What Russia’s SWIFT Ejection Really Mean Amid War Fogs

Filtering information is one of investors’ most important tasks. It is normally a difficult task under the best conditions, but right now, amid the fog of war, filtering information is nearly impossible.
Away from reports, fake images and news from Russia and Ukraine, the fog is also engulfing a lot of the economic commentary, obscuring any attempt to crystal clear assessment of developments and the impact thereof on the weekend and on Monday and stoking a lot of this time is different-style commentary.

Much has changed for investors since the discussion of sanctions late last week. The latest measures still do not inflict enough damage to wallop global markets.

The US, UK and EU agreed to expel some Russian banks from the Society for Worldwide Interbank Financial Telecommunication (SWIFT) network, which facilitates international financial transactions.

This theoretically complicates Russian banks transacting with the developed world, effectively freezing commerce and overseas assets even for entities that are not under sanctions.

Several Western leaders have referred to this, however, as the nuclear option posed its head, now they are patting themselves on the back, promising their actions will create a profound Russian recession.

There are reasons to doubt this outcome will be so clear. That is not an ideological statement nor a political one. Rather, economists keep on remiding one another that their job is to assess these things coolly and rationally, as markets do.

Those who argue the SWIFT expulsion will kneecap Russia’s economy point to the deep economic pain in Iran after US sanctions effectively barred all Iranian banks from SWIFT. Those sanctions included measures targeting Iran’s oil and gas exports, which is what actually crippled Iran’s economy.

So far, the West has done no such thing to Russiak namely the SWIFT ejection applies only to some unspecified banks, meaning there are other banks that still have access and can process oil and gas transactions.

Some officials told the press that they are doing so to avoid interfering with the oil trade. This, of course, is to ensure Russian oil and gas continues flowing to European Union member states, which rely on that supply.

But it also ensures the source of half of Russia’s government revenues is alive and well, which limits a lot of the potential economic damage. Beyond that, SWIFT is not technically a money transfer system; rather, it is a messaging system.

Messages accompany wire transfers, a key component in informing the receiving bank of the intended recipient and other key information. SWIFT is overwhelmingly the most commonly used messaging system globally. But it is not the only game in town.

To maintain access to international markets, Russian banks could use antiquated analog technology like Telex. Or they could use Russia’s relatively new SWIFT alternative, enabling them to use banks in China and elsewhere as conduits. Annoying thing about sanctions: There will always be nations willing to help a pariah state skirt them for a small fee.

Fine print should render the weekend’s other big measure much weaker than advertised: the ban on transacting with Russia’s central bank. The idea: strand Russia’s huge foreign currency reserve war chest abroad, so that the Central Bank of Russia cannot use it to prop up the ruble. Propping the ruble would require the CBR to sell its foreign currency assets and buy rubles on the international market with the proceeds, which is now theoretically off the table.

This, too, will allegedly trigger a Russian currency collapse, bank run and deep recession. That is a possible outcome, of course. Due to Europe’s reliance on Russian fuels, there is an exemption for all entities processing payments for imported Russian oil and gas.

Russia does not need to repatriate its overseas assets to get the hard currency necessary to stabilize the ruble. It can just sell a boatload of oil and gas, then convert the euros and dollars it receives as payment to rubles, through a third-party nation, if need be. Incidentally, this argues against oil and natural gas prices soaring from here. If anything, Russia’s need for hard currency could motivate it to ramp up supply, helping prices stabilize.

Russia has also diversified its foreign currency holdings significantly in recent years. Russia’s US Treasury holdings have gone from over $100 billion in 2017 to too small to report by 2020. The dollar was about 46% of its war chest in 2017, according to the CBR’s data. As of last June, the latest figure available, it was down to 16%.

It could be lower still by now, if the CBR took pre-emptive measures ahead of the long-planned invasion. Meanwhile, the yuan is now 13% of its reserves, and gold is up to 22%.[iv] Between the diversified reserves and the steady incoming stream of hard currency as payment for energy, we think Russia probably has more firepower than most commentary suggests.

It is true that markets had a sharply negative reaction to this weekend’s developments. Russia’s stock market was closed, but Russian companies listed on the London Stock Exchange tanked.