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. Last Updated: 07/27/2016

Article VIII: Boldness or Bluff?

Four years to the day after joining the International Monetary Fund, Russia adopted Article VIII of the Washington institution's protocol. On June 1, the government claimed to "harden the ruble," in turn, "staring the dollar in the face." Pre-election rhetoric, the lot of it: making the ruble "convertible on current account" does nothing but acknowledge reality. More importantly, the government has squandered the modicum of credibility the Article VIII adoption may have won the ruble in the currency markets. The recent slapping-down of the Central Bank of Russia by the president's administration raised the eyebrows of more than a few currency traders.

The adoption of Article VIII means restrictions will no longer be imposed on the conversion of rubles into dollars for current account transactions -- that is, deals lasting less than 180 days. Longer-term capital account deals remain subject to relatively tight regulations. In practice, this means that Russian exporters receiving hard currency from sales in the West no longer have to hold half their earnings in rubles. Similarly, Western suppliers should now accept rubles from Russian importers without hesitation as these can be easily changed into dollars and repatriated. Although Article VIII makes foreign trade easier, if the ousted rules were not ignored, they were usually circumvented. Russians forced to convert hard-currency export earnings into rubles would often change them back into dollars the next day.

Meanwhile, Westerners repatriating import revenues could pick from a variety of scams converting wads of rubles into snug foreign deposits. The simplest was to use a Russian "front" -- current account convertibility restrictions on Russia residents were lifted long ago. Alternatively, foreigners keen to go it alone could use "currency swaps," "under-invoicing" or "payment without delivery." By removing some of the middle-men, Article VIII certainly reduces the costs and headaches of trade, but there is nothing bold about its adoption.

The fact that capital control abolitions are not included under Article VIII cramps the style of Russian investors in the West, more than Westerners wanting to invest here. By using an "I-account" non-residents can already make capital investments in Russia -- that is, deals exceeding 180 days -- and once they have paid tax, the profits can be repatriated freely. But we are still in a situation where Russians cannot legally invest abroad. Only on April 24th did the Central Bank pass a resolution that Russian-residents could purchase foreign real estate -- and only then with specific Central Bank approval. Estate agents in the Canary Islands or the West London suburb of Kensington -- now boasting around 12 Russian restaurants -- might tell you this law is meaningless. But it exists when the authorities want it to: Top brass at Inturbank are currently being prosecuted for Finnish real estate holdings.

But the most interesting aspect of the Article VIII adoption concerns trade not in goods, services or eight-bedroom townhouses, but in short-term government debt, or GKOs. Despite Central Bank hedging schemes, "capped" returns and limits on foreign portfolio holdings, the real obstacle to foreign participation in the GKO market has been profit repatriation. Foreigners yearning for exposure to sky-high GKO yields have been loathe to buy them directly as the proceeds funnel into "T-accounts." Set up for foreign legal entities, "T-accounts" can be used to hold capital and interest from GKO purchases, but not for profit repatriation.

That's the official story, anyway. The reality is that foreigners dealing in GKOs -- that is, selling the Russian government money -- have got around the repatriation problem in the same way as foreigners selling imported women's underwear or frozen concentrated orange juice. Both breeds of entrepreneur use Russian fronts, currency swaps and so on. Particularly fashionable GKO players, after an offshore dollar transaction, buy ruble-denominated promissory notes from a Russian bank with GKO holdings, hedging the currency risk by augmenting the note with a dollar futures agreements. Even before a cash-strapped government starting throwing "foreigner-limits" to the wind -- as has happened in the last few GKO auctions -- foreign money already accounted for at least 50 percent of all GKO investments.

Because GKOs are so short-term, they are treated as current account deals, rather than going through the capital account. Consequently, current account convertibility means, in theory anyway, an end to "T-account" repatriation restrictions. In fact, the distinction between "T-accounts" and "I-accounts" may break down altogether, meaning foreigners can buy GKOs direct, and extract the profits smoothly.

Although the Central Bank has not issued a balance sheet since February, their motives for opening the market can be deduced. The liquidity noose around Russian banks -- usually prime GKO consumers -- has lately tightened. Depositors are withdrawing their money, converting it into dollars and stuffing it in jam-jars: tried and tested pre-election tactics. The demand for cash means banks have been forced to retreat from GKOs -- hence the recent increased role for foreigners. But it is also highly likely that the Central Bank has had to buy a lot of T-bills itself, financing such purchases by printing money.

The whiff of GKO purchases by the Central Bank is in the currency market -- industry insiders reckon that in order to defend the ruble, the CBR lost almost $3 billion of its international reserves during April and May. In some senses, as well as providing Yeltsin with some useful rhetoric to throw at the Soviet intelligentsia, the Article VIII ruling was also an attempt to convince the currency markets that the monetary authorities were not in the least bit intimidated.

This move, alone, might have been a credible bluff. But the latest breach of Central Bank independence is different. The State Duma is screaming for a 5 trillion ruble ($990 million) Central Bank transfer for defence plants, back-pay and other pre-election sweeteners. Yeltsin seems behind the move, backing nondescript Finance Minister Vladimir Panskov, sacrificing ultra-credible Central Bank dirigiste Sergei Aleksashenko. A bluff too far? We can only wait and see.