Will the West tap Russia’s frozen assets?

Hello! This is your weekly guide to the Russian economy — brought to you by The Bell. Our top story is a look at whether the West might be on the verge of utilizing Russian assets that were frozen as the start of the full-scale invasion of Ukraine. We also look at a new tariff on commodity exports and a leak that suggests Russia’s defense spending in 2024 will hit Cold War levels.

EU mulls action on frozen Russian assets

European officials are inching toward one of the most difficult decisions on Russia sanctions — determining the fate of Russian reserves frozen last year. President Vladimir Putin is fond of describing these funds as “stolen,” while Kyiv demands the money should be transferred to help rebuild Ukraine. It’s unlikely that Western countries will ever go that far, but a half-hearted compromise might bring some benefit to all parties.

What’s going on?

European diplomats are completing their work on the 12th round of sanctions to be imposed on Russia since the start of the full-scale invasion of Ukraine, which is due to be unveiled early next month. According to media reports, in addition to bans and restrictions, this round may also address the difficult issue of what to do with frozen Russian assets.

After Russia invaded Ukraine in Feb. 2022, Western countries froze every Russian asset they could get their hands on — including about $300 billion of Central Bank reserves. The ultimate fate of these assets has been unclear ever since.

Russia insists the assets were stolen: “At one fell swoop, they pocketed our reserves,” Putin complained last year in a typical statement on the topic.

Ukraine agrees with Russia that the West is hoarding someone else’s money. However, Kyiv wants these reserves for itself. Many Western politicians support that idea. Even so, the EU and the U.S. are not yet prepared to go the whole hog by officially declaring these assets have been confiscated.

Not even the U.S. senators Jim Risch (Republican) and Sheldon Whitehouse (Democrat), who drew up legislation in July to transfer frozen Russian assets to Ukraine, are proposing a full-on requisition. Instead, their suggestion is that the assets remain frozen until Russia itself agrees to use them to fund the rebuilding of Ukraine. Thus, although the law presupposes the assets will be transferred, it will only happen with Russian consent.

Why not just confiscate the assets?

The behavior of Western countries is consistent with historical practice. Assets of a hostile country have traditionally only frozen for the duration of an armed conflict — and then returned once bilateral relations resume.

The idea of confiscating Russian assets is abhorrent to Western leaders, the heads of their central banks, and the financial authorities. It could trigger radical legal changes and prompt a dramatic outflow of funds held by foreign investors in Western currencies. This, in turn, would push up borrowing costs for developing countries for years to come.

It would also bring major changes to banking confidentiality rules. To freeze assets, the bank which holds them does not need to provide any details to the authorities. But in the case of a transfer, both confidentiality and the inviolability of the asset are compromised. This might be possible if backed by a court ruling. But at present, there is no such ruling.

What else could be done?

The compromise solution currently under discussion in the EU targets not the assets themselves but the revenue they generate. This could be coupon income from bonds, or from interest paid on deposits. By law, this income also belongs to the owner, but the proposal suggests imposing a tax on this income and transferring the revenue to Ukraine.

The scheme under discussion apparently assumes that the tax agent would be the bank or depository that holds the Russian asset. In this case, there would be no need to declare details of the account — merely to transfer the money.

The Belgian-based depository Euroclear will play a big role in such a scheme. According to the Belgian government, Euroclear holds €196.6 billion ($209.09) of Russian assets, including €180 billion of Central Bank reserves. In the first six months of this year, revenues from Russian funds (both Central Bank funds, and, for example, sanctioned banks that have deposits with Euroclear) reached €1.7 billion, according to Euroclear.

This income (which has been boosted by global interest rate rises) would normally be transferred to the account holders. As a result of sanctions, though, it is transferred to a special account from where it cannot be moved. Funds from the redemption of bonds and other fixed-term assets also end up here. While politicians debate what to do with this money, Euroclear is managing it separately and waiting for a ruling.The other holders of income from frozen Russian assets are likely doing a similar thing.

Even if the EU does not come up with a way of claiming revenue from frozen assets, there still may be capital gains tax to pay. It was in this way that the United Kingdom taxed frozen Libyan assets. In Belgium, income from securities is taxed at 30% — although it is unclear exactly what tax might be due on Russia’s frozen assets in the country.

Why the world should care

Firstly, it’s important to be clear about the fate of these frozen assets to fully rebut the Kremlin’s claims they were stolen. Secondly, the EU decision will give Russian fund-holders hope that someday they might see those frozen funds again, with or without interest. Even so, Ukraine and other supporters of a radical approach are unlikely to be content with any compromise decision. This discussion could run and run.

Russia taps commodity exporters to help buoy the ruble, steady inflation

The Russian government has imposed new export tariffs on commodity companies as officials try to find ways to strengthen the ruble, tame inflation and find extra revenue ahead of presidential elections expected early next year.

What happened?

Media reports of an impending raid on commodity exporters first appeared Wednesday evening. Sure enough, the following day, the government published an order to introduce new tariffs. They will come into force on Oct. 1 and run through the end of 2024. Depending on the exchange rate, the tariff will be 10% on fertilizer products and between 4% and 7% for other commodities. If the ruble strengthens to 80 against the U.S. dollar or less, the tariff will be reduced to zero. In effect, the measure is a way of obliging commodity exporters to share their surplus profits from a weak ruble with the Kremlin.

A similar set of motives likely lie behind another recent government decision. On the same day as the tariffs were introduced, the government also imposed a temporary ban on gasoline and diesel fuel exports. The duration of the ban was not specified. “These temporary restrictions will help to saturate the market for fuel, which in turn reduces prices for consumers,” the government said in a statement.

According to part of a letter from the head of state-owned oil giant Rosneft, Igor Sechin, to Putin that was shared with The Bell, it was Sechin who requested a fuel export ban. However, Sechin only urged a ban on exports for September with a view to stabilizing prices during harvest season. He also suggested a return to the “damper” — a subsidy system that compensates oil companies for the difference between domestic and export prices. It is unclear whether Sechin’s proposals — either in terms of the timescale for the export ban, or the return of the damper — have been accepted.

Will it have any effect?

The authorities hope the new tariffs on commodity exports will generate up to 600 billion rubles a year if the U.S. dollar rate is between 90 rubles and 95 rubles, according to Reuters. But that isn’t actually a huge sum for such a major step, which suggests the government has other motives. In particular, Russia is likely seeking to support the ruble and reduce inflation.

While it might reduce inflation and boost the exchange in the short term, the tariffs could have the opposite effect over time. By prompting a decline in exports, it could lead to a reduction in the trade surplus, which would exert pressure on the ruble.

The energy industry was also unhappy with the field export ban, warning that, since there is insufficient storage capacity for refined products, they will have to cut back refining operations. Over time, this will eventually undermine oil production.

However, if the government has got its sums right, the new tariffs — and fuel export ban — should lead to a slowing of inflation and a period of relative calm for exchange rates. At least for a few months. But there is a loophole in the measures as they do not cover exports to the Eurasian Economic Union: which means it will be worth keeping an eye on Russia’s trade with Kazakhstan, Kyrgyzstan and Belarus over the coming months.

Why the world should care

Six months or so before Russia’s presidential election, it appears the government is under orders to bring inflation under control and strengthen the ruble (apparently an “acceptable” level is 80 rubles to the U.S. dollar). It’s unclear to what extent these measures were discussed in advance with the Central Bank, which is ultimately responsible for price stability. In the absence of any specific comments or references to the Bank’s opinion, we can conclude that it was likely not consulted about either of these steps.

Russia’s to raise defense spending to Cold War levels

Russia is set to allocate 10.8 trillion rubles, or 6% of its GDP, to defense spending next year, according to a 2024 budget proposal obtained by news agency Bloomberg. That’s 69% more than this year and more than twice as much as 2022. Russia’s military spending will now be close to the level of the U.S. at the peak of the Cold War in the 1980s.

Social spending will also increase, but not so dramatically: by 15.3% to 7.5 trillion rubles. Expenditure on “national security” (which includes funding for Russia’s National Guard, Rosgvardiya, which has also been deployed to Ukraine) will rise 9.3% to 3.5 trillion rubles.

Total budget revenues for 2024 are projected to reach 35 trillion rubles, a 22% increase from 2023, resulting in a deficit of 0.9% of GDP next year and 0.4% of GDP in 2025.

This is the first time in modern Russian history when military expenditure will surpass social spending. This suggests that not only is the Kremlin doubling down in Ukraine, but it sees the defense sector as the main driver of economic growth. Russia will continue its transformation into a wartime economy, dependent on imports and fated to suffer from high inflation. This will force the Central Bank to maintain high interest rates.

Why the world should care

The 2024 budget is not a “development budget” — whatever Russian Prime Minister Mikhail Mishustin might say. The Kremlin's priorities are clear: boosting the war effort and buying the loyalty of ordinary Russians. Everything else is of secondary concern. There’s no doubt Putin can finance his war through 2025. But things will get more tricky after that.

Key figures

• The Bank of Russia published a review of the banking sector for August, which showed that the trends of recent months continue: lending is increasing faster and faster, Russians are withdrawing currencies from accounts abroad and exporters are stockpiling their foreign currency earnings.
• In particular, the report showed that credit issued by banks to individuals was up 0.98 trillion rubles (3.2%) last month (over the first eight months of the year, it increased by 5.4 trillion rubles). Mortgage lending was up 4% month-on-month and almost 33% year-on-year. Consumer loans rose 2.4% month-on-month and 14% year-on-year.

Further reading

Why the Russian Orthodox Church follows the Russian military in Africa

The United States can't directly intervene in the war in Ukraine, but it can send military advisers — Foreign Affairs

Alexandra Prokopenko contributed to this newsletter

Translated by Andy Potts, edited by Howard Amos