Brad Setser

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Cross border flows, with a bit of macroeconomics

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$100b in five months gets my attention …

by Brad Setser
May 28, 2007

Russia’s reserves just topped $394b – and that is for the middle of May.    On current trends, Russia’s reserves will top $400b by the end of the month.   That is an increase of almost $100b from the $304b Russia had in the bank at the end of 2006.


No wonder Russia now talks of a Russian Davos.    And thinks about an investment fund.   If your reserves are growing almost as fast as China’s reserves – OK, $20b used to the pace of China’s reserve growth, but China raised by the bar in the first quarter — you want a bit of respect. 



Russia started the year with a lot of euros and pounds in the bank – at least 50% of its reserve are in euros and pounds.   But valuation gains only explain $3-4b of Russia’s reserve growth this year.  Most of the increase is real.     


Russia ran a $22b current account surplus in the first quarter on the back of its oil and gas exports.   That surplus may be a bit higher in q2.    Oil prices have moved up.    But given how strongly Russia’s imports are growing (the y/y growth in q1 was well over 30%), I don’t expect a huge increase either.    A $50b current account surplus in the first half of 2007 cannot explain what is likely to be a $115-120b increase in Russia’s reserves.

Clearly, a lot of capital is flowing into Russia now.    Net inflows were $10b in the first quarter (mostly to Russian firms).    The scale of those inflows picked up significantly in q2.   And Russia can no longer hold down the scale of its reserve growth by paying back large chunks of its external debt.  

What does this all mean? 

Well, among other things, it seems like Russia’s financial system has gotten a bit better at creating financial assets that Russians and foreigners alike want to hold.    Private capital is flowing into Russia.   Lots of it.  It cannot all be inflows related to the Yukos auction either.


That is progress.  But it also creates some challenges for Russia’s central bank.   A lot of the “oil surplus” is sterilized by the government, which uses its oil windfall to build up its oil stabilization fund (See Gianella for details, along with this OECD publication).   The central bank, by contrast, is solely responsible for sterilizing a surge in capital inflows.   Russia’s central bank – like the People’s Bank of China and the Reserve Bank of India – has raised reserve requirements.   But the money supply is still growing kinda fast.


It is also evidence that private markets currently want to finance emerging economies that don’t need the money – Russia, Brazil and China all run current account surpluses and all attract large private captial inflows.   The global financial system only balances because their central banks lend a lot of that money to the US.    


Russia only keeps about ½ its reserves in dollars.   But ½ of a big number is still a large number.   Unless the pace of Russia’s reserve growth slows in the second half of the year, Russia may provide the US with over $100b in financing this year.   That far larger than any bailout the IMF ever provided Russia – and way, way more than the US provided Russia to help Russia’s transition.   Strange how things change.


  • Posted by RebelEconomist

    Interesting to hear that sterling has a sizable weighting in Russia’s reserves – worth watching if the Litvinenko murder case damages diplomatic relations between the UK and Russia.

  • Posted by gheorghius

    Where’s the limit of current trends (assuming stable high oil prices)? What scenarios for the future? When do you see monetary pressures to impose too high a cost on Russia? If huge appreciation = dutch disease, then are capital controls “Chilean style” an option in Russia?

  • Posted by bsetser

    limits of current trends — wish i knew. I suspect that the central bank expects inflows will tail off on their own accord, so the current pace of reserve growth won’t be sustained.

    russians tend to be good at evading controls, so i wouldn’t be sure than inflow controls would work .. plus lots of the companies now borrowing from abroad have kremlin ties i think so cutting them off may not be realistic.

    And i don’t know enough about sterilization in russia to have an informed view about limits there. maybe others can help me out.

  • Posted by Bureaucrat

    To the degree that a significant junk of money flowing into Russia probably comes from foreign (portfolio) investors, many of whom probably would not dare to try play silly buggers with the Russian CB, I would think that Chile type controls to make inflows more costly would probably have some effect – but agree that they wouldn’t stop Gazprom and the like to borrow abroad if they want to.
    On sterilisation, the market in domestic currency paper is still fairly shallow, so the CB is not sterilising much of the Roubles they are pumping out to buy reserves (and consequently M2 is growing at unrealistic rates). Whether they could do much more is an open question, but the fact that they don’t try more agressively probably shows that they think they can’t (though I personally think the market would be willing to take up more).
    For some part of the accumulating reserves they have fiscal sterilisation – the money the government saves in the oil stabilisation fund is held in Roubles in the CB for the time being (at least it was last time I looked at the issue).

  • Posted by Guest

    Aren’t some of the inflows through pound sterling priced shares traded on exchanges in London? Would the City want to give up that business?

  • Posted by Guest

    “…In my opinion, financial protectionism will be a major problem for globalization… While the arguments in favor of and against trade protectionism are clear, the pros and cons of resisting foreign capital are not yet clear, and how various countries will react is also unclear…”

  • Posted by bsetser

    bureaucrat — i never quite have figured out the mechanics of the stabilization fund. theoretically it is a ruble account …

    but then again, it also is invested in a 45/45/10 $/ euro/ pound portfolio with (for now) high quality government and quasi-government bonds with a relatively short-duration (the document on the stab fund’s portfolio is on the rge site, and also available from the russian authorities) and the stab fund is clearly part of Russia’s reserves. I never quite have figured out how a ruble account is invested abroad (and given the BoP, it has to be invested abroad) w/o creating a fx mismatch for the Bank of Russia …

    interesting points: re lack of sterilization. so what happens now if cap. inflows don’t slow? m2 growth is rather impressive, even relative to chinese standards. tis almost at qatari levels!

  • Posted by Guest

    Bureaucrat – one minor correction, if I may. Since last summer, the oil stabilization fund is no longer held in Rubles, but in a USD/EUR/GBP deposit with the Bank of Russia. The Ministry of Finance, who owns the Fund, and the Central Bank, who acts as an agent, have agreed an index formula to calculate the return on this deposit based on an undisclosed basket of government bonds in the 3 currencies in question. The central bank effectively continues to manage the stabilization fund as part of the overall reserves, but the foreign currency return on the fund is now enjoyed (and the FX risk is borne) by the Ministry, not the central bank.

  • Posted by bsetser

    Guest — thanks. your explanation helped me as well.

  • Posted by Bureaucrat

    Guest, thanks for the precision, that’s useful to know. The point I wanted to make was simply that the stabfund money was de facto included in the reserves, and hence at least some junk of the reserve growth is fiscally sterilised (but very far from enough).
    Brad, I agree that the problem they have with inflation is likely to get bigger if capital inflows don’t slow (which, on the other hand is not excluded with elections around the corner). Judging by history and recent noises, they’ll allow for a bit more real appreciation and do some fiddling with administrative prices, but that’s not going to do the trick. A shame that they didn’t manage to get inflation (still somewhat below double digit levels) further down in recent years when the whole world was disinflating, especially given that the “great world disinflation” period seems now to be over.

  • Posted by Guest

    Bureacrat : If I could correct you.. its not JUNK of money.. its CHUNK of money…

  • Posted by df

    how does the threat of financial mutual destruction square with Iraq and Iran ?

    Compared to 2003, the USA have now a bigger debt, a discredited and exhausted army, China, Russia and saudi Arabia, all have tons reserves and are the US main providers of cash.

    If there is military action against Iran, would china and russia pull the trigger of the financial war (let the RMB and ruble float and watch the USA strugle with high interest rates and high commercial deficit) ?

    How does the balance between Us allies (Japan, South korea, Saoudi Arabia, other gulf states, potentially India) and the enemies (china, Russia, vietnam, Iran) ?

    COuld the allies pick up if the ennemies would stop adding to their reserves ?

  • Posted by Bureaucrat

    Guest, probably something Freudian in this…

  • Posted by Guest

    Why would China or Russia would want to ‘pull the trigger’ on a war of “financial mutual destruction”, especially when the health and growth of their own financial sector is very much dependent on their partnerships with ‘the West’ and may have the most leverage in determining the success and growth of their economies for years to come. No? If I could suggest that your definition of the enemies, along with the size, capabilities and arsenal of their respective armies, may be seriously flawed.

  • Posted by RebelEconomist

    One thing that growing reserves do not do is increase the chances of war. Every day, China and Russia have more to lose from conflict with the USA…..most of their US dollar assets would be immediately sequestered.

  • Posted by Guest

    Can you please define ‘fiscal sterilization’ as opposed to ‘non-fiscal’ (monetary?) sterilization.

  • Posted by bsetser

    fiscal sterilization = fiscal surplus set aside at the central bank. for russia, the fiscal surplus is used to purchase foreign assets — in broad terms, the gov. gets $ from its oil and saves those $ at the central bank. there isn’t any injection of rubles into the economy (the actual mechanics are a bit more complicated in russia b/c some accounts are denominated in rubles). the central banks’ foreign assets (reserves) and fx-denominated liabilities (deposits from the government) both increase.

    the government can also withdraw local currency from circulation by running a fiscal surplus out of its local currency revenues and holding the surplus on deposit at the central bank — rather than say holding those deposits in the banking system.

    Monetary sterilization — $ comes into the economy, and is traded for rubles, increasing base money. the government may want to take some of its export tax revenue and spend it locally, so it goes to the central bank. or a private investor may want to buy a ruble denominated asset, and thus changes $ for rubles. To sterilize the initial increase in the money supply, the central bank has to run down its domestic assets/ sell sterilization bills. absent such action, the money supply increases.

    at least that is how I understand it.

  • Posted by Guest

    I think it’s right to distinguish ‘junk’ money from capital inflows intended for sustainable investment.

    “… Government agencies measuring price changes in consumer goods report an extended period of benign consumer inflation… What’s missing is an equivalent calculation of asset inflation…”

  • Posted by Guest

    From Asia Times Online,

    The commodity boom is changing the economic landscape across the developing world. The volume of global trade rose 9.2% year on year in 2006, and emerging-market countries increased their international reserves by $738 billion. This explains the emerging-market boom. This is not a fad or a reflection of global liquidity. The $256 billion of net private inflows into the emerging markets reflect the credit strength of these economies and their ability to grow.

    At the same time, the United States is withering away under the weight of its enormous debt load and various asset bubbles. The US economy grew an anemic 1.3% year on year during the first quarter of 2007. Unemployment is picking up and the dollar is collapsing. The unemployment rate in the US increased to 4.5% in April. Indeed, April saw the weakest pace of job creation in two years. The impact of the housing slowdown is starting to appear in the employment data. The tightening of lending standards is reducing the availability of mortgages, forcing further slowdowns in the construction sector.

    The economic slowdown in the US is accompanied by serious concerns about the health of the financial sector. With more than $700 trillion in derivative contracts floating in the marketplace, and much of it tied to the mortgage market, an accident is definitely on the way. Some analysts attribute the steady rise in gold prices to concerns about a looming crisis in the US financial sector.

  • Posted by df

    “One thing that growing reserves do not do is increase the chances of war. Every day, China and Russia have more to lose from conflict with the USA…..”

    THe same holds for the USA (their addiction to cheap financing grows and they rely more and more on foreign products with less and less to offer in exchange.

    The same could have been said about nuclear weapons. Increase in the arsenal of Russia, china, NATO, reduced the chances of a war, since all have more to lose.

    THe other side of the coin is of course that if a war is to happen, the damage will be higher.
    THe likelyhood of a complete anhilation of the human specy through a nuclear war was nihil in 1944, it has steadily increased ever since.

    Same with financial terror. Indeed noone has an interest in blowing the all thing, yet, just as the arm race could not go on forever and has dangers, the greater imbalance race has to be stopped because it has its own dangers.

    most of their US dollar assets would be immediately sequestered.

  • Posted by df

    The volume of global trade rose 9.2% year on year in 2006..

    just how long do you think it is possible to have global trade rise faster than global production ? (bout twice the rate)
    Same with debt / GDP ?
    same with international imbalances / GDP ?
    REserves / GDP ?

    THe idea that asia could be strong as the US grows weaker is a total joke. WHo are the asian lending to ? the USA ? WHo are the asians selling to ? The USA and EUrope ?

    WHo is going to be hurt the most if the consumers in the USA start to save more ? THe US room or the asian radiator ?

  • Posted by JSP

    As long as most countries accept US dollars as a means of payment and as a store of value (in the form of Central Bank reserves) the present major deficit/surplus imbalances between USA and other countries will continue to grow. At the micro level, and in most developping countries, most consumers and investors do not perceive the effects of the weakening dollar. Moreover, their people more often than not prefer to hold US dollars over local currency. Furthermore, the very large oil trade, and probably the global illegal drug trade, are financed mostly in dollars. In addition, large international reserve holders, such as China, are buying up commdities in Latin America and everywhere with US dollars. In some countries, there are joint investment projects with China, mostly in oil and commodities. Governments, and sellers of goods and servcies, do not mind being paid in US dollars by China. Hence, there are very strong economic and political interests, world wide, as regards maintaining, and doing nothing, about the growing deficit/surplus imbalances. Maybe, given this international situation, there is still time for a global and gradual adjustment of the imblances. I think the imbalances cannot last forever, and could break as a result of a major international crisis: say a China invasion of Taiwan. But it would seem there is still time for top level, Government, discussions: among G-8 countries, China, India, Brazil and others.

  • Posted by flipper

    Brad, CBR does little to sterilize beyond stabfond. Bureaucrat is absolutly right – sterilization comes via Stabilization fund, which is rouble account. That’s basicly the only tool which is used, cause there is virtually no market for sovereign bonds here.

    That’s why the M2 has been and is ballooning. The flow of money has lowered rates for corporate bonds and goverment bonds well below inflation and poped a buble in real estate. It has not created an outright buble in equities yet.

    As for the inflows – there are but for the most part it’s debt – corporate for the most part, and direct investment, which has been growing significantly. In equities we are seeing ouflows actually for more than a year already due to political tentions and that other brics have became more glamorous. That’s another reason why the stock market has not poped up significantly.

    As for another strategy to semi-sterilize which may come true – it looks like the goverment is on a path to make some promotion for stock market in general. I think they will continue to do IPOs of goverement related companies in large sizes, the private sector is already doing it, there is an IPO boom here. Then i think those companies will retire debt with those money and finance expantion projects.

  • Posted by Guest

    And yes – on the paper it’s Finance Ministry which manages the Stabilization fund, and it’s nominated in Rubles, guest is absolutely right, it’s just that they do not exchange roubles back and forth with CBR, and the fund is just a part of reserves.

    And one more thing – there is ongoing debate just what is the real inflation level in Russia,
    russian official statistics is somethat similar to CPI, but it’s even more narrow, and more targeted to “average consumer”, i’m not sure but it don’t think they even calculate home rents, which is a significant portion of expenditures for average citizen, since that market is officaly non-existant – nobody wants to pay taxes on that. BTW realiable real estate stats are also non-available, deals are often conducted several times below their true price to avoid taxation, and the only stats are just estimates and gray realtor’s records. Supposed to be CPI for middle and upper class is growing much faster, not to mention the “CPI for the rich”.

    And every year there is a similar pattern of several percent inflation in January.