Toxic Convertibility: Russia already has de facto different exchange rates for the ruble, although the difference between them is still insignificant

In the three weeks since trading of the dollar and euro ceased on the Moscow Exchange, two main features of the new foreign exchange market configuration have emerged: increased volatility and the effective splitting of the exchange rate.

The most favourable rate is for purchasing non-cash dollars and euros from sanctioned banks that allow holding currency in an account but do not execute transfers either abroad or within Russia. A specific ‘internal dollar’ has appeared in Russia. Less favourable is the rate for purchasing cash currency. Even more expensive is currency for importers and other clients intending to transfer it out of the country. Stablecoins tied to the currency cost roughly the same.

The Central Bank claims that the shift to an over-the-counter (OTC) rate aligns with global practices. However, this is not entirely accurate. The effectiveness of the OTC market relies on its participants having free access to the international market. In Russia, most major players are practically cut off from it and therefore have limited resources.

The yuan now somewhat acts as an 'anchor' on the foreign exchange market, continuing to be traded on the exchange. However, trading in the yuan is gradually moving to the over-the-counter market as large Chinese banks withdraw from the Moscow Exchange, fearing secondary sanctions.

In general, the ruble has made another step away from convertibility. Exchanging rubles for dollars and using them at one's discretion is possible, but the range of such opportunities is shrinking. The main question is whether the further splitting of the exchange rate will continue along the Iranian scenario, where years of international sanctions have led to an almost official system with multiple rates.

In the near term, exchange rate differences may remain small, creating the illusion of a single exchange rate. However, in the future, with the emergence of various macroeconomic challenges, rates may diverge significantly, revealing what is already a fact today: the break with the world's reserve currencies, which the Russian authorities call 'toxic', is a step towards the deepening inferiority of the ruble.

In the three weeks since the cessation of dollar and euro trading on the Moscow Exchange, at least the short-term consequences of the reconfiguration of the Russian foreign exchange market have become clear, hinting at the trajectories of its further evolution and the fate of the ruble.

The official ruble exchange rate, which the Central Bank now calculates based on OTC market transactions, has slightly strengthened. The fundamental factor behind its strengthening, as before, is the increase in the current account surplus due to issues with import payments (→ Re:Russia: Gas and Brakes). In order to bring the exchange rate back to the level that the government was aiming for when planning the 2024 budget (95 rubles per $1), exporters were allowed to sell only 60% of foreign currency earnings rather than 80%. The 80% threshold had been in place since October 2023, when the ruble was weakening. Thanks to this adjustment, the dollar could rise to 90 rubles in the short term (it has recently fluctuated between 85-88 rubles), according to analysts from Alfa-Bank and Gazprombank Investments.

However, in the absence of exchange trading, the official Central Bank rate reflects the statistical inaccuracy, while in practice, different rates operate. Their dynamics do not even fully align.

In addition to banks setting a larger spread between buying and selling rates (currently around 10 rubles, meaning rates can differ by more than 10%), different rates apply for cash and non-cash currency. The most favourable rate is for purchasing non-cash dollars and euros from sanctioned banks that allow holding currency in an account but do not execute transfers either abroad or within Russia. This way, rubles can effectively be stored, protecting them from exchange rate volatility and partially from inflation. Essentially, this means that specific dollars for internal use have appeared in Russia.

A less favourable rate applies to cash purchases. Currency is more expensive for importers and other clients who buy it to transfer out of the country. A few Russian banks still performing SWIFT transfers to the EU and banks from neighbouring countries that continue to serve Russian clients initially sold non-cash euros almost 10 rubles higher than they cost at operational cash desks. But by the end of June, the difference had decreased to 3-4 rubles, or roughly 4-5%. Similarly, the premium for buying USDT, a cryptocurrency pegged to the US dollar, is about 5% compared to the Central Bank rate. Previously, this difference was virtually nonexistent, analysts from Finam note. According to Bloomberg, some Russian companies are already using stablecoins for import payments with the tacit approval of the Central Bank.

Another consequence of the cessation of exchange trading is increased volatility. In the last three weeks, the minimum dollar rate fell to 82.6 and soared to 89 rubles. The Central Bank promises that fluctuations will smooth out as the rate adjusts to the ‘new infrastructure, to the new fragmentation’.

Announcing the new procedure for determining the exchange rate, the Central Bank emphasised that 'both the international foreign exchange market and the domestic foreign exchange markets of most countries are OTC – exchange trading in currency is not a necessary condition for the convertibility of a national currency.' The regulator also noted that in recent months, the official exchange rate, calculated based on exchange trading, almost did not differ from the OTC rate (the deviation was 0.01–0.03%). In other words, according to the Central Bank, until now, the Russian foreign exchange market was a unique phenomenon, and now it will start to operate like the global market. However, this is not entirely accurate.

Although transactions in the global market are conducted without the involvement of exchanges, the lion's share of settlements eventually goes through one platform – the American CLS Bank, financial expert Sergey Romanchuk points out. In the absence of centralised clearing, not everyone will have free access to currency in Russia. 'Platforms without centralised clearing operate on a matrix of limits and do not accept participants with few credit lines, which Russian banks currently have almost none for moving dollars and euros among each other', Romanchuk notes. As a result, the market becomes concentrated: large players aim to connect currency sellers (exporters) and buyers (importers) directly to themselves.

In other words, the OTC market works efficiently if its participants have free access to the international market, analysts at Finam emphasise. In Russia, however, most major players are practically cut off from it and therefore have limited resources. Additionally, Finam notes that during the times of exchange-based currency trading, an important liquidity provider was individuals, non-residents, and small companies, which accounted for up to 20% of the total trading volume. Meanwhile, the interbank market in Russia is already small. On June 21, according to the Central Bank, the total turnover of the OTC dollar trading market was 123 billion rubles, of which only 24 billion were interbank trades. On ‘normally functioning foreign exchange markets’, the ratio of interbank to client operations is the opposite, Romanchuk observes.

In such an opaque market, the sharp exchange rate fluctuations observed over the past three weeks may result from manipulation. For instance, senior consultant at Alfa-Capital, Alexey Klimyuk, noted that in several cases, sharp jumps coincided with dates when the official rate was used to calculate payments to investors on Russian securities denominated in foreign currency.

The yuan now plays the role of an 'anchor' on the foreign exchange market to some extent, continuing to be traded on the Moscow Exchange. According to the Central Bank, as of the end of May, the dollar and euro accounted for 45.9% of the exchange market, while the yuan's share was 53.6%. On the over-the-counter market, the share of currencies that are globally called 'hard' or 'reserve' but are referred to as 'toxic' in Russia, was still higher (55.4%) than the yuan (39.2%). On 2 July, the cross-rate of the ruble to the dollar through the yuan was approximately 84.86 rubles per $1, which was significantly lower than the rate set by the Central Bank for that day (87.3 rubles per $1).

However, the prospects of the yuan on the Moscow Exchange are unclear. If Chinese banks refuse to work with the Moscow Exchange and the National Clearing Center (NCC) to avoid secondary sanctions, exchange trading of the yuan will also cease. Concerns about the yuan's future were one of the factors strengthening the ruble in the first days after sanctions were imposed on the Moscow Exchange and the NCC, suggests Evgeny Kogan, a professor at the Higher School of Economics. According to Kommersant, the Russian subsidiary of the Bank of China, one of the largest banks in China, has already decided to cut business with organisations on the US sanctions list. According to Kommersant's assessment, based on data from the Moscow Exchange, some yuan trading has already moved to the over-the-counter market in recent weeks.

One way or another, the ruble has taken another step away from convertibility. Exchanging rubles for dollars and using them at one's discretion is still possible, but the range of such opportunities is shrinking, and exchange markets will segment. In a broad sense, fully convertible currencies are those that can be used for any purpose and exchanged for other currencies without restrictions and at market rates. Experts from the International Monetary Fund, which established a list of convertibility criteria, note that various currency restrictions exist in almost all countries. To be considered convertible, a currency must substantially satisfy each of these criteria. Strictly speaking, the ruble does not currently meet any of them. However, this diagnosis could have been made earlier. For example, former Finance Minister Alexei Kudrin, under whom the ruble was first considered fully convertible, stated that the Russian currency lost this status in the early months of the war.

The main question today is to what extent will the splitting of the ruble exchange rate increase? In Iran, years of international sanctions have created a system with multiple exchange rates. One rate is for exporters who sell currency. This rate is in effect on the NIMA trading platform, which operates on the principle of hawala – a trust-based system of settlements. Another much more favourable rate is available for importers of critically important goods, subsidised by the state. The difference from the NIMA rate can be several hundred percent. Finally, a third rate is for unprivileged buyers, close to the rates offered by street money changers tracked by the Bonbast service. The USSR had a similar system of multiple exchange rates in 1990 and 1991, which ended on 1 July, 1992, when a unified free exchange rate for the ruble was established.

In the near future, the difference between variously determined exchange rates in Russia may be insignificant, creating the impression of a single rate. However, in the long term, under various macroeconomic challenges, these rates may diverge significantly.