ELI5: Why is Russia's requirement for oil to be paid in Roubles abnormal?

Question

There seem to be various stories of Russia cutting off various neighbouring and other Euro states from its oil over failing to pay for the oil in Roubles (this is independent of the Ukranian war and so on, I'd like to focus on the economic issue here rather than the paramilitary issue, if at all possible). The way this is painted in the media is that it is abnormal for Russia to require this, and it is an unreasonable endeavour for these countries to acquire Roubles to pay for the oil; consequently, Russia should accept other countries' currencies for its oil, and it should not be the other countries' responsibilities to acquire Roubles.

It is my understanding, from a rudimentary macroeconomic perspective, that it is more normal/common than otherwise, in international trade, for the importer to pay for goods in the exporter's currency. The reason being that the exporting company needs to pay their wages/labour/materials/R&D/shareholders/etc in local currency, not in the import country's currency. For example, if Google does business in the UK, Google needs to pay its SF employees in USD; paying them in British pounds doesn't help them, and Google's employees would be right to be mad if they were paid in Pounds. This, from my understanding, is the norm.

Now, given that the export country (Russia) uses Roubles as the currency, it should be normal and not newsworthy that the exporting company requires payments in Roubles.

1. Why is this newsworthy?

2. Is the only reason why this is onerous for the importing country the fact that the Russian economy has been locked down and Roubles aren't commonly available on the common forex markets, or is there something else here that I'm not aware of?

Answer 1

Because the contracts stipulated payments in other currencies (euros, dollars), not roubles.

i.e. all your other arguments are superseded by the fact that these were not the contractual commitments Russia signed up to.

Here's one recent example of Germany's position:

Germany Rejects Putin Demand for Ruble Payments for Russian Gas - Bloomberg

“Contracts are contracts,” Lindner (German Finance Minister) said Wednesday in an interview with Bloomberg Television in Washington. “Contracts are based on dollars and euros and so private-sector companies should pay in dollars or euros.”

And...Explainer: Russia wants countries to pay for gas in roubles. Will buyers comply? | Reuters

Currently, nearly all Russian gas purchase contracts are denominated in euros or U.S. dollars, according to consultancy Rystad Energy. Payments in roubles would benefit the Russian economy and shore up its currency. .

Answer 2

it is more normal/common than otherwise, in international trade, for the importer to pay for goods in the exporter's currency

Not for oil in general (see "petrodollar") and also not for imports in the euro area in general, see e.g. for the latter.

We use a unique data set covering Belgian trade with all countries—unique in that it comprises information on the currency of invoicing as well as firm characteristics. The data show that while the U.S. dollar accounts for a disproportionate share of international trade, a small subset of other currencies is also actively used in international trade alongside the U.S. dollar—most notably the euro but also to a lesser extent the Japanese yen, the British pound, the Swiss franc, and the Chinese yuan. These patterns are shown in the chart below, which plots the dollar and the euro share of trade for Belgian exports in the left panel and Belgian imports in the right panel. Each circle corresponds to a separate country outside the EU, and the size of the circle depicts the country’s share of total Belgian trade. The fact that most circles lie on the negative diagonal reflects the dominance of the combined use of the dollar and the euro in trade invoicing with virtually every trade partner.

Notes: Each dot represents the share of trade invoiced in dollars (vertical axis) and the share in euros (horizontal axis).

A distinctive feature of dominant currencies is that the same currency is equally prevalent in both imports and exports; this feature is common to both the dollar and the euro. These patterns are at odds with standard international macro models that assume countries adopt either the destination currency or the source currency, with the role of many currencies roughly proportional to their country’s role in world trade.

Dominant currency (i.e. dollar) pricing is also typical for many exports from developing countries.

The US dollar dominates in trade invoicing, especially across emerging market economies. While data on trade invoicing currencies are scant and scattered, available information indicates that the US dollar plays a dominant role. A significant share of bilateral trade between countries other than the United States is invoiced in US dollars (Figure 1). This pattern is particularly marked in emerging market and developing economies, although it is also relevant for some advanced economies (for example, Australia, Japan, Korea). The euro is used widely, but primarily in trade that includes euro area economies on one or both sides of the transaction.5 Similarly, partial data indicate that invoicing in other major currencies (for example, British pounds, yen, Swiss francs) is significant, although mainly in cross-border transactions involving the economies that issue those currencies.

Although the prevalence of US dollar invoicing varies across countries, it has been fairly stable over time (Figure 2). Invoicing data show that the US dollar has played a clearly dominant role in invoicing of both exports and imports in Asian and Latin American emerging market and developing economies, with very stable shares in total invoicing over the past two decades. With somewhat lower shares, the prevalence of the US dollar in some advanced economies (for example, Australia, Japan and New Zealand) has also been quite stable. The exceptions to this pattern are mainly in countries that trade heavily with the euro area such as non-euro European and Northern African countries or some countries in Sub-Saharan Africa who use the euro as a vehicle currency (West African Economic and Monetary Union) and where there was a visible increase in the use of this currency following its inception.

Even for (imports into) the EU, the petrodollar is a (sizeable) reality when it comes to oil imports from outside the EU area, much more so than for other products:

(Whereas only 9% of the EU oil imports came from the US that year.)

So, no, the simple macroecon 101 models that countries export in their own currency aren't true for the most part, when it comes to developing countries' exports. This also has implications that devaluing their currency (via the exchange rate) doesn't actually help a developing country boost exports as much as the simple theory predicts.

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For what's worth it, such decision apparently can be subjected to strong political considerations, at least in some economies, e.g. if we judge by the sudden shift from dollars to euros in the Russia-China trade around 2019. (Alas I didn't find a similar graph for the 1st half of 2022.) According to Chinese sources, that move was agreed upon by China after Trump threatened them with "decoupling" the US economy from China's.

As far as I know, insofar Putin has only asked "unfriendly countries", i.e. the Western ones who imposed sanctions on Russia to switch payments to roubles.

Answer 3

Of course it is normal to try tricks to evade economic sanctions during economic war. How it could be else?

You need to sell something for Russia first to get these roubles. With sanctions applied, there is not much you can sell, so the need to get roubles creates the pressure to remove at least some of the sanctions. Most you can do is to buy roubles from some neutral country that has them because it does not join the sanctions.

Looks like both sides fully understand the idea behind. This is why Russia is pushing for roubles and EU refuses. Formally EU has right to demand the payment in the currency that is written on the contract, however. But the suggestion to change USD into GBP or chunks of gold for instance probably would have not caused that much discussion.

Be the contracts in roubles, the gas supply would have been reduced anyway because of the EU having not enough roubles to pay so no difference after all.

Answer 4

It is quite unusual (and risky) to trade a great deal of goods internationally in a rather volatile currency.

It is at least quite a hassle when a single payment on your contract can shift the currency value by a few percent.

It is worse when the currency is known to be politically controlled and such control is done in a rather rough manner.

These three considerations always override the minor advantage of the currency being a home currency for either (or both!) of the contract partners.

The "...or both" clause of the previous sentence is important. As late as few years ago it was pretty much normal in Russia to advertise and trade expensive items (real estate, vehicles, industrial equipment) in EUR (and some more years ago it was all in USD).

Deals of more than e.g. $1000 were closed primarily in EUR or USD between pretty much Russian companies and citizens.

This is why neither Gasprom, nor their European contractual partners ever considered the Russian Rouble. Until recently.

Answer 5

Why is this newsworthy? ... is there something else here that I'm not aware of?

Short answer: Yes, changing the currency of payment in a contract is just a contract dispute and not really front page newsworthy (even if billion dollar companies are involved). The reason it became newsworthy is because Russia found a way to circumvent some sanctions imposed on it. And those who imposed the sanctions can't really do anything about it legally or politically in the short-term.

The longer answer involves foreign currency reserves, currency exchange rates and sanctions. So let's understand these basic international economic trade aspects first:

• Foreign Exchange Reserves are assets - like foreign currencies, bonds, treasury bills, and other government securities - held by a country to ensure that a central government agency has backup funds if their national currency rapidly devalues or becomes entirely insolvent. (It's like a savings only for emergency use). For example, if the Russian currency suddenly falls in value, international traders won't accept it. In such cases, Russia can dip into its foreign currency reserve and trade with some other currency or gold or bonds etc..

• Currency Exchange Rate is the value between two currencies that is determined based on various factors, majorly central bank interventions, the foreign trade they do, and the demand for a currency from others.

• Sanctions are punitive measures imposed on one country by another country or an international organisation. These can also be actions that hurt another country economically.

After Russia invaded Ukraine, the United States, some EU countries and all their allies imposed some economic sanctions on Russia to punish it. One of the ways they did this was to seize Russia's foreign currency reserves and assets of Russian businesses in their country.

Russia's foreign exchange reserves were around $600+ billion. Unfortunately for Russia, its central bank partially held these funds in foreign countries too (which is a normal practice, especially if you trade with them a lot):

Thus, when sanctions were imposed these countries easily seized all Russian assets in their country:

This meant Russia was denied from accessing around $300 billion of its own foreign currency reserves!

Moreover, further sanctions were being planned to completely cut off Russian banks from doing international money transfers using SWIFT. This meant that even if some Russian bank accounts in foreign countries were not seized, Russia would still not be able to easily access the money.

As everyone by now knows, the largest trade between Russia and EU countries is natural gas. (Reportedly, Russia supplies upto 40% of the gas Europe needs and earns around one billion dollar a month from them). This gas is sold through a Russian company called Gazprom. As is a normal practice in international trade, Gazprom too has bank accounts in foreign countries to accept payment for the gases it sells (in whatever currency that had been pre-negotiated between them).

(For those wondering why Russia didn't negotiate payment in Rubles itself, sometimes it is economically beneficial to receive payment in some other more stable currency).

Once many of these countries started imposing sanctions on Russia, a major worry for Russia and Gazprom was whether it would be able to access the funds it receives for the gas payment.

Gazprom sells it gas to European companies. If these European companies deposited the gas payment into Gazprom's foreign bank account in their country, their legal obligations are fulfilled. For all purposes, they have paid Gazprom. It is not their problem if their government has sanctioned Russia or Gazprom from getting their hand on this money. In effect, European companies could claim they were paying for the gas while the reality could be that due to sanctions Russia would not get any money in their hand.

Sanctions thus created the following problems for Russia:

1. Payments made to non-Russian bank accounts could be seized.
2. Payments made to non-Russian bank accounts could not be easily accessed.
3. Currency conversion to Rubles could be blocked by foreign central banks.
4. Payments in other currency created legal and economic issues for the buyer and the European countries.

(And remember that all these sanctions were also designed to cause damage to Russia's economy).

So Russia came up with a clever method to not only bypass some of these sanctions, but to also counter it in a way that would also strengthen its economy. It created a new payment mechanism (pdf) for all companies buying gas from it and asked them to:

1. Open a foreign currency bank account with a Russian bank.
2. Open another Ruble only bank account with the same Russian bank.
3. Deposit the gas payment in Euros (or whatever currency stipulated in the contract) to the foreign currency account in the Russian bank.
4. The Russian bank would then convert the Euros to Rubles and deposit it in the buyer's second Russian account.
5. It would then transfer the Rubles from that account to the seller's (Gazprom) bank account.

The payment would be considered complete only when Gazprom received the payment in Rubles.

This was quite clever for the following reasons:

1. Allowing the European companies buying gas to pay in Euros first ensured they were technically adhering to the contract.

2. Asking them to transfer the Euros to a foreign currency account in Russia meant that Russia had the money in their hand (in a Russian bank).

3. This also meant that Russia's central bank couldn't be sanctioned as all large foreign currency transfers involve the central bank of the respective countries.

4. By insisting the buyer's payment obligation is fulfilled only with the last transfer when the Ruble funds are credited to Gazprom’s account, Russia ensured the foreign central banks couldn't block the currency conversion.

5. Converting foreign currencies to Rubles meant its value would shoot up in the international market and strengthen it.

6. By allowing payment in Euro first, Russia knew it would also strengthen the Euro currency rate as it was being used in a trade. (This meant EU nations would be less opposed to this tactic as they get minor economic benefits from it).

All in all, by insisting on this process of payment, Russia made sure that its Central Bank, and a few other large banks were not sanctioned and Russia made its Ruble the world’s top-performing currency for some time.

The fact that Russia managed to find a loophole to get payments in Roubles, while ensuring that it countered some of the economic sanctions imposed on it is why everyone was pissed.

Answer 6

Of course it's not abnormal. While the majority of western media outlets portrayed it as "Russia holding the EU economic hostage", any person who thinks logically and rationally, as opposed to our leadership which clearly makes decisions solely based on emotions, could see it coming the second the EU imposed sanctions.

A lot of politicians called it a "breach of contracts and agreements", while at the same time failing to see that economic sanctions waged against Russia are also breaches of the very same contracts and agreements. Economic sanctions are not supported by international law and have no legal basis.

EU bureaucrats began seizing Russian assets and reserve funds in foreign currencies. Seizure of foreign state assets goes directly against "State Sovereignty" which is a principle of international law and actually has legal basis.

Once this happened, Russia began writing a list of non-friendly states and demanded payment in Roubles from these states. And why wouldn't they? The EU, UK & US seized Russian funds and assets, without legal grounds and without a single legal process.

Would you keep selling your goods and services to a person, knowing full well they'll steal the payments back within a week or two? No, nobody in their right mind would.

The fact that it became headlines, despite it being fully rational and logical, is because bureaucrats in the US and EU aren't used to repercussions. They're not used to consequences or push-back. The mere thought of someone actually pushing back against economic sanctions, which have no legal basis, are indecipherable to these people.

These people act on emotion rather than justice, logic or rationale, and have proved that western European states, along with the US, cannot be trusted. Because if they can seize another country's assets and funds, without legal basis, what's stopping them from seizing yours?

That being said, Russia is still supplying Europe, despite sanctions, with oil and gas. And have so far not done a single thing back, which they absolutely could and most likely will do eventually.

People also tend to forget that both Russia and China have agreed that they will begin phasing out the dollar as their national reserve currency for this very reason, and as Putin put it, "this is the beginning of the end of US hegemony into a more balanced world order".

The US, who do not abide by international law in the best of cases, should not be able to hold countries economic hostages for not agreeing with them. Neither should they be able to lie in front of the entire UN assembly and present false evidence in order to invade and demolish a country, resulting in the death of 500 thousand children, but they did, and they can. Which is just absurd. And I fully understand the reasoning behind wanting to move away from the US dollar.

This is the beginning of the end for the petrodollar, and the US themselves are speeding up the process.