How the war in Europe will affect South Africa and…
To paraphrase Ernest Hemingway, change in the macroeconomy and the global financial system happens slowly and then suddenly. Wars have also been shown to act as catalysts for these systemic recalibrations. Since the Russian invasion of Ukraine dates back more than a month, it is time to take stock of what happened and to deduce what the longer-term consequences of this war might be, in particular for the global financial and monetary framework.
Perhaps most interesting is what didn’t happen. Following the invasion of Ukraine, the Russian ruble collapsed, weakening by around 35% almost instantly. Since then, it has rebounded dramatically and erased almost all of its losses, stabilizing at around 8% lower than before the war. It didn’t continue to implode. This is largely due to the aggressive raising of interest rates by the Central Bank of Russia to 21%.
Second, the sanctions imposed on Russia were among the toughest against a country, let alone a member of the G20. Banned from the Swift international payment system and with Russia’s central bank’s vast foreign exchange reserves effectively confiscated, it was expected that a massive banking sector failure could occur, along with runs on deposits. This does not happen. Instead, the central bank managed to prop up commercial banks by removing reserve requirements and providing ruble liquidity en masse. It seems that most, if not all, Russian banks are limping on life support.
Third, much to the chagrin of Ukrainian President Volodymyr Zelensky, the world continues to buy Russian oil and gas, a key source of foreign currency for President Vladimir Putin’s war machine. Although Europe would like to immediately cut off all purchases of Russian gas, the European Commission believes that to do so would be economic suicide. Instead, the continent intends to phase out Russian gas before 2024. The UK has indicated it will do much the same. Russian oil is largely not bought by Western oil majors, which sanction themselves. However, it is still finding buyers (at substantial discounts) in China and India, which have quadrupled their purchases of Russian oil, according to Kpler, a commodity data and analytics firm.
Finally, the Central Bank of Russia still has over $200 billion worth of gold in its vaults in Moscow. It seems that these are proving to be a key factor in the resilience of the Russian financial system, supporting repo lines of credit to commercial banks. Importantly, experienced central bank governor Elvira Nabiullina – who tried to resign when she heard about Putin’s plans to invade Ukraine, but was later banned from doing so by Putin itself – was instrumental in minimizing the cataclysmic fallout of the war on financial markets.
What happens now? And, moreover, what impact will all of the above have on the future global financial system?
First, sanctions against the Russian central bank and commercial banks would be expected to contribute to the development of financial centers in East Asia, which are always happy to lend and even borrow from Russian financial institutions. China and India, in particular, have become key sources of liquidity for the Russian financial system as Russian banks have quadrupled their RMB (renminbi) transaction volumes, according to Bloomberg. These ties are likely to become stronger and more entrenched, perhaps also in the form of an integrated payment platform that can operate outside of Swift, perhaps based on China’s cross-border interbank payment system.
Second, the future current account surpluses and foreign exchange reserves of the Russian central bank. As oil and gas revenues increase, given soaring energy prices, these will have to turn into gold, or securities and currencies that they can still access. This will strengthen the financial ties between Russia and favorable financial markets. Once again, China, India and the United Arab Emirates are expected to experience much larger inflows of Russian foreign reserves.
Third, how war and sanctions affect the behavior of other emerging market central banks, sovereign wealth funds and public pension funds. It is now clear that Western powers are able and willing to freeze a country’s dollar, euro and Swiss franc reserves if that country does something it deems contrary to Western interests (invading a neighboring sovereign, like a large island in the South China Sea, for example).
It must be a source of great concern and frustration for countries seeking political agency outside the West – particularly China and India – to know that their astronomical foreign exchange reserves could be at risk and dependent on bow down to the United States and Europe. China, India and other emerging markets could therefore seek to emulate Russia and diversify further and further away from the greenback to find alternative currencies, assets and markets in which to store their liquidity.
Despite the tired references to “dollar dominance,” this in itself is not a new trend. Indeed, the share of dollars in global foreign exchange reserves has been on a downward trend over the past 20 years, falling from just over 70% at the turn of the century to just 59% in the third quarter of 2021. Much of the margin of maneuver was filled with an increasing prevalence of RMB. This decline in the once almost universal use of the dollar as the world’s reserve currency will continue, albeit at a much faster rate.
Finally, another development of this trend is that trade is increasingly starting to be charged in alternative currencies to the dollar. Perhaps an early indication of this is Russia’s assertion that all purchases of its oil and gas will be in roubles. It may be increasingly common to see Chinese companies under the Belt and Road Initiative transacting only in RMB, and other Asian countries to follow suit.
Currencies do not die with wars. However, history has shown that they have a tremendous impact in shaping and accelerating changes in the global financial architecture. World War I heralded the collapse of the gold standard, and the end of World War II brought about the set of Bretton Woods institutions that underpinned the reserve status of the dollar, a system largely designed by John Maynard Keynes.
What impact will this conflict have on future global financial structures? Today’s competing notions of dominance are instructive. We are now firmly in an us versus them context. The future of finance looks bifurcated and fragmented. One system will be the status quo USD reserve, traded largely in New York and London. The other could use the RMB alongside a number of other currencies, perhaps even a special drawing right from the New Development Bank. This more disjointed and scalable alternative system would largely be run in the emerging financial centers of Shanghai, Singapore and Dubai.
China, so far, has approached the internationalization of the RMB with some trepidation. For China’s blend of command politics with a state-controlled market economy, control over the value and convertibility of the RMB was seen as more important than political power, strategic sovereign autonomy (in particular, as is now evident, foreign affairs) and the influence flowing from wilderness status. This war could be the moment when President Xi Jinping reconsiders this position.
Another long-standing stumbling block for an alternative to the dollar has been the extremely volatile political relations between those who might seek to oppose it. Although Russia, China and Pakistan are apparently (at least momentarily) deeply aligned, India is at war with two of these emerging future partners.
Where this will leave mid-sized emerging countries like South Africa is highly uncertain. Politically, since the beginning of the war, the deep historical ties with Russia and increasingly with China are all too apparent. South Africa is siding with the East and risks becoming a complete pariah of the West. President Cyril Ramaphosa and the ANC have brazenly confused, offended and infuriated long-standing and key strategic allies such as the EU and the US. It was not surprising to see the new development bank and the Chinese investors that came with it be much more evident at the recent South African investment conference than the World Bank or the European Bank for Reconstruction and Development.
But these things are complicated. South Africa has deep economic, financial, cultural and historical ties with the West. The country is still, at least theoretically, a democracy with the rule of law, unlike the autocracies of Russia and China and the strongman democracy of India. South Africa’s advanced financial sector and businesses are deeply tied to hard currency capital markets, global trade markets and the western dollar-based banking system. A prolonged period of divorce and eventual transition to a fragmented and unproven RMB-based financial order is virtually unthinkable.
South Africa will in all likelihood attempt to consolidate its place as a non-aligned commodity-exporting country, like Indonesia under Suharto during the Cold War. In theory, this would preserve access to capital and export markets, while maintaining old political ties with emerging hegemons in the East. Hedging bets, however, could prove considerably more complicated in the face of an increasingly assertive China and Russia. It remains to be seen how successful or sustainable this strategy will be. DM168
This story first appeared in our weekly newspaper Daily Maverick 168 which is available for R25 from Pick n Pay, Exclusive Books and airport bookstores. To find your nearest retailer, please click on here.