Recently, central bank and Russian government reserves that usually only interest the relevant officials and analysts have found themselves at the center of public and media attention on more than one occasion. A sharp drop in dollar investments and the concept of de-dollarization, increased investments in yuan, gold purchases, spending cuts, and surplus transfers to the National Wealth Fund (NWF) have all prompted questions about how sensibly the Russian authorities are managing the country’s reserves.

The National Wealth Fund, whose assets currently amount to 4 trillion rubles ($60 billion dollars), comprises reserves that can be used to cover the budget deficit, pay off the national debt, subsidize the Pension Fund, or for any other purposes that require large and urgent spending. 

Also under discussion are the central bank’s international reserves, which amounted to $468.5 billion as of January 1 this year. These reserves include investments in bonds held in dollars, euros, and other currencies, and special borrowing rights from the International Monetary Fund, as well as the gold reserve.

Central bank reserves are managed according to liquidity, reliability, and profitability, with the first two taking precedence over profitability. All countries’ reserves are traditionally calculated in dollars, so investments in other currencies and gold are regularly revalued to calculate their current market value. Generally, the structure of international reserves is slow to change.

But 2018 was no ordinary year for Russia: new sanctions were imposed against Russian companies, and possible sanctions against official Russian assets are being discussed. Situations in which countries have their international reserves confiscated or are cut off from international payment systems are extremely rare, but overall jitters—along with criticism of the very idea of Russia investing in the bonds of a country that has sanctioned it—forced the central bank to revise its policy.

Since the dollar bond market is the largest and most liquid, Russia had few diversification options. Six months later—that’s how often information about the structure of reserves is published—it became clear that the central bank had drastically reduced its investments in dollar assets in favor of cash, yuan, and gold.

Around 15 percent of reserves (5 percent at the end of the first quarter) was invested in the yuan. The Chinese currency was depreciating for most of 2018, resulting in losses of about $3.4 billion at the end of the year. However, interest rates on yuan assets are higher than on dollar ones, which will likely make up for a significant portion of the loss (an accurate estimate would require information on the duration of the investment, and that’s not made public). Investments in both euros and gold were reasonably stable.

Considering its limited convertibility, the yuan is a somewhat controversial choice for a reliable investment. This is perhaps the first time that political calculations have impacted on the central bank’s investment decisions, with the regulator having found itself between a rock (the risk of sanctions) and a hard place (the weakening yuan and fluctuating gold prices).

The burning question is whether Russia actually needs to accumulate reserves on such a scale right now. Since 2017, the government has fully adhered to the so-called budget rule: the NWF receives all federal budget surpluses generated when the oil price is over $40 a barrel (that cutoff price increases by 2 percent every year, so it’s around $41.60 in 2019).

Oil prices were quite high throughout 2018, so the NWF received around 2.5 trillion rubles. The projected amounts for this year are slightly lower.

Supporters of the budget rule point out that the Russian budget is excessively dependent on oil revenues, and that reserves are created in case of a crisis and sharp decline in revenue, such as those seen in 2008–2009 and 2014–2016, when the reserves helped to soften the impact. In addition, large budget reserves reduce the need to borrow money on the national debt market.

Opponents respond that it’s strange for the government to raise VAT and the retirement age, which should generate around 800 billion rubles a year in budget revenues, while simultaneously channeling several times as much money into reserves.

Putting away money for a rainy day makes it possible to restrict the spending appetites of government agencies and state-owned companies, as well as reduce inflation. But this rigid policy prevents additional growth, even when oil prices are high.

Almost all of last year’s GDP growth resulted from a combination of the ruble exchange rate (with the Russian currency weakened by sanctions and capital flight) and high non-oil-and-gas export prices. But despite the attacks—some of which come from within the Russian ruling elite—the Finance Ministry and the central bank are sticking to their promises, which is admirable.

Finally, many question the central bank’s tactics in making quite large currency purchases for the Finance Ministry every month. Some of these purchases coincided with the active selling of ruble assets (in April, August, and September), which further weakened the ruble.

On the one hand, the regulator is not obliged to purchase specific amounts of currency during specific periods, but on the other, it can’t allow the destabilization of currency markets. Consequently, the rules of engagement in the event of speculative attacks were being made up on the spot. In April, purchases were suspended for a few days and weeks, and in September a moratorium on stock exchange currency transactions was imposed until January.

To avoid destabilizing the market, the shortages in currency purchases will be replenished over a period of three years, starting in January 2019. Analysis of the currency market shows that the central bank has tried to behave in the most careful and predictable manner. Its involvement hasn’t always been smooth, but it now has algorithms for dealing with virtually every imaginable market situation.

The Russian authorities’ reserves policy will likely remain stable for the next few years. The budget rule will probably remain unchanged, though the oil cutoff price may increase to $45 or $50 a barrel.

A more radical and less likely step is to calculate the oil cutoff price and budget surpluses in rubles. Given the floating exchange rate, this would be entirely reasonable and would make it possible to peg state borrowing programs to the size of reserves.

The central bank’s reserve structure is unlikely to change much after the recent powerful yuan shock. On the contrary, unless new sanction threats emerge, we can expect the share of dollar assets to grow again, while investors will treat the yuan with greater caution.

The greatest risk, which will grow along with funds and reserves, is that of the open or creeping politicization of investment. In other words, the state will choose to invest in “friendly” but unstable currencies, as well as to extend loans to even “friendlier” states and companies. Experience of past crises should make the responsible government agencies stay well away from such initiatives—as far as it’s politically possible.

  • Anton Tabakh