Russia unsheathes its currency cudgel: mandatory sale of exporters’ proceeds is intended to strengthen the ruble

Market participants expected the worst—100% sales. But it turned out that ultimately no more than 72% needed to be sold. However, the latest Central Bank review of financial market risks emphasizes that the ratio of net sales to foreign currency earnings (excluding the ruble component) already in August amounted to the desired 72%.

The game, it turns out, was not worth the candle. Doubts about the need for this control measure from the government were initially expressed by the head of the Bank of Russia, Elvira Nabiullina. She warned: it is necessary to influence capital flows that affect the exchange rate through economic measures; administrative restrictions on the foreign exchange market have only a limited effect.

Nabiullina also emphasized that the share of the ruble in exporters’ revenue reached 42%. And it will only grow in the future. Why are they needed on the domestic foreign exchange market?

However, on October 11, speaking in the State Duma, she still supported the presidential decree, admitting that the volatility of the exchange rate can be contained through the mandatory sale of foreign currency earnings. Many experts noted her hardware defeat in the confrontation with Finance Minister Anton Siluanov and First Deputy Prime Minister Andrei Belousov, who had been demanding tightening of currency legislation since mid-August.

But the heart of the matter is not the hardware games of the powers that be. What’s more important is whether the rate will strengthen to at least 90 per dollar next year. The desired effect is already happening. So far the ruble has strengthened by about 3%. The history of modern Russia also shows that mandatory repatriation and sale of currency have a certain positive effect.

Let us recall that for the first time after the abandonment of the state monopoly on foreign trade, the mandatory sale of export foreign exchange earnings in the amount of 40% was introduced on January 7, 1991. That is, back in the Soviet era. 50% appeared in July 1992. In November 1994, the government of Viktor Chernomyrdin tried to announce a 100 percent sale of foreign currency on the domestic market.

A month earlier, as we know, “Black Tuesday” happened. In one day, the ruble fell by 1000 points at once. President Boris Yeltsin was beside himself with indignation. The then chairman of the Central Bank, Viktor Gerashchenko, as well as Deputy Prime Minister and Minister of Economy Alexander Shokhin (now head of the Russian Union of Industrialists and Entrepreneurs) resigned. To stabilize the exchange rate, at one of the closed government meetings it was decided to force exporters to fully return the proceeds to authorized banks and also sell it in full on the domestic market. The then head of the Ministry of Foreign Economic Relations (in 2000 included in the Ministry of Economic Development) Oleg Davydov was assigned to work on the issue.

At a closed meeting, the board of the Ministry of Foreign Economic Relations drew up a draft resolution of the Cabinet of Ministers on the 100% sale of foreign currency from January 1, 1995. However, the classified document “leaked” and ended up in the editorial office of a leading business newspaper. One of Davydov’s deputies tried. A scandal occurred, actively fanned by the banking community. Presidential Assistant for Economics Alexander Livshits intervened. Chernomyrdin was forced to back down.

Nevertheless, in the default year of 1998, the size of mandatory foreign exchange sales had to be increased to 75%. In the 1990s, when hyperinflation and low oil prices ruled the roost, ultra-tight currency regulation certainly contributed to the stabilization of the ruble exchange rate. When oil prices went up, the authorities began to gradually soften the currency regime. In 2001, they returned 50%, and in 2006 they completely abandoned the mandatory repatriation and sale of export proceeds.

The currency baton had to be used again on February 28, 2022. Sanctions brought down the ruble and increased inflation. Therefore, exporters were obliged to sell 80% of the received currency on the domestic market. At the same time, the Central Bank raised the refinancing rate to 20%. But already in June, mandatory sales of foreign currency were canceled. Accordingly, the rate was reduced.

It is not entirely clear whether the latest currency restrictions will have the desired effect. It is difficult to disagree with Nabiullina, who until October 11 opposed mandatory repatriation and sale of export proceeds. The ruble exchange rate will be stable only when the trade balance and current account increase. Why is it necessary to stimulate exports and curb imports? Which is not an easy task right now.

However, for now, it will apparently be necessary to use administrative levers to suppress excessive exchange rate volatility. All participants in the process seem to agree with the tightening of currency regulation. In contrast, for example, to the recent proposal by the Minister of Economic Development Maxim Reshetnikov to introduce a kind of “membrane” on the Chinese model between the domestic and foreign ruble markets.

At the same time, he emphasized that there was no need to introduce two ruble exchange rates. The main thing is to track all ruble flows, primarily foreign ones, so that rubles transferred abroad do not put pressure on the domestic foreign exchange market. Nabiullina rejected this idea out of the gate, explaining that ruble funds in any case do not affect foreign exchange trading. Major state banker Andrei Kostin, on the contrary, partially agreed with Reshetnikov, proposing to limit ruble transfers abroad to at least 100 million per month.

It is unlikely that anyone else will support Reshetnikov. Meanwhile, China’s financial system is very original. There are not one, but four currencies circulating in the country: the internal yuan, or onshore (stock ticker CNY), external, or offshore (CNH), the Hong Kong dollar and the Macau pataca. Therefore, several regulatory regimes are in effect at once – from centralized currency and export control to the currency board (external financial management).

CNY is traded only in mainland China; its exchange rate is controlled by the People’s Bank of China and can only fluctuate within 2%. CNH (introduced in 2010) are regulated by the Hong Kong Monetary Authority. They are used there, as well as in a number of other global financial centers, and have a floating rate.

Outside the mainland of China, all yuan are offshore. They can only be used in transactions with mainland China if there is an export-import contract. For this payment in mainland China, the currency will be credited to the account in CNY. By the way, foreign exchange earnings are repatriated to authorized banks in mainland China at a rate of 100 percent.

For transactions outside of China, the currency will go to the CNH account. At the same time, the domestic yuan is more expensive than the offshore one. CNH are convertible without restrictions as they are outside the scope of Chinese law. CNY is allowed to be converted into foreign currency only within the framework of import-export contracts; other transactions require appropriate permits and licenses from regulators.

The Hong Kong dollar was issued by the British colonial authorities since 1895 and remained in circulation after returning to China under the concept of “one country, two economic systems.” In Hong Kong, there is a currency board regime, or currency board (the independent Hong Kong Monetary Authority), which regulates fluctuations in the exchange rate of the local dollar in the range of 7.75–7.85 per $1. The currency is issued by the government of the special administrative region and three specially authorized private banks, which, as a rule, recognize all Western sanctions.

The pataca, the currency of another special administrative region of China, the former Portuguese Macau, is pegged to the Hong Kong dollar.

From this brief description of the Chinese financial system, it is clearly seen that there are at least four monetary membranes in the Celestial Empire, and not one, as Reshetnikov says. The Chinese financial authorities are mostly coping with their regulation, although recently they have been liberalizing it. China’s economy and, accordingly, foreign exchange exports are many times larger than Russia’s, which keeps the country’s overcomplicated financial system afloat, at least for now.

Russia clearly cannot cope with such challenges. All that remains is to hope for mandatory repatriation of currency and an adjusted Central Bank rate.