Streetwise Professor

As part of its efforts to address its looming financial crisis, the Central Bank of Russia announced a new program to assist Russian companies needing dollar and euro financing, and in particular, needing dollars and euros to repay maturing loans. The CBR will lend USD and EUR to banks for 28 to 365 days. The banks, in turn, will lend to exporters and foreign currency borrowers: the banks secure the borrowings with the CBR by pledging as collateral the loans extended to exporters.

On 23 December 2014, the Bank of Russia Board of Directors took a decision to introduce a new instrument — FX loans secured by a pledge of claims on FX loans. This decision aims at expanding credit institutions’ possibilities to manage their own FX liquidity, as well as to refinance external FX loans of Russian exporters, which are soon to be redeemed, given a restricted access to international capital markets. The introduction of the said operations will also be conducive for the exchange rate to return to its fundamental values and to the achievement of demand-and-supply balance in the forex market amid lower exchange rate volatility.

The said operations will be effective until 1 January 2018. The earlier set total maximum amount of credit institutions’ debt to the Bank of Russia equivalent to US$ 50 billion applies to FX repos and FX loans secured by a pledge of claims on FX loans and remains intact.

Note that this program will be in place for more than three years. This is compelling evidence that the CBR expects the crisis to last for some time. Whether the CBR’s resources will last that long is another matter.

Through this mechanism, the CBR is using “credit institutions” as cutouts to lend to Russian corporates. Rather than borrowing FX from foreign banks, the “exporters” will borrow from the CBR via the banks. And who would these exporters be? Well, the biggest are energy producers (Rosneft and Gazprom in particular) and other natural resource firms. Given that Rosneft is sanctioned, and hence is most restricted in its access to foreign debt markets; is an extensive foreign borrower; and due to lower oil prices is facing greater difficulties servicing this debt; it is likely the biggest beneficiary of this program.

Through this action, the CBR is weakening its balance sheet. It will replace $50 billion in low credit risk assets (e.g., US Treasuries) with high credit risk assets from companies like Rosneft (BBB-, and almost certain to be junk soon). Moreover, the CBR is taking on wrong way risk: the loans will be most likely to default or require restructuring precisely when the Russian economy is weakest.

I also suspect that this dovetails with the stealth capital controls, in which the government has commanded state enterprises to reduce their dollar holdings. Some of the dollars that they will spend will be obtained from the CBR via this loan program. This combination of programs therefore allows the CBR to use reserve dollar and euro holdings to support the currency without recognizing declines in official reserve holdings.

Desperate times call for desperate measures, and these measures are desperate indeed.