Russia Counter-Sanctions “Unfriendly Nations” by Requiring Gas Payments in Roubles; Dallas Fed Predicts 2022 Global Recession if Russian Energy Supply Remains Restricted
Yesterday, Russia launched what amounts to a counter-sanction by mandating that all payments for Russian gas from “unfriendly countries” be made in roubles. Sadly most commentators missed what these measures amount to. And they also miss some potentially significant secondary effects, one of which may be to solidify the ties between India and Russia.
We’ll also turn later to a new Dallas Fed paper that warns that keeping the Russian energy spigot turned off for the rest of 2022 will put the world in a recession.
“Unfriendly Nations” Rouble Payment Counter-Sanctions
Putin announced this move before the US and other countries were set to launch new sanctions against Russia at NATO-G7 meetings on Thursday. The gas payment counter-sanction is highly unlikely to change the West’s plas, but it might wind up superseding other discussions planned for this summit:
We are calling the Putin measure a counter-sanction because it is designed to unpick a key part of the Western sanctions, which is to subject Russia to payment arrangements under the control of the US and EU. It is not a sanction because Russia is not withholding supply. And separately, both Russia and China object to the US-EU sanctions because they were not approved by the UN. So expect any additional Russian actions, even if they have the effect of sanctions, not to be structured as sanctions.1
As we’ll explain, this counter-sanction does not amount to forcing (much) more demand for roubles (unless Russia sets an above-market rouble price for these gas buys). Russia has already imposed currency controls, including requiring major exporters to sell 80% of their foreign currency receipts and buy roubles. And contrary to popular mis-perceptions, the rouble is not collapsing. Russia reopened its financial markets earlier in March. The rouble, while still much lower than it was in 2021, has rebounded from its low as of when sanctions were imposed, as this chart from Trading Economics shows:
Let us consider how Europe is buying gas from Russia now:
EU buyer pays Euros, to say Gazprom via one of Gazprom’s banks.
Either that bank is one of the non-sanctioned Russian banks, or Gazprom transfers the funds to a non-sanctioned Russian bank to convert enough of the Euros to roubles to satisfy Russian requirements. Note that there are not enough roubles circulating outside Russia for it to be very likely that a garden-variety European bank could acquire enough roubles for Gazprom.2
So what is different now?
The EU buyer is now required to deliver roubles, not Euros, to Gazprom at an unblocked account or an unsanctioned bank. Since there is very little in the way of roubles outside Russia, the buyer will now need to open and maintain rouble accounts in a Russian bank. That means Russia controls whether or not the account is blocked on its side.
To put it more bluntly: To sell Euros, the EU needs to keep the Russian banks sanction-free, otherwise it can’t trade Euros for roubles to procure gas.
Buyers that don’t play ball don’t get Russian gas. Trying to replace it won’t be easy. From Statista, share of gas supply from Russia in Europe in 2020, by selected country:
Bosnia and Herzegovina* 100%
North Macedonia* 100%
Moldova* 100%
Finland 94%
Latvia 93%
Serbia* 89%
Estonia* 79%
Bulgaria 77%
Slovakia 70%
Croatia 68%
Czechia 66%
Austria* 64%
Greece 51%
Germany* 49%
Italy 46%
Lithuania 41%
Poland 40%
Hungary 40%
If anything, some of these figures may be low. One reader at the Financial Times said that Germany now gets 55% of its gas from Russia and Italy is the second largest customer, by volume.
Some observers contend that the Russian change is of little consequence because Qatar, one of the world’s largest LNG suppliers, agreed to send more to Europe. But Qatar already said, at the beginning of February, that it could not unilaterally fill the loss of Russian-supplied gas. Moreover, most of the world’s LNG supplies are subject to long-term contracts and thus can’t be redirected quickly. I would be curious to see more detail as to how much LNG Qatar is expected to send to Europe and how much that could increase over time.
The EU buyer can whine about it if the contract with Gazprom doesn’t allow for Gazprom to be paid in other currencies. This is a Russian edict overriding existing agreements. After the West freezing $300 billion in Russian central bank assets and the US and to a large degree the EU refusing to take oil deliveries from Russian ships already bound for various ports, the EU does not have a very firm basis for complaining about being treated badly. If you want the gas, you need to pay in roubles.
IMHO the much harder part will be agreeing on a price or price formula for roubles, particularly for any gas deliveries set under a long-term price agreement as opposed to spot prices.
Some have suggested that the Russian requirement will allow buyers to change other contract terms, like shorten the length of their agreements. If you listen to Putin’s statement, the Russian position is that it is keeping the contracts in place. So it seems very unlikely that Russia would allow other changes in terms unless Russia deemed them to be in its interest.
Around the margin, the Putin requirement does increase demand for roubles, but this isn’t a game changer, since the sales of Russian gas abroad will now go from being 80% converted to roubles to 100%. And those operators do have expenses outside, so they will presumably need to and be allowed to convert some of those roubles back into foreign currencies.
There was some very good commentary on a new Financial Times article on the Russian counter-sanctions, provided you had the patience to wade though the huge number of jingoistic and low-information-value comments. From reader vlbuzz:
On top of this development:
– a RUBINR swap line is being established between Russia and India, effective as of the next week, allowing direct exchange of currencies and using bi-lateral settlement system
– Central Bank of Russia finally takes the lesson from the Fed and the ECB and engages in QE, targeting the RUB yield curve by direct purchases of government debt on MICEX from the local investors (foreign owners’ holdings are effectively frozen as of now and can not be sold in the market)
– a comprehensive set of capital controls stops the capital flight, USDRUB is down 30% from the recent post-invasion peak
– retail fuel prices are down 5-10% in RUB terms across the country as the excess export volumes of diesel go to domestic market
– export oil prices are up markedly, fully negating the Urals-Brent discounts in absolute terms, the same in thermal coal, fertilizer, wood and cellulose, copper and aluminium among others
– the heating and electricity bills for the population will be indexed by just around 8% y-o-y in nominal RUB terms (or effectively decreased by -4-7% in real terms), negating the higher food/FMCG price effects
– food inflation is rising due to increased stock-piling by the distributors and population (sugar, mostly, as widely used in home breweries to make moonshine), but the impulse buying has mostly subsided while the stocks are managed by temporary export bans for most of the agricultural commodities…You’ll have to pay up a bit to buy a new Bentley and ship it from Azerbaijan or Kazakhstan to Moscow, but other than that, the impact on the larger part of the society is so far rather limited.
One possible partial way around the counter-sanctions would be to deepen the market for roubles outside Russia. From Financial Times reader no illusion:
This means that the buyers will need to go sell their euros in Russia and buy Rubles to pay for gas. This creates a big forex market here – with spot and derivative components.
Possibly, but the reason banks are willing to run big intra-day dollar exposures with each other that are settled out at the end of each trading day in the US is that large-dollar payments go through banks with US licenses that are on Fedwire, meaning the system is ultimately backstopped by the Fed. It is over my pay grade to guess how much rouble trading would be done outside Russia save on a regulated exchange (with all sorts of trading limits and both trade and exchange margins required) or if OTC (which is how nearly all foreign exchange trading is done) or with a Russian central bank backstop…or with a bank in a country with currency swap lines with Russia’s central bank.
One fascinating secondary effect of the rouble-pay scheme may be to increase India-Russia ties. Yet another Financial Times comment, this one from Anonymous columnist, writer:
Some days back a top forex trader and now monetary economist for HSBC Global Market remarked recently that following Russian Central Bank’s foreign currency dollar asset freeze order by US, it’s only a matter of time that the Russia would be forced to go for trading with the west in Rouble only or Rouble and Yaun/Renminbi currencies only to ensure it remains 100% risk free from sanctions and asset freezes, despite potential risk of inflationary costs at home.
India, one of the major economies and the largest democracy in the world has already been trading with Russia under Rouble – Rupee exchange agreements for many decades. Indian banking and finance lawyers privately say that India’s finance ministry along with Reserve Bank of India (RBI) and Bank of Russia is “racing against time” in exploring options to “internationalise” Russian version of the SWIFT version – SPFS, starting with India as a launch base outside Russia (being helped by the fact that India has reservations in dealing with China’s CIPS – China’s version for SWIFT – though it is ready to accept expansion of China’s UnionPay card payment system subject to restrictions).
In fact many Indian online retailers, like Israeli online retailers and service providers, have/are on the verge of setting up Russia’s Mir card payment system online to enable Russian citizens to trade with/buy products from India.
Israel has/soon to have similar arrangements in place. Turkey, Malaysia, Bangladesh, Argentina, Venezuela, Iran, Saudi Arabia, South Africa and many AU countries and of course China all have (or most already rushing to have) rouble + their respective currency exchange agreements in place.
A number of lawyers based at Indian corporate law firms in Mumbai say “they are working around the clock” like never before following the outbreak of Ukraine war, in advising number of governments of African Union countries on enabling rouble-based trades and also currently advising many of the corporations and conglomerates based in emerging markets on setting up rouble based contracts, given India’s half-a-century unsurpassed experience in trading with Russia under rouble – rupee exchange agreement/and or rouble – rupee swaps.
However, notwithstanding this, Indian corporate law firms are advising many large corporations based in the emerging markets to evaluate their governing contract and arbitration clause options and to seriously consider other major jurisdictions available as alternative to London, New York, Paris and Singapore, with the options of Dubai, Hong Kong being on the table among others.
Corporate law firms in India’s financial capital Mumbai say that government of India with the help of country’s premier members of the legal profession is also seriously considering to see current Russian-Ukraine crisis as “either or never” opportunity for India to emerge as future international arbitration centre alternative to London, Paris, New York, Singapore and Switzerland and evaluate whether it can become alternative to London and New York as governing law provider for English law or New York law respectively, by using India’s well established English common law system, though this is likely to take some time (Dubai, Singapore and Hong Kong provides a tough competition).
On another note, an Indian lawyer said they along with Hong Kong and Dubai based lawyers are advising banks in Bangladesh, UAE, Pakistan and African Union member countries alongside Bank of Russia in exploring options to consider rolling out/enable cross-border Russia’s Mir and China’s Union Pay systems in the said countries’ retail and commercial banking as well as to roll out rouble currency accounts for retail customers as FCY account options for customers wishing to open forex based rouble (or alongside limited capacity Renminbi Yua) fixed deposit schemes for the purpose of sending their children to Russia for education and medical treatments, given that Ukraine is out of the equation for many; until recently, Russia, Ukraine, Belarus, Georgia after the west, Turkey and the Far East was considered one of the most attractive cheaper alternatives for study medicine and study abroad for STEM subjects for middle class citizens from the emerging markets.
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1 The conveniently timed damage to the Carpathian gas pipeline to Southern Europe and loss of supply though it for at least three weeks could fall in this category.
2 Note that once Gazprom got the Euros to a Russian bank, it could presumably transfer them to a sanctioned Russian bank if it also had bank accounts there. But that wrinkle does not matter much for the big picture.