[Salon] Russia and SWIFT

VIVEK Y. KELKAR, MUMBAI

It’s not so simple to ban Russia from the SWIFT system that serves as the backbone for global financial transactions, and the unintended consequences could be calamitous.

Just over four years ago, three economists, Camilo E. Tovar, Tania Mohd Nor, and Kristina Kostial, published a paper for the International Monetary Fund examining the changing role of major currencies, especially the US dollar, in the global monetary system. They warned that there was evidence that a global transition from a bipolar system dominated by the US dollar and the euro to a tripolar one that included China’s renminbi was well underway.

Underlying their thesis was the way currency blocs—a group of countries the value of whose currency is nominally anchored to the value of a dominant currency, like the US dollar or euro—were changing. A Chinese renminbi bloc was emerging, and it was slowly gaining influence primarily because of the currency’s effect on the large emerging economies, among which Russia was a significant player both by its size and its place in the composition of global trade.

The primary role of the anchor currencies in the global monetary system is to ensure unencumbered trade, stability for the real value of global debts and receivables, and liquidity to guarantee payments when they fall due. It also offers the main anchor countries like the US tremendous advantages when it comes to borrowing on the global markets. This is why the US and the European Union are reluctant to ban Russia from the SWIFT system that serves as the backbone for global financial transactions.

There are near- and long-term concerns. If Russia is taken out of SWIFT, what happens to near-term trade payments for European and global supplies of natural gas, corn, wheat, and other commodities of which Russia is a major supplier? Would there be a long-term domino effect that steers countries toward a China-anchored or Russia-China-anchored payment system, affecting the status of the dollar and shocking the US economy?

Further complicating the mix are blockchain-based digital currencies, or cryptocurrencies, which despite the SWIFT system are slowly affecting the world of financial transactions. Large economies, with significant commodities and other exports and imports, may have an incentive to move from dollar-denominated transactions for the products like crude oil and natural gas which form the backbone of global trade. Back in the early 2000s, one version of the story of why President Bush Jr. invaded Iraq was that Saddam Hussein was threatening to denominate his country’s oil sales in euros and other currencies. The denomination of oil in dollars dates to 1971 and led to the petrodollar supremacy that has driven global economics for nearly three decades.

THE IMPORTANCE OF SWIFT

At its core, the SWIFT system is a bit like Gmail. Global banks use it to deliver messages about financial transactions, ensuring the global markets don’t falter in paying for goods and services. In December 2021, the euro and US dollar together made up nearly 76 percent of payments worldwide. The Chinese renminbi ranked sixth, with just 2.7 percent. About 40 percent of the payment flows were in US dollars.

That is an extreme speculation, but the Cold War theory of mutually assured destruction, or MAD, assumed that military superpowers would make rational calculations, with rational actors at the helm. Putin’s invasion of Ukraine puts the rational actor theory into doubt.

Global currency reserves are still overwhelmingly in favor of the dollar. IMF data shows that the dollar still accounts for 59 percent of the reserves maintained by countries worldwide, with the euro second, at just over 20 percent. The renminbi accounts for 2.7 percent, ranking behind the yen at about 6 percent and the pound sterling at just under 5 percent.

These figures might suggest that any US and EU concerns that their currency might be displaced are farfetched. But remember much of their power in the international monetary system derives from not just the size of the economies but from their ability to ensure unencumbered trade, stability for the real value of global debts and receivables, and liquidity. That calls for stable geopolitics and continuing geopolitical clout.

THE NUCLEAR OPTION

Moving Russia out of SWIFT abruptly, therefore, has two consequences. One, it destabilizes world trade to a significant extent in the near-to-medium term. Why? Russia accounts for 11 percent of the world’s oil, 18 percent of the world’s wheat, 23 percent of global ammonia, 17 percent of global potash, and 10 percent of phosphates, all vital in the manufacturing of fertilizers. It also supplies 14 percent of global urea, the primary fertilizer worldwide. More significantly, Russia supplies 40 percent of Europe’s natural gas. Cutting Russia off from the SWIFT system has the effect of considerably destabilizing world trade. The near-term economic shock could be considerable, with reverberations felt not just across the developed or developing economies, but the poorest ones as well.

Though the world is cheerfully castigating the EU—and especially Germany and Italy—for having made trade with Russia central to their economies and for their timidity in pulling the plug on SWIFT, it’s undeniable that the global economy would feel the impact. Trade partners cannot be replaced overnight. The global poor, as always, would suffer the most.

Countries trading with Russia would have little choice but pay in rubles or other currencies, perhaps the renminbi, using SWIFT alternatives that Russia itself has developed, or moving to an alternative system that China has been pushing since 2015.

Now recall 2014, when Russia made its first moves to destabilize Ukraine and forcibly annex Crimea. Pundits in the West began to talk of cutting off Russia from SWIFT as a punishment for destabilizing the order of nation-states that had emerged since 1991. Alexei Kudrin, then Russia’s foreign minister, was quick to warn that the country’s GDP could contract by as much as 5 percent in the wake of such a move. Worried about an economically unstable Russia and following threats from Russia that it would be tantamount to “a declaration of war,” the US and EU hesitated.

Today is no different. Yes, Russia has built up over US$600 billion in currency reserves, the country’s debt levels are low, and, at some levels, it does seem self-contained. But if exports fall, reserves fall, and debt levels rise.

If Russia is cut off from SWIFT, policymakers may well fear, Putin could up the ante further by using chemical weapons, fomenting greater instability in Europe through hybrid warfare, or worse, using nuclear weapons.

That is an extreme speculation, but the Cold War theory of mutually assured destruction, or MAD, assumed that military superpowers would make rational calculations, with rational actors at the helm. Putin’s invasion of Ukraine puts the rational actor theory into doubt.

THE DOMINO EFFECT

Cutting Russia off of SWIFT could destabilize the dollar-led world monetary order born in 1945 as well as its dollar-euro avatar that arose in the late 1990s.

World trade, economics, and payment mechanisms have changed considerably since 2014. China is fast replacing Europe as Russia’s biggest trading partner. Just one example: natural gas. As the Cosmopolitan Globalist has noted before, Sinopec, one of China’s largest energy companies, estimates that by 2040, China’s demand for gas will reach 620 billion cubic meters, nearly double its current level. This is equal to Europe’s forecast consumption for the same period. Furthermore, the EU’s own estimates indicate that gas will remain a key energy source until 2050 until renewables and other options take over.

The Power of Siberia pipeline, owned by the petrochemical giant Gazprom, started pumping gas from Siberian fields last year. In 2022, it’s expected to reach its full capacity, 36 billion cubic meters per year. A new pipeline, Power of Siberia 2, is jointly owned by Gazprom and the Chinese National Petroleum Corporation. It connects the Yamal gas fields to Mongolia and thus to China. These are also the fields that supply natural gas to Europe, via Germany and Turkey, and, of course, the controversial Nord Stream pipeline project. Work on this pipeline has begun. The pipeline is expected to begin pumping 50 billion cubic meters of gas per year by 2030.

If Russia’s trade with China leaks from SWIFT and its euro-dollar backbone to, perhaps, the renminbi, smaller developing and poor economies will be given incentive to follow suit. Then the domino effect comes into play. The primacy of the dollar and the euro will slowly be lost.

Over time, the influence the US can exert over the global economy will shrink. The country’s US$30 trillion-plus debt bonds, all denominated and backed by the dollar, will start losing their value, especially if China, one of the biggest holders of US debt, begins strategic sales. The ability of the US to impose sanctions as a punitive policy action will decline.

This is why the emergence of currency blocs is so important. China dominates global trade. Russia partners with China. A China-Russia-managed currency bloc slowly gains ascendancy both out of sheer economic convenience and geopolitical considerations.

IS THE FUTURE HERE?

It’s not that SWIFT alternatives haven’t been tried. Russia’s central bank started building an alternative system, the System for Transfer of Financial Messages, in 2014. It put through its first transaction in 2017. Admittedly, as of today, the system exists only within Russia, and Russian banks. But it accounted for 20 percent of Russian trade through the country’s bank settlement system in 2020. Ominously, in recent months, one Chinese bank, the Bank of China has connected to the Russian STFM system.

China started building its own alternative to SWIFT in 2015. The Chinese have been considerably more successful than Russia, mainly because of their trade clout, rising levels of BRI debt, and the subtle control they exercise over many small economies worldwide. The Chinese Cross-Border Interbank Payment System now has more than 600 global banks participating, but its transaction size is just 0.3 percent of SWIFT. Other options include blockchain alternatives like Ripple. These have yet to gain momentum, but the lure of fintech, its potential to offer lower costs and faster transaction times than SWIFT, and the attractiveness of a system that manages to pull together a significant portion of the world economy—backed by an economic giant like China—should not be underestimated.

The EU is in this game. Following Trump’s reimposition of Iran sanctions in 2017, the EU launched the Instrument for Supporting Trade Exchanges as an alternative to SWIFT. For now, the INSTEX is limited to humanitarian trade permissible under US sanctions. In the future, however, an EU system that operates outside SWIFT and is somewhat insulated from the threat of US sanctions would be an attractive option for trade with Europe.

The challenge is not creating a new system. Technologically, that’s the easy part. The difficult part is getting a critical mass of global banks and countries to participate in the payment mechanism. If the US and the EU agree to cut Russia off from SWIFT, the incentives for other players—notably China—to step in and bridge the gap are huge.

Don’t forget that the world economic order and its dollar backbone do not date back merely to Bretton Woods and 1944, but to the 1920s, when Great Britain was beset with economic problems following the First World War and the pound sterling began to slide. Through much of the 1920s—through to the early 1940s—the dollar-sterling order ran nearly 97 percent of the world economy. Today, the international monetary system is far more fragmented and vulnerable to the systemic shocks to which Putin’s folly will give rise.

There are many moving parts and systemic threats the US and the EU must consider before cutting Russia off. The SWIFT decision must not come too swiftly.