11 Mar 2022

IMEMO Deputy Director Vladimir Milovidov: Sanctions will last but reality may change

Vladimir Milovidov

Vladimir Milovidov
Courtesy photo

Over recent years, we have got used to the term "new reality" or "new normalcy." Before the pandemic, we had one reality, after it – another. What do we have now? Our special correspondent Vyacheslav Terekhov discussed the matter with Vladimir Milovidov, Deputy Director of the Primakov National Research Institute of World Economy and International Relations of Russian Academy of Sciences (IMEMO) for research. Milovidov also used to be assistant to the Prime Minister of Russia, head of the Federal Service for Financial Markets.

New reality – what is it?

Question: In the last days of February, the old reality for this country gave way to new. The sanctions that the USA and several European countries imposed against this country badly hit critically important elements of the economy. What reality do we have now?

Answer: New reality, new normalcy, post-normalcy and the West has also started using such a term as post-truth. Therefore, first a word about the terms.

When we are speaking of post-normalcy as such, of course, this primarily applies to changing tendencies in international economic and political relations. This applies to the very broad spread of the social media and new technologies. As a result human relations, including economic relations, unnoticed by many before are beginning to play an increasing role. Which means that roughly speaking, in the past prominent economists, even Nobel Prize winners, who studied the financial market and financial theory regarded such science as behavioral economy or behaviorism [the study of human and animal behavior] quite disparagingly. However, now we see that behavioral aspects are becoming increasingly active and influential.

I hold the opinion that the world is networked, i.e. we live in a networked world in all senses of the word. However, what is a network? It is an interconnection of key nodes of the network. And the world was such always, for centuries. However, the logic of the emergence of this network was always reverse, i.e. the network always remained a network but each node considering itself to be more or less strong tried to rise above the general network to become a more important and even key node. In turn, the change of strong nodes led to a situation of constant fluctuations, disturbances, waves, storms etc. which remained in history in the form of wars, conflicts, political debates, collisions and crises.

Presently the developments largely follow the same line. Let us look at last year's events in economic policy. In a sense, it was a year of milestone anniversaries. Firstly, in August it was 50 years since the United States gave up the exchange of dollars for gold, 70 years since the end of the Marshall plan that helped Europe revive after World War II. Simultaneously there was talk of the 70th anniversary of the beginning of the emergence of the European Union.

If we look at all these events, we will realize that the roots of the current processes were largely determined then because the world, the post-war economic world developed according to a single pattern, fitting one node or to be more exact the center of this network. By virtue of different historical, economic and political circumstances, the United States came to the middle. I do not want to label it but that was an objective outcome of developments. As a result, the entire economic system together with the political and ideological systems following it was built to fit the USA.

By the way, one of the previous presidents of the U.S., Mr. Obama, directly spoke of American exclusiveness saying that the U.S. possesses certain missionary capabilities and truths.

This seeps into the minds of people living in that country, especially as in one way or another this was supported by a fairly powerful economy, financial market, the domination of the U.S. dollar in foreign economic settlements, a powerful army, enormous military spending and ultimately by nuclear weapons that, of course, are a major factor of deterrence today and emphasize the military-political might of a state.

However, at some stage this post-war world built to fit the interests of the U.S. started changing. This happened because the wealth it created in its own interests, for instance, the introduction of the dollar in international settlements, the establishment of international economic organizations such as the WTO, the International Monetary Fund, the World Bank – all this started gradually benefitting the development of not only the U.S. but other countries such as China, India, Brazil and many others that were customarily attributed to developing. And it reached the point when even today European states as well as Japan, Canada and even the U.S. is trying to raise the question whether it is justified to regard them as developing countries. The question arises: aren't they new industrialized nations? That is how new reality appeared in the world.

Russia changed, world changed

Q.: That is as far as the world is concerned but what about Russia?

A.: During the 30-year period since the USSR ceased to exist Russia also traversed a road of certain economic strengthening. It also started speaking out as a certain economic force. We revived our other industries, not only the defense industry. We are no longer simply an oilrig but the oil and gas sectors became high tech industries. A super high tech sphere appeared – the production of liquefied gas, which Russia delivers to other countries today. According to statistics, today, for instance, three countries – the U.S., Qatar and Russia – satisfy 70% of Europe's demand for liquefied gas. Three countries actually dominate on the European market of liquefied gas. And Russia gained this place literally in the past three, four or five years. Naturally, this led to changes in the economic and political configuration within the network.

The world has changed and the bulging node of this network called the U.S. became an obstacle, became unnaturally because other nodes have grown next to it, Russia being one of them. Naturally, when situations arise that lead to the restriction of someone's growth this causes a conflict.

Where are our forex reserves?

Q.: After the imposition of sanctions against us heads of the financial authorities made statements in the media reassuring the public and saying that we have forex reserve assets. However, the question arises: where are they? Abroad or in Russia?

A.: In this economic situation, Russia found itself in a circle of very tough sanctions, primarily on the part of the United States and its allies. I believe that the most painful sanctions that exist today are measured by two factors. Firstly, sanctions against the Central Bank. This applies to forex reserves. Secondly, and this is most important and does not concern so much the forex reserves in themselves, as the operations of the Central Bank with its assets. The structure of assets is such that by operating them the Central Bank can continue functioning. However, the restrictions imposed on these operations strip it of a considerable part of these opportunities.

In this context, let us look at the structure of its assets. The latest publications appeared sometime last summer. At the time, the total volume of the forex reserves of the Central Bank was $614 billion, not $643 billion as now. Out of that amount, gold directly kept at the bank was worth $128 billion. Currency in cash and deposits constituted $152 billion; banks kept about $60 billion, accounts of the Russian Central Bank for $93 billion were opened with other central banks. This is the official statistics of the Russian Central Bank.

Besides, $300 billion in securities, in foreign currency, of course, $105 billion in short-term and $194 billion in long-term securities.

The currency structure also according to the Central Bank was 32% in euros, 13% in yuan, 16% in dollars, 6.5% in pounds, 10% in other assets and 20% in gold.

Thus, given the sanctions that were imposed one can assume that a fairly big volume of long-term and short-term securities, as well as bank deposits may come under sanctions, especially if they were denominated in euros, dollars and pounds. This, of course, considerably limits the ability of the Central Bank to conduct interventions on the currency market to maintain the ruble rate and such interventions are necessary primarily for this purpose.

One should keep it in mind that in addition to the Central Bank sanctions affect the National Wealth Fund that was also formed actually on the same format as Central Bank forex reserves.

Q.: I want to clarify: is money from the fund kept at Russian or foreign banks?

A.: I cannot say what its structure is but judging by publications the Finance Ministry is changing the currency structure of the fund, in particular sharply reducing the dollar share and increasing investments in other currencies, including yuan. I believe that part of the National Wealth Fund is also invested in such instruments and accumulated in the logic of forex reserves in one way or another. Therefore, naturally certain problems arise with them too.

As for amounts, I am not prepared to make evaluations, I simply do not know but I proceed from what is written in documents.

Q.: Is it disastrous?

A.: It is probably one of the most serious aspects of the sanctions. But I would not say that it is the end of everything. Why? Firstly, correct measures are being adopted today to keep the currency within the country: a ban on exporting currency by non-residents, the payment of dividends and income on securities to them, a ban on the sale of securities by non-residents, i.e. is the export of capital is being stopped in this way.

On the other hand, the absolutely correct mechanism of reviving currency control related to the sale of receipts from exports. Thus, by selling their dollar receipts parties to foreign economic operations influence the rate of the ruble.

Q.: Isn't anxiety on the market affecting the ruble?

A.: There is anxiety and even profiteering on the market, of course. And this indisputably has a negative effect on stabilizing our currency and consequently affects the dynamics of prices. But I believe that the measures that are being taken in the currency sphere persuade us that this speculative wave of anxiety will be stopped.

Banning with one hand, permitting with the other

Q.: So have sanctions fully crushed our economy after all?

A.: We are used to looking at the economy as an entity of institutions, authorities and policies. However, I am convinced that ultimately the economy amounts to the economic operations of a person, to human relations, which is underestimated by those who have assumed the mission of exerting pressure through sanctions. It is believed that the imposition of sanctions leads to a situation when the economy is torn to pieces leading to a collapse and so on. This is a blow, of course. No need to be arrogant. However, those introducing sanctions themselves are saying that gas or oil exports from Russia should not be limited because Europe strongly depends on oil and gas.

And it is notable that, for example, the U.S. Treasury that restricted the operations of our banks – VTB, Sberbank and Sovcombank –virtually on the day of announcing sanctions issued a license to conduct certain transactions. Literally the same day a license was signed allowing the self-same banks to conduct payments related to the energy sector, as it says. And then they specify what is related to energy: settlements, payments and many other things, including the sale of oil and gas.

Q.: They permit doing what is advantageous for them?

A.: No doubt. However, this license is effective until the end of June and what happens next is for us to see, it is difficult to tell now. However, it means that despite the announced blocking of correspondent accounts of these banks with U.S. banks, the correspondent accounts are still used when it comes to settlements for the whole entity.

Q.: Can't we say: no, guys, if you are imposing sanctions, then impose them on everything and we will see who will suffer more?

A.: I cannot predict the decisions of executive authorities but I simply proceed from the example with liquefied gas. In recent years, Russia made big achievements in this sphere, and the oil and gas industries made achievements despite all talk that this is our oil curse and that it should be given up. However, those who are saying that do not realize one simple thing – we were gaining new markets for ourselves. In a certain sense, this is our safeguard.

Q.: A safeguard from what or whom?

A.: Our presence on international markets of energy resources which everyone is in dire need of despite the robust development of renewable sources of energy is a safeguard of our economy. That is number one. The second is oil and gas extraction, high tech industries whatever they may say.

I am not even going to mention liquefied gas – these are most sophisticated technologies. Both gasification and regasification, the establishment of terminals.

Here is a simple example. Germany is a country of high technologies. They keep very big technologies at a high level. And it dominates in a number of technologies. However, it is almost the only major, if not the only major country, dominant in Europe that does not have gas terminals where tankers with liquefied gas could arrive and unload, they have none! They have only pipeline gas.

Then the question to Germans arises: "Well, alright, you stopped Nord Stream 2. Are you ready to stop Nord Stream 1? How will you be getting gas? Where from? From France? Or from the south, via TurkStream? Across Ukraine – I agree. The Ukrainian string of the gas pipeline exists."

But you have no terminals! Spain that is incomparable with Germany in economic might has some five terminals. France, I think, has three.

Literally in the past few years Americans built their delivery terminals in Louisiana. It is a growing industry; therefore it would be naïve to give up these markets. And then, if we stop transporting gas to Europe or somewhere else, we will transport it to other countries but they will start reselling. This is also possible. Therefore I still proceed from the fact that we, as our president said, are a part of the world economy and why should we be destroying it with our own hands? This is an important moment.

We cannot be making everything ourselves!

Q.: On the issue of import-substitution. We are constantly speaking of imports. So what? We cannot be making everything ourselves. The technology is not the same it used to be!

A.: True, not a single country in the world can be fully isolated from all the rest. But look: today we have advanced armaments that are strong, powerful and employ the highest technologies. If we are capable of making such products, probably, we could find ways of promoting import-substitution in other, peaceful spheres of production, so to say.

It seems to me that import-substitution is now becoming simply a key task. I think that after a time, after all, as I already said, economic relations will make their way anyway, will still find ways of resolving different economic problems. That is in the first place. In the second... Well, all right, you hear talk now that one company does not want to deliver something. However, they made enormous money in Russia. I think they will return after all, business will make them do so!

Is defense industry our node?

Q.: True, we really have powerful technologies but let us return to network nodes. The economy gave the U.S. the possibility of rising above the network, the economy of China also rose above the entire network. Our economy cannot do that. But we tried to raise our node by creating most powerful new weapons. The new technology of armaments permitted us to act as a new node. However, the time when the might of a country depended only and mainly on the power of arms is over. They are necessary, it is true, but without a strong multifunctional economy, arms do not determine the might of a country even though they create confidence in it.

A.: I agree with you. However, firstly, after all faith in the better is moving us now. Of course, one can say that it is extremely difficult to rise in this situation, of course. However, there still is the world with which we continue to maintain economic relations. I will give you another example.

I have not seen the latest figures but figures for the pandemic period indicated that there is a surplus of the Russian foreign trade turnover, i.e. exports outweigh imports even without gas, oil and oil products. It was achieved in farm produce and, strange as it seems, in machine-building. We are selling certain machinery. We have mineral fertilizer and finally metals, there is coal that has also been exempted from sanctions as a source of energy. Uranium is exempted.

The production and generation of electricity – all this is exempted. Biofuel is exempted and even farm produce that can be used for the production of biofuel is exempted. So if Russia keeps up – and I hope that it keeps up trade relations with our neighbors in the framework of EurAsEc, in the framework of the Eurasian space, with China, with Turkey that announced today that it does not support sanctions, with Brazil that did not support the sanctions, with India and Latin America, it means that we have countries to cooperate with, it means that we remain in the world economy.

It seems to me that given a proper organization of import-substitution we can find the resources that will permit us to do so. I would want to believe in that.

Combatting inflation means everything to us

Q.: Will we be able to rein in inflation in the present conditions?

A.: Depending on the scale. It is clear that it started growing long before these developments.

Q.: At least at less than 7%?

A.: I do not think so. It is already around 8-9%. I think that even the 20% key [Central Bank] rate indicates that the general internal forecasts of the Central Bank are much higher. I think that it will be higher with regard to a number of prices.

However, we have had periods with such spikes. We had 1998. We had 2008. We had 2014. We had all that. Later the economy won back everything. All this simply goes to a different level. It is a question of adapting. A question of adjusting. Yes, at first it will really be a bit difficult, there will be inflation, there will be spikes. Then I hope things will stabilize.

Q.: How will the sanctions affect the entire financial system? Is it for the short or term?

A.: I proceed from the assumption that this will last long. Because sanctions are imposed fast while the procedure of lifting them is very complicated. Very complicated and overburdened with bureaucracy. Therefore honestly speaking I do not expect any rapid changes. We will have to live with them.

Living with the coronavirus, with sanctions and what comes after?

Q.: Living with the coronavirus, with sanctions... Will it ever be possible to just live?

A.: Given the best course of developments, the only probability is the appearance of permitting licenses of the U.S. Treasury to certain transactions. And they will be opening up these niches, windows silently, without making a display. Overall... we are speaking of four, five or seven Russian banks. Today it was announced that seven banks were disconnected from SWIFT.

Q.: It is surprising that they dared to do it to Sberbank; it has very many foreign shareholders...

A.: Once again. When there is such emotional mayhem - and it is emotional on both sides - therefore I hope that our response measures, our steps will be less emotional than theirs. Amid emotions, one tends to forget about oneself too. For instance, I believe that the restrictions concerning forex reserves are a very painful measure. However, on the other hand, in the end they are quarreling with their own bread and butter.

Q.: Which means?

A.: For a long time they steadily promoted the idea that the dollar is a safe haven. A safe haven that can be used when risks arise. Holding reserves in dollars and euros as reserve currencies by central banks, as the purpose of a reserve currency is to preserve these reserves.

However, when we see that this storage is a risk, what can be a reserve asset? What then is a safe haven? Where is it? This factor will make many countries having forex reserves think that potentially they may have problems and conflicts with the U.S. And they will think! I believe that China has a very strong reason to think – it has its own geopolitical plans. And it is more difficult to punish it without damaging oneself. Nevertheless, it has a trillion in reserves.

What to do with rubles? Exchange?

Q.: The last practical question. Should one be rushing now and exchange rubles to foreign currency – euros, dollars, yuan or something else? Or the ruble will remain the ruble, the panic will subside and...

A.: Simply look at the figures. On the last date that the Central Bank counted for, on January 1, 2022, as at the end of 2021, there were 30 trillion rubles on personal accounts. Seven trillion in an equivalent of dollar accounts and three trillion rubles on accounts financing construction, shared-investment construction. So work it out. Actually, people keep 40 trillion rubles in banks. This is an enormous sum. However, not breathtaking for the financial system.

In practice, it is probably best not to rush amid this panic. Yes, rubles are losing their value. By virtue of inflation and the falling exchange rate, of course. But one must wait because it is always possible to make a mistake taking spontaneous steps. And there were times... We went through a time when in 2014 even the oil price fell. We remember that the interest rates of the Central Bank were 17-20%, we remember that the rate of the euro was over 100 rubles and the dollar cost 80 rubles but now due to the severity of sanctions the figures are higher. Nevertheless, it was so, but then it passed. Somehow, we got over.

Therefore, I would still take the developments without panicking.