Friday, December 19, 2014


Russia

Explainer: New Western Sanctions May Severely Hurt Russian Economy

Empty shelves in Russian supermarkets could become the norm if Moscow decides to retaliate against Western sanctions by banning commodities such as fruit and vegetables from the EU.
Empty shelves in Russian supermarkets could become the norm if Moscow decides to retaliate against Western sanctions by banning commodities such as fruit and vegetables from the EU.
By Charles Recknagel

The latest round of EU and U.S. sanctions over Ukraine will restrict Moscow's access to what Russia arguably needs most: Western financing and new technology. Here are five things to know about the sanctions and their impact.

How much could the sanctions hurt Russia?

This batch of sanctions comes at a time when Russia is already in a fragile economic state. The turmoil over Ukraine has made investors nervous and sparked massive capital outflows -- some $75 billion from Russia so far this year, or more than for all of 2013. That has sent the value of the ruble tumbling by some 9 percent and raised the price of imported goods. 

But the new sanctions, which for the first time target Russian economic sectors rather than only individuals or entities, have the power to weaken Russia's economy even more. They will dramatically reduce the country's access to Western capital markets and to new Western technology -- two things the economy needs to stimulate growth.
 
"Our baseline economic [growth] forecast before the latest round of sanctions for Russia was just 0.2 percent for 2014, so already very close to zero," says Adam Slater, senior economist at Oxford Economics, a global advisory firm based in England.  "With these new sanctions in place there is now quite a strong danger Russia will have negative growth this year."

According to Slater, the danger of negative growth does not come from just the impact of the new sanctions themselves but also the chilling effect the West's steady ratcheting up of sanctions is having on investors.

 "They signal that Russia is a location where investment is not really approved, or is risky because sanctions might be extended further," he says.

What will be the most immediate impact?

The most immediate impact will come in the financial sector. Both the new EU and U.S. sanctions sharply restrict access for Russian state banks to Western capital markets, currently their biggest foreign source of financing. 

Under the sanctions, EU and U.S. firms are barred from providing financing for longer than 90 days to the country's key state-owned banks. That will severely limit the banks' ability to finance major development projects.

"Most projects require long-term investments, and it is especially important given the current economic situation in Russia to have long-term investments, but now Russian state-owned banks cannot access that kind of financing," says Vladimir Miklashevsky, a Helsinki-based economist specializing in Russia at Danske Bank. 

The tightening of Western investment in the state banks could have a ripple effect throughout Russia's economy, where the need for foreign financing is acute at all levels. 

In one measure of how much foreign money has already been borrowed in Russia, Britain's "Financial Times" reported July 30 that Russian state banks have $33 billion in external debt due over the coming 12 months. Russian non-financial state companies have $41 billion due over the same time frame, and private banks and companies $87 billion.

What will be the longer term impact?

The longer term impact will be largely in the energy industry. Other sanctions restrict access for Russia's energy sector to new Western technologies. 

These will be less immediately disruptive to Russia's economy but will have a long-term impact on its future competitiveness. 

The sanctions do not target Russia's gas sector, which provides the European Union with about one-third of its natural gas. But they do target Russia's oil sector, whose growth has powered Russia's economic resurgence since the collapse of the Soviet Union.

Limiting access to new Western drilling technologies could be particularly painful because Russia is counting on developing Arctic, deep sea, and shale resources to replace its current reliance on Siberian oil fields, which are becoming depleted. 

Can Moscow find alternatives to the West?

The West is betting that its sanctions program will succeed because it believes that Moscow cannot find comparable sources of financing or new technology elsewhere.

It is a belief Moscow has tried to undermine by looking east for new capital and energy markets, particularly China, and by trying to highlight the strength of the BRICS group of emerging economic powers (Brazil, Russia, India, China, South Africa), which agreed in March to form a development bank. 

But financial experts say Asian capital markets cannot provide the Russian economy with the variety of investments it needs because Asian markets are dominated by state investors and not the private investors who give Western markets their vitality.

"Private investors are more eager to take additional risks, they are very interested in the majority of sectors, while state investors in China, large state corporations, the area of their investment interest would be much smaller," Miklashevsky says. "They might be interested in the energy sector but they wouldn't be so interested in the retail sector, for example."

Similarly, Asia cannot provide the kind of cutting-edge new technology that Western oil companies have.

"Chinese companies can't step in and provide shale technology where U.S. companies are blocked," notes Michale A. Levi, an energy expert at the Council on Foreign Relations in New York. "They can provide capital, they can provide people. But they can't fill in on the technology front."

Won't the sanctions hurt the EU and U.S, too?

As Brussels announced its new sanctions this week, officials in several EU states warned citizens they might have to pay an economic price for imposing sanctions on Russia, the EU's third largest trading partner.

British Foreign Secretary Philip Hammond said there could be "pain," but said it would be worth it to curb "Russian aggression".

The EU Observer, an online news website, which watches Brussels closely, quoted an EU diplomat telling it privately on July 28 that the EU commission expects the bloc to lose 40 billion euros this year and 50 billion euros in 2015 as Russia is expected to retaliate with trade bans of its own.

In one sign of such trade bans, Russia's health inspectorate, Rosselkhoznadzor, announced a ban on most fruit and vegetable imports from Poland on July 30. Moscow, which buys more than 2 billion euros worth of EU fruit and vegetables a year, denied the move was linked to any sanctions. 
 
Still, the amount of pain any individual EU state will feel is likely to be small compared to that inflicted on Russia. A chart prepared by the German weekly 'Der Spiegel' shows that exports to Russia represented less than 4 percent of all foreign trade for the vast majority of EU states and only reached double digits for those on Russia's border.

Many EU states are vulnerable to Russian retaliation if it takes the form of an energy war. But they are betting that Moscow's own need to keep Europe as its most lucrative energy export market will keep things from reaching that level.

Russia accounts for less than 1 percent of U.S. exports and the United States does not import Russian energy, making Washington's exposure to any backlash over sanctions far less than Europe's.

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