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Russia To Pay For Putin's Ukraine Invasion With Higher Inflation, Weaker Ruble, Slower Growth


The Russian ruble hit a record low.

The economic fallout from Russian President Vladimir Putin's decision to invade Ukraine will hit citizens in the wallet as prices and borrowing costs rise, curtailing growth and creating an uncertain future, economists said.

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The United States and its European allies this week announced what they called the toughest sanctions yet against Russia after Putin chose to recognize parts of eastern Ukraine claimed by Moscow-backed separatists as independent nations and then launched an unprovoked military campaign against the country.

The United States, Britain, and the European Union targeted top Russian banks and state-owned corporations, sovereign debt, and critical technology, crimping the nation's ability to raise cheap funding and import high-tech goods essential for defense-related industries. It also slapped sanctions on top officials and executives, including Putin.

The Kremlin's February 24 invasion -- and expectations of severe sanctions response by the West -- drove economists to slash their economic growth forecasts for Russia. The developments also pushed investors to dump their Russian stock and bonds, triggering the biggest one-day stock market decline in the nation's history and sending the ruble to a record low.

As U.S. President Joe Biden warned that Putin was turning his country into a "pariah" state, international organizations canceled major sporting events scheduled to be held in Russia this year, a possible sign of the economic isolation that lays ahead.

Foreign companies could pull out of Russia amid greater country risk, further hurting the economy's competitiveness and modernization, economists said. U.K. oil giant BP is now under greater pressure to exit its investment in Russian state oil giant Rosneft.

The sanctions largely target state-owned banks and enterprises that Putin has relied on over the years to enhance his power and strengthen the armed forces. Nonetheless, Russians' living standards will inevitably be collateral damage as the targeted sanctions take effect, economists said.

"The bottom line is that these sanctions will have a significant impact on Russia's overall economy, and average Russians will feel the cost," the International Institute of Finance said in a statement on February 24.

Big Targets

The measures announced by the White House this week included cutting off Russia's two largest banks, Sberbank and VTB, from the U.S. financial system, as well as a few others among the top 10, dealing a blow to trade and investment needed for economic growth.

The White House also banned U.S. investors from purchasing Russian sovereign debt on the secondary market, a move that will drive up the country's borrowing costs, ultimately feeding into higher rates for consumers and businesses.

One of Russia's largest banks, Sberbank, has been targeted by the U.S. measures.
One of Russia's largest banks, Sberbank, has been targeted by the U.S. measures.

In an attempt to prevent Russia from getting around the debt ban, Washington also imposed restrictions on the ability of U.S. investors to fund 13 leading Russian banks, energy, and industrial companies, most of which are state owned. Europe has reduced Russia's ability to tap its financial markets.

The sanctions imposed by the United States and Europe went beyond financial flows and included sweeping restrictions on Russia's access to its cutting-edge technology -- such as microprocessors -- for use in the defense, aerospace, and maritime sectors.

Daleep Singh, the deputy national-security adviser who helped develop the sanctions, said the trade restrictions will slash Russia's import of high-tech goods in half.

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He said the moves by the United States and the EU "will undercut Putin's aspirations to project power on the world stage."

In describing their impact, he said the sanctions will eventually lead to "higher inflation, higher interest rates, lower purchasing power, lower investment, lower productive capacity, lower growth, and lower living standards in Russia."

2014 Lessons

In seeking to cause problems for Russia in response to its new invasion of Ukraine, the Biden administration studied the U.S. response to the first invasion.

The Obama administration leveled sanctions against Russia in 2014 after it occupied and seized control of Crimea -- and while they helped stymie economic growth, critics said they did not nearly go far enough in punishing the Kremlin for its actions.

The Biden administration's sanctions against Sberbank and VTB -- which hold more than half of Russia's banking assets -- represent a tougher posture, economists said.

The sanctions largely prevent the two banks from carrying out U.S. dollar transactions, a huge hurdle for trade and investment, said George Lopez, a sanctions expert at the University of Notre Dame in the U.S. state of Indiana.

While Russia has tried to sanction-proof its economy since 2014, including by reducing its dependence on the dollar by transacting in other currencies, the U.S. currency still accounts for about one-third of Russia's imports and more than half of its exports.

Sberbank can receive waivers from the U.S. government for commodity-related transactions in dollars. However, VTB will be fully blocked by the United States and its assets abroad frozen.

Washington has "essentially put VTB in a straitjacket," George Lopez, a sanctions expert, told RFE/RL. "It can't move money in or out of Russia."

VTB clients that make dollar transactions, such as paying for imported goods, will have to find another way to settle their bill. Likewise, clients may have problems using VTB's credit or debit cards abroad, said Lopez.

The sanctions have “a strong impact on trade and that is going to affect economic growth," Lopez said.

Economists have predicted that sanctions will lead to lower living standards in Russia.
Economists have predicted that sanctions will lead to lower living standards in Russia.

The United States has also blocked several other large Russian banks, including Otrkitiye and Promsvyazbank, which is used by the nation's armed forces.

The impact of the sanctions on the Russian economy could actually be greater than their scope would imply because of the phenomenon known as "overcompliance."

Global banks, fearful of getting fined by the United States for transacting with a lender under sanctions, may shy away from working with other Russian financial institutions, economists said.

Lost Opportunity

After years of stagnation that have led to falling living standards, Russia's economy had been primed for a second year of strong expansion as the price of oil -- its main export -- surged on a rebound in global growth.

After Russia attacked Ukraine, that outlook is now unclear.

Underscoring the potential economic difficulties ahead, Putin held a meeting the following day with the nation's largest business lobby, something he hadn't done in quite a while.

Oxford Economics economist Tatiana Orlova just cut her Russian economic growth forecasts for the next three years by between 0.6 percent and 1.2 percent, implying a total loss of tens of billions of dollars in economic output over that period.

William Jackson, an economist at Capital Economics, said that Russian growth expectations could be reduced by as much as 2 percent due to higher interest rates and lower trade resulting from the sanctions.

Capital is expected to flee Russia faster as risks grow, putting further pressure on the ruble and adding to inflation, pinching the pocket of the average citizen.

Natalia Orlova, a chief economist at Moscow-based Alfa Bank, said in a February 25 note to clients that capital outflow from Russia could reach $150 billion this year.

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The Russian Central Bank has more than $600 billion in foreign exchange and gold reserves that it can use to protect the currency and support the banking system. The United States is reportedly considering hitting the bank with sanctions, a move that could freeze its dollar holdings.

The ruble fell to a record low on February 24, tumbling just shy of 90 to the dollar, increasing the cost of imported goods like food, clothing, and computers.

The Russian currency has lost more than 20 percent of its value since the start of the military buildup and could fall further if the war escalates or sanctions mount.

"The fall in the ruble will push up inflation, eroding real incomes and consumer spending," Jackson said in a note.

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    Todd Prince

    Todd Prince is a senior correspondent for RFE/RL based in Washington, D.C. He lived in Russia from 1999 to 2016, working as a reporter for Bloomberg News and an investment adviser for Merrill Lynch. He has traveled extensively around Russia, Ukraine, and Central Asia.

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