading in dollars and euros in Russia will be done directly between buyers and sellers: exporters will hand over currency directly to financial institutions, and importers, accordingly, will buy.
The result of this direct trading will be an increase in the spread: the difference between the purchase price and sale price of a currency. It will likely now be more profitable for banks to work with both sellers and buyers of currency, and to bring them together. In other words, the interbank market will be skewed in favor of several large players doing very well out of the commission.
Another difficulty is that there are hardly any large interbank market operators left that have not been sanctioned. The currency market in Russia will most likely be divided into sanctioned and non-sanctioned segments, each with its own currency exchange rate.
The central bank will now determine the official exchange rates of the dollar and euro against the ruble on the basis of bank reports and data on the results of transactions received from digital over-the-counter trading platforms. Some companies have already begun to calculate indicative exchange rates for their clients. The central bank has issued assurances that individuals and legal entities will still be able to buy and sell both currencies through Russian banks, and that all funds in their accounts and deposits “remain safe”—though there have been restrictions in place on withdrawing cash in foreign currencies since March 2022.
The ruble exchange rate will become more volatile, and the more complicated it gets to import goods, the less demand there will be for foreign currency. Accordingly, prices for imported goods will rise further—as a result of new, more expensive schemes for circumventing sanctions. That will make it even more difficult for the central bank to fight inflation.
The new sanctions are turning the yuan into the main currency of exchange trading and settlements in Russia once and for all. In May, its share in exchange trading once again hit a new record, reaching 53.6 percent. Its share in the over-the-counter market was 39.2 percent. The Chinese currency accounted for just over a third of the total volume of foreign trade in the last year.
Despite U.S. sanctions, yuan trading continues, although the new restrictions cannot fail to have an impact on that too. The Chinese banks that are connected to the global financial system will have to sever their ties with the National Clearing House due to the risk of secondary sanctions. Either their place will be taken by financial institutions created exclusively to work with Russia that will not be scared off by secondary sanctions, or a new clearing intermediary will be created.
Both Moscow and Beijing have shown that they are capable of adapting to evolving sanctions. When leading Chinese banks stopped dealing with Russian clients over the threat of secondary sanctions, regional banks stepped up to take their place. Schemes with numerous intermediaries from places such as Kazakhstan and the UAE also began to be used more actively, and companies began to use cryptocurrencies in payments. Bartering is also now flourishing, with Russian products exchanged for Chinese goods, eliminating the need for any bank transaction at all.
In addition to new sanctions against financial institutions, the U.S. Treasury also broadened the definition of Russia’s military-industrial base, ties with which can result in sanctions for banks. Initially, that legislation covered transactions relating to five sectors of the Russian economy: defense, technology, construction, aerospace, and manufacturing. Now all companies that are sanctioned under executive order 14024 have been added to the list.
The new approach amounts to a direct ban on U.S. tech companies consulting for or supplying IT solutions (including tech support and updating cloud services) to anyone located in Russia. There are no obvious homegrown substitutions for customer relationship management (CRM) and enterprise resource planning (ERP) systems such as SAP and Oracle. Given the extent to which business processes are now digitalized at almost any major manufacturing or financial enterprise, the latest bans may even be more painful than the sanctions against financial infrastructure.
The sanctions lists also include very small intermediaries and shell companies used for circumventing sanctions, such as the Moldovan company Aerostage, which sent $80,000 worth of aircraft parts to Russia. The U.S. Treasury’s net is closing in on supply chains, and the chances of getting caught are increasing.
The new package of sanctions and broader definitions will be extremely painful for the Russian economy. They reduce productivity, increase costs, reduce profits, and fuel inflation. Still, the Russian government and businesses have been in survival mode ever since the start of the war, and devising various ways to keep doing business under ever stricter sanctions has become part of everyday life. Moreover, Russians are not constrained by the procedures and approvals faced by Western bureaucracies, and are buoyed by previous successes on the sanctions front.
In the two and a half years of war, an entire infrastructure of intermediaries in various jurisdictions has sprung up, schemes for swiftly restoring supply chains interrupted by sanctions have been developed, and payments in yuan and rubles have been settled using local infrastructure.
The new sanctions, therefore, could only really have seriously wreaked havoc with the Russian economy if they had been introduced at the beginning of 2022. Now their influence will only be fully felt in the long term—and the impact will not be limited to the Russian economy.
The whole world is closely watching the sanctions battle between Russia and the West, uneasy over the growing politicization of the global financial system. Apprehension is rising not only in Asian countries and the Persian Gulf, but also within the European Central Bank, which is concerned about the euro’s declining share in world reserves. There was demand for an alternative financial infrastructure even before the war between Russia and Ukraine.
Cutting off Russian banks from the SWIFT payment system, along with secondary sanctions, has proved a powerful incentive to accelerate the development of China’s Cross-Border Interbank Payment System, India’s Unified Payments Interface (UPI), and other alternatives. There is still a long way to go before there is a real threat to the dominance of the dollar, but the trend toward the fragmentation of the global financial system cannot be reversed now.
