The Big Freeze: Sanctioning Russia Raises Questions on Other Currencies

Freezing a central bank’s currency reserves is not new, but Russia is the first globally integrated economy to suffer this fate. Thus far, we have seen dramatic ramifications for Russia, with potential implications for the status of the U.S. dollar as the world’s main reserve currency and strength of China’s renminbi.

The potency of sanctions on Russian central bank reserves has stemmed from coordinated actions of the U.S., Europe, the U.K., Canada, and Japan, among other jurisdictions. That unity created de facto near unanimity, as Chinese banks became reluctant to deal with Russia for fear of secondary sanctions. However, for most countries outside China, sanctions risk should remain low.

A big question is to what extent will existing foreign exchange (FX) reserve allocations and indeed the portfolio allocations of international investors be adjusted out of fear of future sanctions, as foreign investors seek to avoid risks of capital lost or trapped onshore? If these reserves cannot be shifted to safe locations, then their insurance value may be deemed limited and, accordingly, the extent of sustainable foreign liabilities may be less than previously assumed.

Our view is that reserves will shift to currencies of countries deemed as sanctions-remote. A corollary is that a sanctions-risk premium on FX reserves realistically applies only to countries where the risk of globally coordinated sanctions is high.

Ultimately, we believe the U.S. dollar will come out at least as strong as before, while the picture for the renminbi is more clouded.