Editors’ note: This column is part of a Vox debate on the economic consequences of war.
In March 2022, the Kremlin created a complex mechanism for settling gas exports to “unfriendly countries” in rubles. The request sparked a lively debate over the Kremlin’s intentions. Indeed, the purpose of the measure – and the consequences of pursuing it – remain unclear.
A closer inspection of the Kremlin’s decrees provides an important clue as to what may be happening. In March, the Kremlin mandated not only payment in rubles, but also the receipt of rubles from the Moscow Interbank Currency Exchange MICEX-RTS (MICEX). This detail is interesting: there is no immediately obvious reason for the Kremlin to be interested in where the currency exchange takes place.
In this column, I argue that the ruble payment scheme is intended to protect MICEX – a cornerstone of ruble trading and a central part of Russia’s financial architecture – from financial sanctions. MICEX’s reliance on correspondent accounts with Western banks makes it vulnerable to US sanctions Should it come under sanctions, ruble pricing and ruble trading may be thrown into chaos. Although alternative pricing systems and trading venues will emerge, the Russian economy may suffer short-term damage.1 In making MICEX essential for the settlement of gas transactions, the Kremlin is therefore signaling that sanctions aimed at that direction will come at a high price.
Settlement in rubles
On 31 March 2022, a Russian presidential decree requires gas importers from “unfriendly countries” to follow a new procedure for settling gas payments.2 The procedure includes the following steps:
- Open two ‘Special K’ accounts with Gazprombank – one in foreign currency and one in rubles
- Make contractual payments into special foreign exchange accounts
- Instruct Gazprombank to convert MICEX amounts into rubles and pay into a special ruble account
- Instruct Gazprombank to use ruble balances to pay for its gas imports
Crucially, gas transactions are considered settled only after receiving the ruble balance obtained through the outline method.3 To further emphasize this, a subsequent decree mandated Gazprombank to deposit the converted foreign currency into correspondent accounts of the National Clearing Center, a non-financial institution wholly owned by the Moscow Exchange, which also hosts MICEX.4
Although several hypotheses have been put forward, no consensus exists on what the Kremlin intends to achieve with this measure.
A first set of assumptions sees the measure as supporting the ruble. Mandatory export revenue conversion and capital control measures, however, proved sufficient to ease pressure on the ruble (Itskhokhi and Mukhin 2022).
A second set of hypotheses views the measurement as a surgical means of gas delivery. One hypothesis assumes that by charging additional exchange commissions, Gazprombank could raise gas prices (Mihailov 2022). An alternative gas supply payment should be locked in an escrow account viewing the measure in preparation for shutting off the supply. This measure appears to make it easier for Gazprom to declare cases of coercion, thus incurring fines for breach of contract (Ason 2022). While gas prices are already at record highs, exchange rate risk appears to remain with exporters.5 And Russia has cut off gas supplies without much regard for already contracted ties.6
A third set of assumptions sees the measure as a ploy to avoid financial sanctions. One hypothesis concerns central bank sanctions (Astrasheuskaya et al. 2022, Demertzis and Papadia 2022). Another hypothesis sees the channeling of payments through Gazprombank as a way to cut off EU banks and take foreign currency funds out of Western jurisdictions (Merler 2022). In the first case, however, it is unclear why Russia’s central bank would participate – even indirectly – in foreign exchange transactions, at the risk of adding to its stock of frozen reserves. In the second case, the presumption discounts the fact that – even in the hands of non-residents – assets do not tend to leave their local jurisdiction. For example, it would be reasonable to expect euro payments to Gazprombank to be deposited with its euro-correspondent – Bank GPB International SA, a wholly-owned subsidiary chartered in Luxembourg.7
A fourth set of hypotheses sees the measure as the beginning of the ruble’s internationalization. Taken together with the Russian central bank’s decision to resume gold purchases in late February, some estimates see the ruble settlement request as drawing a link between the ruble and gold (Merler 2022). Ruble internationalization, however, seems incompatible with Russia’s current account surplus and its (temporarily) closed capital account. Rule of law and geopolitical considerations will also contribute to headwinds. The currency’s peg to gold, in addition, requires two-way convertibility, that is, a permanent commitment to redeem the ruble for gold.
Finally, this measure is also seen as a ploy to sow political divisions among EU member states (Koncha 2022, Osmolovska 2022), or as grandstanding on the part of President Putin.
Hiding in plain sight
Most of these surveyed assumptions ignore the role that MICEX plays in establishing new settlements. MICEX is the main ruble trading venue. Rubles are, however, also available bilaterally through a limited number of foreign banks. Although the offshore market is now much reduced, MICEX has options and there seems to be no obvious reason for the Kremlin to be so particular about trading venues.
However, what is unique about MICEX is that it is the only organized exchange for ruble trading and the most liquid ruble market by far. Arguably, no other market is deep enough to provide a solid anchor for the ruble’s value-formation.
To clear the foreign currency leg of transactions, MICEX relies on euro and dollar correspondent accounts with foreign banks. Specifically, the National Clearing Center – which provides clearing services for the exchange – holds its euro and dollar correspondent accounts with US bank JP Morgan.8 If the US freezes these accounts, MICEX will no longer be able to clear transactions in euros or dollars, throwing the main ruble trading venue into disarray. Although alternative pricing systems and trading venues will emerge, the Russian economy may suffer short-term damage.
Gives shelter to the ruble
To see how ruble-settlement could be a measure to shelter MICEX from US sanctions, it helps to focus on two key principles of the Kremlin’s decree: (i) currency exchanges must take place on MICEX, and (ii) consideration of transactions. Either ruble payment is settled when received by the gas exporter. With this in mind, it is clear that if MICEX comes under the ban, it will no longer be able to clear the foreign exchange leg of transactions. As a result, Gazprombank will be unable to convert foreign currency into rubles and will not be considered a payment settlement for gas supply transactions. If the transaction is not settled, gas supply is stopped.
This measure effectively binds MICEX to the gas settlement system, which previously belonged only to Gazprombank. Whereas Gazprombank had to remain outside the scope of authorization to allow EU gas supply payments, the same will now apply to MICEX. In linking gas exports to the EU to the functioning of MICEX, the Kremlin could create a clever incentive scheme whereby it encourages the EU to lobby against US sanctions that the US might otherwise impose on a unilateral basis.
This hypothesis may mark a new step in the ‘weaponization of interdependence’ dynamic. Indeed, economic sanctions have evolved from direct bilateral trade sanctions, to external financial sanctions, to value-chain promoted targeted trade sanctions. As sanctions extend their outward reach, so can defenses.
Author’s note: The views expressed are personal and do not necessarily reflect the views of the Bank of Italy or the European Central Bank. I am grateful to Claudia Biancotti, Emidio Cocozza, Flavia Cornelli, Riccardo Cristadoro, Fabrizio Ferriani, Gabriele Fraboni and Giovanni Veronis for their thoughts and comments.
Asson, A (2022), “The Ruble Gas Payment Mechanism: Implications for Gas Supply Contracts”, Oxford Institute for Energy Studies.
Astrasheuskaya, N, H Dempsey, K Martin and C Giles (2022), “Why does Putin want Europeans to pay for gas supplies in rubles?”, Financial times.
Concha, J (2022), “What’s Driving Moscow’s New Gas Payment System”, Energy Intelligence Group.
Demertzis, M and F Papadia (2022), “An embargo countermeasure: gas to Russia in roubles”, Bruegel Blog.
Harrison, M (2022), “Western sanctions on Russia are working, an energy embargo now a costly distraction”, VoxEU.org, 13 June.
Itshoki, O and D Mukhin (2022), “Sanctions and exchange rates”, VoxEU.org, 16 May.
Merler, S (2022), “The ruble problem: why the new Russian gas payment scheme matters”, Algebrais Investments, Market View.
Mihailov, A (2022), “Why ruble payments may matter for Russian gas and oil”, VoxEU.org, 29 March.
Osmolovska, A (2022), “Ruble gas gamble”, Atlantic Council.
Schropp, S and M Tsigas (2022), “Searching for ‘favorable’ sanctions on Russia”, VoxEU.org, 17 June.
1 For additional analysis of sanctions on Russia, see Harrison (2022) and Shrop and Sigus (2022).
2 Presidential Decree No. 172.
3 Presidential Decree No. 172, Sections 6 and 7.
4 Presidential Decree No. 254, Section 7.
5 This explanation is confirmed by the Italian gas importer ENI: https://www.eni.com/it-IT/media/comunicati-stampa/2022/05/eni-apertura-conti-gazprom-bank-avviata.html
6 To date, gas supplies have been cut off to Poland, Bulgaria and Finland.