Can the Russian central bank’s foreign exchange intervention prevent a ruble crisis?


The Central Bank of Russia (CBR) is intervening by selling foreign currencies to contain the extraordinary volatility that has gripped the Russian ruble (RUB) following its invasion of Ukraine.

The international reserves held by the Russian central bank have never been higher than today. The CBR currently has $630 billion in international reserves, the sixth largest in the world – an arsenal that could be deployed to moderate wild exchange rate volatility.

Almost $500 billion of Russia’s international reserves are foreign currency reserves (foreign exchange reserves), while $130 billion are gold reserves.

But how does central bank intervention in the foreign exchange market work in practice? And, in the case of Russia, will its huge international reserves avert a currency crisis?

Russia has accumulated huge international reserves

International reserves by country at the end of 2021 – Credit: Capital.com / Source: IMF “https://data.imf.org/regular.aspx?key=63087882”

How does monetary intervention work?

In a world where the majority of exchange rates are floating, foreign exchange transactions are mostly regulated by the private sector.

Central banks, in both advanced and emerging markets, rarely intervene. As a rule, the central bank carries out operations in ordinary currency only for the purpose of managing its foreign exchange reserves.

However, when severe bouts of currency volatility endanger financial stability and disrupt normal market functioning, central banks may temporarily enter the foreign exchange market to smooth wild swings.

Foreign exchange intervention is the practice of buying and selling foreign currencies.

When a central bank acquires foreign currencies, it accumulates foreign exchange reserves. Sales of foreign currencies are especially common during times of market turbulence when the central bank seeks to support its domestic currency and reduce volatility in the market.

In this context, international reserves represent the buffer available to a central bank to avoid monetary crises.

The Russian central bank, for example, sells US dollars for rubles on the foreign exchange market in response to the sharp drop in the ruble after its invasion of Ukraine.

A chart showing USD/RUB price action on February 24, 2022USD/RUB price on February 24, 2022 – Credit: Capital.com / Source: Tradingview

Why the Russian central bank intervened in the foreign exchange market

The Russian central bank has sufficient foreign currency liquidity to conduct operations in the foreign exchange market without significantly harming the macroeconomic and financial situation of the country.

However, the three main reasons for the intervention of the Russian central bank in the foreign exchange market are:

1. Avoid excessive volatility in the ruble market in order to avoid trade and financial disruptions between Russia and other trading partners.

2. To avoid a sharp depreciation of the rouble, which would lead to a sharp rise in inflation and force the central bank to raise interest rates, possibly triggering a recession.

3. The existence of over $130 billion in gold reserves represents a buffer that could actually increase in value if the precious metal continues to rise, limiting the decline in international reserves.

Are Russian reserves sufficient to avoid a monetary crisis?

Russia’s international reserves are at an all-time high. Since the 2014 crisis, when Russia invaded the Crimea region of Ukraine, the international reserves of the Central Bank of Russia have increased by around 70%, from a low of $355 billion to an all-time high of $630 billion, which is 45% of Russia’s GDP. .

Russia’s international reserves have grown mainly due to prudent fiscal and monetary policies, as well as export earnings from oil and gas – two commodities that account for more than half of Russia’s total exports and have experienced sharp price increases over the past year.

A chart of Russia's international reservesRussia’s foreign exchange reserves hit record high in 2022 – Credit: Capital.com / Source: Tradingview

While the Russian ruble obviously experiences periods of significant volatility in the market due to the sale of Russian assets by foreigners, investors may wonder if Russian reserves are sufficient to avoid a currency crisis.

Only time will tell, but what the data shows is that Russia enters this crisis in good shape from a macroeconomic and financial perspective, as analyzed here.

The Foreign Monetary Fund (IMF) has established a framework for determining the adequacy of a country’s international reserves. The statistic is called Assessing Reserve Adequacy (ARA) and measures the ratio of a country’s current level of reserves to the amount that would be adequate given the country’s unique external risks and vulnerabilities.

A value greater than one in the ARA metric implies that a country’s current reserves are more than sufficient to avoid a balance of payments or currency crisis. When the ARA indicator is less than one, the country’s reserves are insufficient to cope with adverse financial and macroeconomic circumstances.

According to the most recent edition of the Foreign Monetary Fund’s ARA index, Russia’s international reserves are 3.6 times larger than would be considered appropriate. No other country in the world has a higher ARA metric.

It remains to be seen how this stands up to potentially crippling economic sanctions from the West following Russia’s unprovoked attack on Ukraine.

Russia’s international reserves

a column chart showing the IMF's ARA metricRussia ranks 1st in the IMF’s ARA indicator – Credit: Capital.com / Source: IMF “https://www.imf.org/external/datamapper/[email protected]/CHN/IND/BRA/RUS /ZAF”

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