• Friday, June 14, 2024
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BusinessDay

Russia’s plight and the need for a diverse Forex Reserve

Three banks rake in N390bn on FX reform

It is a season of bank runs and rouble crash for Russia. The situation has been particularly pronounced since the face-off with Ukraine.

Following the widely condemned attacks on Ukraine by Russia’s Putin-led government, international concerns have weighed heavily on the Kremlin, with the United States of America mainly leading the pack as they impose a series of nerve wracking sanctions on Russia.

The series of sanctions imposed by the US, Japan, and the European Union are designed to isolate Russia from the international financial system and in the process humble the Russian economy. On the platform of such impositions, the Russian Central Bank has been barred from accessing billions in reserve assets that have been saved up in overseas banks. Before now, however, Russia has been stockpiling foreign reserves in gold and other assets to create an insulated covering against unplanned impulses coming from the international market, especially from its not-too-friendly partners.

… imposing sanctions by freezing a sizeable proportion of the country’s accessible reserves push further the need for a more diversified portfolio of reserves beyond the crippling powers of a single dominant economy

Since it annexed Crimea in 2014, Russia has built up its foreign reserves to $630 billion from $368 billion in 2015. This build-up was designed to help the Kremlin mitigate unfavourable economic down-turns such as the current sanctions and give the central bank more ammunition to protect the integrity of its own currency, the rouble.

However, since the recent sanctions on Moscow, the rouble has lost up to a fourth of its value against the dollar, and the economy has been exposed to lingering dangers. With the freezing of about half of Russia’s foreign reserves held in overseas banks, Russians are now set on edge as they scamper to exchange the rouble for dollars in the bid to mitigate the anxiety of a currency fall.

Also, the Central Bank of Russia has had to defend its local currency by selling off its reserves while it could, in order to secure its economy from an eventual currency-led collapse. Since China remains the major issuer of foreign reserves to Russia and still maintains an allied position with the Kremlin, Putin’s economy can still access up to 13 percent of its reserves held in the Chinese yuan.

Read also: Russia-Ukraine conflict: Russia considers accepting cryptocurrency for oil payments

However, the current action-for-sanction experience and the consequent effect on the Russian economy have constituted a global eye-opener to most world economies. Government of nations are now beginning to learn from Russia’s experience, and a reconsideration of what should constitute an optimal reserve portfolio is being contemplated.

More especially for countries susceptible to sudden foreign impulses, considering a more diversified portfolio of reserves across the various currency and commodity classes becomes pertinent in the wake of recent global occurrences. While precautionary reserve holdings may hold a composition that is more skewed towards the safest asset classes, efficient reserve accumulation should be composed to provide sufficient hedge against sudden stops, as is currently experienced by Russia.

Indeed, a weakly diversified foreign reserve in which investments are concentrated in assets denominated in a single currency can be very risky. Current events in Russia and past experiences by Afghanistan, Iran, Syria, and Venezuela attest to this assertion. Given a poorly diversified foreign reserve and weak inertia towards other protection lines against external shocks, an attack in the similitude of Russia’s experience can lead to a currency free fall and subsequent crippling of the country’s economy. This is because a weak currency will exaggerate import prices, raise domestic production costs and output prices and consequently slow down aggregate demand.

Furthermore, current sanctions against Russia’s use of its foreign reserves in retaliation for their activities in Ukraine now serve as a new precedent to world economies on the legality and extent of use of economic prohibitions in this regard in the fight for global peace and tranquillity. Foreign reserves held by central banks are separated as an instrument of wealth that should be safe and accessible and can be used whenever the need arises. Hence, imposing sanctions by freezing a sizeable proportion of the country’s accessible reserves push further the need for a more diversified portfolio of reserves beyond the crippling powers of a single dominant economy.

This ongoing situation as it affects Russia is especially relevant for weaker, less developed nations and particularly African economies whose over-dependence on the greenback is despicable. While dollar-denominated reserve currencies may assume a safe option, especially as it draws on the strength of the US Treasury market, countries holding a significantly large proportion of their external wealth stock in the US dollar or other commodities backed by the dollar may be exposed to foreign economic intimidation just as Russia is currently having to contend with. In the light of the foregoing, we urge our policy makers to take very seriously the current trauma of the Russian rouble. Such a fate should not be allowed to befall the naira. And such a situation is best averted by ensuring that we wean away our currency from its current overwhelming dependence on the dollar. Rather, and under the circumstances, what is prudent for us, is to put our reserves in a basket of currencies.