WASHINGTON -- Campaigning last year, U.S. President Joe Biden promised to be tougher on Russia than his predecessor, and so far he has been taking steps to live up to his words: Since he took office on January 20, the United States has hit the Kremlin with two rounds of sanctions over “harmful” acts carried out by Moscow during Donald Trump’s presidential term.
The latest measures, announced on April 15, were wide-ranging: the White House announced the expulsion of 10 Russian diplomats and imposed sanctions on six Russian technology companies as well as 32 other individuals and entities.
It also targeted ruble-denominated sovereign debt, a key ingredient in Russia’s economic activity and the topic of animated discussions about potential new sanctions for months.
The measures received praise from political analysts and members of Congress who said they sent a strong signal to Russian President Vladimir Putin, though some called for tougher measures, including sanctions to stop a controversial Russian natural-gas pipeline to Europe, Nord Stream 2.
But the Russian market’s reaction was muted, indicating the punishments will not be as painful economically as some had expected. The ruble even rebounded against the dollar as Biden pulled his punches on the debt sanctions, analysts said, leaving their impact uncertain.
“Still more bark than bite,” was the verdict in the title of an April 15 note from Evghenia Sleptsova, an economist at U.K.-based research firm Oxford Economics.
Since Biden emerged last spring as the Democratic presidential nominee and polls pointed to his victory over Trump in November 2020, anticipation had been growing that the United States would impose harsher sanctions on Russia’s economy, in particular by restricting the ability of U.S. banks and investors to buy Russian sovereign debt -- bonds the government sells to raise cash for its coffers.
The logic for doing so was clearly laid out by the Biden administration on April 15, when the new sanctions were announced: “There's no credible reason why the American people should directly fund Russia's government when the Putin regime has repeatedly attempted to undermine our sovereignty," a senior official said.
The smaller the pool of investors ready to buy Russian sovereign debt, the more expensive it becomes for the Kremlin to raise the money it needs, a development that has a ripple effect throughout the economy, affecting companies and consumers.
But the Biden administration chose to go with a relatively mild variety of sovereign debt sanctions.
When it takes effect on June 14, the measure will prevent U.S. banks from buying ruble-denominated, government bonds, known as OFZs, directly from Russia. It will not stop them from buying those same bonds on the secondary market, from Russian banks.
The effect on the market for ruble sovereign debt is likely to be “largely symbolic,” Sleptsova wrote in the note.
Investors’ expectation that the Biden administration could ban all ruble-denominated debt drove foreign ownership of OFZs to a six-year low of 20 percent at the beginning of April, down from 35 percent at the start of 2020. The large-scale selling of OFZs by foreigners drove the ruble to 80 to the dollar, near a record low, helping stoke inflation in Russia.
Russia currently has about $185 billion in outstanding OFZ debt, according to Vladimir Tikhomirov, a Moscow-based economist for investment bank BCS Global Markets, putting foreign ownership at about $37 billion.
U.S. investors own roughly between $12 billion and $14 billion of OFZs, he said, with European and Asian investors accounting for most of the remaining foreign-owned debt.
The sanctions don’t obligate non-American foreign investors to follow suit in steering clear of the OFZs. But Brian O’Toole, a former Treasury Department official and now a senior fellow at the Atlantic Council think tank, said that major European banks often implement U.S. Treasury sanctions, meaning that the potential knock-on effect could be greater.
However, when the Trump administration imposed a similar ban in 2019 on U.S.-dollar debt issued by the Russian government, there was no significant impact.
Sleptsova said that the Trump-era sanctions “did little to dent the Kremlin’s access to foreign funding” as Russia turned to issuing more Euro-denominated bonds. In fact, she added, percentage of foreign investors owning sovereign debt issued by Russia in foreign currencies actually increased after those sanctions were announced.
Russia Scales Back
The Russian government is much more dependent on ruble-denominated debt for funding its budget than on dollar-denominated debt, potentially making the new sanctions more robust.
A senior Biden administration official suggested the White House is hoping for a substantial knock-on effect.
"Judging from history, removing U.S. investors as buyers in this market can create a broader chilling effect that raises Russia's borrowing costs, along with capital flight and a weaker currency,” the official said on condition of anonymity after the new sanctions were announced. “And all of these forces have a material impact on Russia's growth and inflation outcomes."
At the same time, the choice of a milder form of sovereign-debt sanctions may have been calculated to land a softer blow for now while keeping a more powerful punch in reserve.
In comments late on April 15, Biden said the United States "could have gone further" with the sanctions, but that he chose not to because he wants to avoid a “cycle of escalation and conflict." But he warned that if Russia "continues to interfere with our democracy, I am prepared to take further actions to respond."
Elina Ribakova, deputy chief economist at the Institute of International Finance in Washington, said that could make some U.S. banks and investors cautious in the “near term” about buying Russian ruble debt.
“Some compliance departments will say, ‘You know what, it's just not worth it,’” she said.
But as they currently stand, she said, the debt sanctions will have just a “minor symbolic impact.”
Putin has been preparing for a Western ban on sovereign debt ever since the United States and its allies began imposing sanctions on Russia in 2014, after it seized Crimea and backed fighters in eastern Ukraine. His government has curtailed spending growth and built up the nation’s foreign currency reserves to nearly $600 billion.
A plunge in world oil prices combined with those sanctions hit Russia’s economy hard in 2015. But this year, it is benefitting once again this year from a jump in the price of oil, its main export commodity.
The government had planned to borrow 3.7 trillion rubles ($48.5 billion) this year assuming an average oil price of $45 a barrel. To date, the oil price has been averaging near $60, potentially generating more than $25 billion in additional budget revenue, Russia’s Finance Ministry said in March.
In response to the new U.S. sanctions, Russia announced it would cut its 2021 borrowing needs by nearly a quarter, or by about $11.5 billion. The cut is greater than the proportion of its debt owned by foreigners.
“If we don't see a meltdown of the global economy and a significant drop in oil prices, then Russia really doesn't need to borrow that much,” said Tikhomirov. “So, they can easily adjust their policy and curb their needs for new debt.”
He said the sanctions would not impact his forecast for Russian economic growth.