The plan emerging from central bank proposals and a gradual unwinding of local restrictions will focus on mobilising capital at home while catering to jurisdictions it considers friendly.

From Monday, the Moscow exchange will allow trading in debt securities for investors from countries that haven’t joined the sanctions imposed by the US and its allies. The decision ends a hiatus in place since Russia sealed off its markets to restrict the flow of money out of the country when the war began in late February.  

But the resumption won’t extend to clients from “unfriendly” countries, who remain subject to capital controls banning foreigners from selling or collecting payments on local securities. The group – which includes nations from European Union members to Canada and Japan – accounted for around 90% of total portfolio investments into Russia as of last year.

“At the start it was a necessary capital control to stabilise the situation,” said Christopher Granville, managing director for global political research at TS Lombard in London. “But now it’s more a matter of principle of not relaxing while there are these unprecedented sanctions from the West in place.”

Friend from foe

It’s the latest example of Russia taking an increasingly hard line sorting friend from foe. 

This month, President Vladimir Putin banned some foreign banks and energy companies from exiting their businesses in the country. Another decree allowed Russian lenders with frozen foreign exchange to halt operations with corporate clients in those currencies. And Russia’s sovereign wealth fund may now invest in the currencies of nations like China, India and Turkey, after penalties blocked euro and dollar purchases.

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“Given the circumstances, it will be necessary to develop trade and financial relations with those countries that are ready to do this with Russia,” said Oleg Vyugin, a former top Russian central bank and Finance Ministry official.

Finance emerged as a new front against Russia almost immediately after Putin ordered his military into Ukraine on 24 February. 

To punish the Kremlin, foreign governments slapped sanctions on trade and finance, froze about half the reserves of its central bank and cut many of its banks from the SWIFT global messaging system. 

Unable to intervene to defend the ruble with only yuan and gold, the central bank put up capital controls and other emergency measures to calm investors. 

Bouncing back?

But Russia is turning the page now that domestic markets appear to have ridden out the storm. 

Windfall energy revenue and a collapse in imports helped the rouble bounce back, allowing authorities to roll back restrictions on capital controls. Local bond yields are back to pre-war levels. 

It’s unclear how Monday’s partial reopening of the domestic market will affect investors from hostile jurisdictions intending to divest their holdings of local currency debt. Even now, it is possible for investors to sell their holdings, albeit at depressed prices, according to Viktor Szabo, a fund manager at Abrdn in London.

As life returns to the market, authorities are watching to see how the financial system functions in the absence of adversaries that made up more than half of Russian trade before the war and accounted for the vast majority of non-resident holdings in local government bonds known as OFZs.

To cope with what it called “an extraordinary change of circumstances”, Russia’s central bank published a report for public discussion that laid out myriad innovations to help. 

Looking within

Policy makers are looking inward for sources of funding, floating concepts like charity bonds and participation financing. 

Other proposals aim to discourage businesses from using “toxic” currencies and state companies should convert their foreign-exchange holdings into the currencies of “friendly” countries, according to the central bank. 

“Pivoting the financial system will likely be gradual,” said Sofya Donets, economist at Renaissance Capital. “If it happens abruptly, then it will be a big shake-up for the economy.”

But even as some investors gain more access to domestic markets, it’s also a reminder of the challenges ahead.

Non-residents from “friendly” countries accounted for only 5%-10% of foreign OFZ holdings a year ago, a share that Otkritie Research’s Vladimir Malinovskiy calls “insignificant.”

“It’s not about facilitating more offshore trading,” said Abrdn’s Szabo. “It’s more about showing willingness to restore some semblance of normality.” BM