On February 16th, Russian opposition leader Alexei Navalny died in an isolated Arctic penal colony where he was serving a 19-year sentence for extremism. The Kremlin said he “collapsed,” but it was unclear to no one that Navalny, a fierce critic of Vladamir Putin, was murdered. A week later, in retaliation, U.S. President Joe Biden announced more than 500 sanctions on Russia, targeting its financial sector.
In Biden’s words, the sanctions “will ensure that Putin pays an even steeper price for his aggression abroad and repression at home.”
However, President Biden overestimates the impact of sanctions on Russia. Many economists, Western and Russian alike, predicted a contraction of 10% or more of Russia’s GDP, but it only contracted by 1.2% in 2022.
Then, in 2023, Russia’s economy did not contract at all. On the contrary, it grew 3.6%, outpacing the economies of the United States and of most of Europe. Western economists bemoaned Putin’s strategy of “Fortress Russia,” which has sought to make Russia’s economy “sanctions proof.”
While much of the resilience of the Russian economy can be explained by continued oil revenue and spending increases that accompany a wartime economy, the actions of the Bank of Russia and its technocratic governor, Elvira Nabiullina, have played an outsized role.
Nabiullina is well-liked in Western financial centers, which is important because just less than half of the Central Bank’s $630 billion in assets, including its all-important foreign currency reserves, are kept abroad in banks in the UK, France, Germany, Japan, and the USA.
This has led some influential observers, including but not limited to Steve Forbes, chairman of the eponymous media outlet, to suggest Western governments should simply seize these assets and turn them over to Ukraine to fund the war effort. Unsurprisingly, no bankers are lining up to divest.
Russia’s Sanctions-Busting Central Bank
Undoubtedly Russia’s surprisingly healthy GDP in 2023 benefited from stimulus provided by armament sales and military orders. Also, oil money continues to flow into Russia by the billions, since as late Arizona Senator John McCain famously said Russia is “a gas station masquerading as a country.”
That’s only part of the story. Whereas oil and arms could be considered the wind in Putin’s sails, it’s the sober monetary policy by the Bank of Russia that has provided the ballast to keep his ship underway with this surprising momentum.
In June of 2013, Elvira Nabiullina, formerly Putin’s chief economic advisor, was made chair of the Central Bank of Russia. A year later Russia annexed Crimea and the West reacted with a series of sanctions. Soon thereafter the price of oil plummeted.
Given Russia’s history of entering into “foreign adventures” when the price of oil is high (see Afghanistan in 1979, Georgia in 2008, Crimea in 2014, Ukraine in 2022), the sudden drop in revenue coupled with U.S. sanctions posed dual challenges for Nabiullina and the Central Bank.
In response, she drastically raised interest rates to combat inflation. There was a painful period of adjustment, but her actions worked. Meanwhile, Nabiullina went to work making Russia sanctions-proof, shifting Russian reserves away from the US dollar and into gold, the euro, and the Chinese renminbi. As shown in the chart above, roughly $200 billion of the Central Bank’s assets are held in gold and Chinese Renminbi.
When she began at the Central Bank, 40% of Russian reserves were in the form of U.S. dollars. Now it’s 11%, whereas Russia’s gold holdings have tripled in the same time. Concurrent with these actions, Russia aggressively paid down its debts, building up a large war chest and becoming a net creditor by the time troops began amassing at the border with Ukraine.
Desperate Times Call For Desperate Measures
In the wake of the invasion of Ukraine in early 2022, the West quickly saddled Russia with extensive sanctions meant to bring its economy to its knees. The rouble quickly plunged by more than 25% against the US dollar. Lines of anxious customers began forming at Russian banks to exchange for foreign currency. It looked as if the sanctions would cripple the Russian economy, and Western media outlets heralded the payback.
In response, Nabiullina and the Central Bank raised the interest rate to 20%, more than doubling it. The stock market was closed. Capital controls were put in place to restrict the flow of money out of Russia.
The crisis passed and Nabiullina and the Central Bank went about addressing another problem: Russia is severely restricted from using SWIFT, the cross-border payment system used by most of the world’s banks.
No matter, Russia created its own system called SPFS, System For Transfer of Financial Messages, which by comparison, is still in its infancy. Additionally, the Central Bank has also begun using China’s Cross-border Interbank Payment System known as CIPS, which while larger than Russia’s SPFS, is still miniscule compared to the size of SWIFT.
The Old, Irresistible Gazprom Station
Since the pandemic, worldwide oil prices have remained stubbornly high, which offsets the reduced price in which Russia is made to sell much of its product. Additionally, while sanctions are extensive, they are also riddled with so many carve-outs and exceptions that their effectiveness is undermined, to some extent.
The world is dependent on Russia’s oil and the US and Europe are unwilling to fully close the tap, never mind other large economies, such as India and China, which mostly do not abide by U.S. and European sanctions anyway.
While oil prices are high, it gives the Kremlin and the Central Bank time to develop and move the economy away from the influence of the West.
An Offer Elvira Couldn’t Refuse
Rumor has it, Elvira Nabuillina tried to escape her job but was rebuffed. The former Russian Prime Minister Alexey Goncharuk wrote on Facebook that Nabuillina quit, but Putin refused to accept it. According to a correction later issued, Nabuillina “expressed her desire to resign,” and Putin kindly dissuaded her from doing so. After nine years, the job was still just too good to leave, Nabuillina must have realized.
For informed supporters of the Kremlin, she might as well resign because she is too friendly with her counterparts in the European and American spheres of high finance and governance. But Putin must need her there because she is no doubt pliant to his needs. He’s known Nabuillina since the early days of his presidency because she came up in the same circles, as a low-level bureaucrat in the wreckage of the Soviet Union.
Nabuillina rose to power in part because of her friendship with Yevgeny Yasin, the former Minister of the Economy. He nominated her to head the Commission on Economic Reforms back in 1995. Then, she became a deputy to German Gref at the Center for Strategic Research. Gref went on to become a Minister and later the Chairman and CEO of Sberbank.
Interestingly, all these people are regarded as liberals by Putin’s staunch supporters. And they have faced major blowback from the banking system and their acquaintances and friends in Europe and the US. Sberbank was forced to close branches in Europe after a Ukraine War-related run on deposits. Both Sberbank and Gazprom were instructed by the Kremlin to skip out on paying dividends in 2021.
Putin Herds His Cats
In these ways, through his intermediaries, Putin personally directed the Russian response to sanctions. These sanctions had teeth, driving down Western banks’ exposure to Russia to its lowest level in 20 years, according to S&P Global.
Still, they greatly failed because the West wasn’t ready to turn off the faucet. Not only that, when some Western firms quit the Russian market, they sold their equipment to Russians in fire sales. This allowed those Russian firms to turn around and sell the same products at a discount, while the European citizens were paying higher prices for Russian oil and gas than before the invasion.
James K. Galbraith, a professor at the University of Texas at Auston, described the situation this way, “I characterize the effect of the sanctions, in fact as being in certain respects a gift to the Russian economy. And this is, I think, quite different from what the authors of the sanctions expected.”
Corrupt Money Laundering
In his last interview, Navalny said, “So I hope that 10 years from now if you interview me again, I’ll be able to tell you how we managed to overcome the corrupt money laundering.”
As with everything we read about Russia that has even a mere kernel of hope in it, Alexei Navalny’s life was snuffed out by faceless terrorists lurking in the shadow of Vladimir Putin. Unfortunately for ordinary Russians, Western leaders just can’t get their act together.
Putin always strikes fear in his opponents due to the certainty of a caustic, sneering, and spite-filled official Kremlin response to the least bit of Western aggression with something worse from the security services just under the surface. A secret agent may take a dump in the house of a visiting Western journalist. Or maybe they’ll arrest them, who knows?
Nabuillina must have been thinking, “Do I really want to push that button?” If Putin can make you ask yourself that question, he wins.
That’s at least partially why it feels like Putin has been running the table on us for decades now. That sentiment rides on a misapprehension and overestimation of how much control Putin has over events. Russia, unlike China, is a paper tiger.
As we’ve seen on the Ukrainian battlefield, the Russians often suffer catastrophe due to their own bungling. You can be confident that Russian soldiers will keep coming by sheer force of will because at least some of them can always be counted on to answer the call of the fatherland. God bless them.
That is what is perhaps more galling. Russians are a people so easy to love. Even if you despise and fear them, you will in some deep recess still admire them, their jocular manner, physical prowess, and famed determination. Yet, the specter of the Kremlin must always be kept in mind because it lurks behind every solitary Russian and many of the emigres from the former USSR, and the Kremlin is as malign a force and antagonistic to freedom as the world has ever known.
Russian Patronage: I Just Can’t Quit You!
So why must the West accept Russian patronage, hiding their financial assets in our institutions? Western banks could choke off Russia’s war machine in a fortnight, but that would go against the Western guarantee of always honoring covenants. Thus, the West is obliged to raise a weak wrist in protest when any petro-state like Russia threatens to destroy or enslave another nation. Sanctions have always been and will always be only as strong as the political will behind them to stop the carnage.
Putin has always known, in concert with his allies in China, how to undermine Westerners who would like nothing better than to see Putin or Xi Jin Ping run in an open and free election. In this game of divide and conquer, nobody is better for a greedy and vindictive strongman like Putin than a staid, smiling liberal financier like Elvira Nabuillina to make sure that Western banks remain dutifully protective of the Bank of Russia’s assets.
Author: Matt Collison
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