Analysis - Economic Trends
Limited political consequences on Russia
Wednesday، April 08، 2015
The United States, the European Union and several other countries started imposing sanctions against Russia from March 2014 following Moscow’s active involvement in the Ukrainian crisis. Several rounds of sanctions targeted Russian individuals and companies allegedly directly or indirectly involved in the situation in Ukraine or believed to be of special importance for the Russian state (or President Putin personally) in general. Due to the need to show their own public a rapid reaction, the first round of sanctions by the US came out in a very limited time period and probably lacked sophisticated background research. It essentially targeted a small group of individuals that are believed to be Putin’s personal friends or people directly involved in the Crimea annexation. Later, as the time passed by, the sanctions became more sophisticated and complex.
Overall, there has been 9 EU sanctions agreements that correspond to sanctions imposed by the United States and target 119 individuals and 23 Russian companies as well as three major sectors of the economy: finance, energy and defense. The sanctions impact has been greatest on Putin’s close friends as it has been significant in terms of their personal comfort, ability to travel and enjoy at least part of their property located outside of Russia. Various assets in the EU and the US either cannot be accessed due to travel restrictions or even were arrested by Western authorities. Trying to limit the sanctions effect on their businesses and personal wealth, some of the people in the sanctions list already sold their property like Gennady Timchenko going out of Gunvor trading company and the Rotenberg brothers selling their shares in some international assets to other family members that are not included in the sanctions lists.
The general approach initiated by the United States largely follows the same pattern Ronald Reagan’s administration used against the Soviet Union in the early 80s: they created challenges for the country’s most important money making industries to undermine the regime’s cash flows and thereby destabilize it. The sanctions limit Russian companies’ access to certain oil extraction technologies which is likely to prevent them from exploring new oil fields, especially in the Arctic. That, as well as the fact that the sanctions are being discussed in the US Congress and may be passed into law, mean that the sanctions are likely to have a longer effect than just altering Russia’s policies in Ukraine. Unlike executive branch’s decisions that can be made and changed relatively fast, laws can take years to be amended. At the same time, none of these measures are likely to make any immediate impact policy-wise.
Impact on the economy in general
Absence of access to capital markets has so far become the greatest challenge for the Russian economy. Large Russian companies and state-owned banks have been relying on international borrowing to refinance existing leverage and support large-scale investment projects. With many of them having debt payments coming in the next year, inability to borrow in the European markets is an issue as the companies have fewer options. China is seen as the largest potential capital market and most large state-owned banks and enterprises rapidly develop competences related to China.
Challenges to investment projects have become another outcome of the sanctions situation. A large majority of international investment projects have been frozen. Although technically not forbidden by the sanctions or Russian counter-measures, most new investments were put on hold due to the general lack of stability. The US leadership even undertook proactive steps in order to prevent private companies from fostering cooperation of US companies with their Russian counterparts. Moreover, there are even reports of US diplomats approaching European companies to prevent them from further developing existing or starting new projects with Russia.
Current operations of multinational corporations in Russia have also been challenged by the sanctions. Large Western companies that are already in the Russian market are essentially in a hostage situation. For decades they have invested both financially and in terms of time input in order to establish working relations with the Russian government in order to be able to resolve arising issues. Now, with external pressure being exercised upon Moscow, government officials would mention that nationalizing some of international investments in the country could be an option in the worst-case scenario. Of course, that policy option is hardly considerable and in any case could only be used as a means of the last resort, but the rhetoric itself demonstrates a change of attitude. International investors bear losses both from Western official and unofficial sanctions and from Russia’s official and unofficial responses. However, they have limited options at the moment as Russian government officials advise them to approach Western governments while the latter remain unresponsive.
Russian financial markets are experiencing turbulence due to sanctions. Russian rouble exchange rate has dropped over 30% in the sanctions period. Although it is hard to evaluate the exact impact of sanctions as they coincided with a substantial oil prices drop which also contributed to the national currency depreciation, it is believed that the sanctions account for at least one half of the overall 30% exchange rate change. There are reasons to expect further currency rate changes as several large companies are to make payments to international loaners in the next few months. The case of Rosneft state-owned oil company is one of the most complicated as the company’s total debt exceeds the foreign debt of the Russian Federation and large payments are to take place early in 2015. If the company purchases foreign currency to make the payments, it would need to sell that much rubles so the exchange rate further decreases. On the contrary, if Rosneft fails to make the payment in time, that would also damage the economy and further depreciate the ruble.
Other large companies in Russia now operate in a challenging environment that is hard to predict which also complicates the economic situation. Many large companies do not know exactly whether they may also be added to the sanctions list and try to use their own and their business partners’ political connections in the West in order find out details about the sanctions list development. Some Russian business owners already sold their international assets located in the countries that already joined the sanctions policy. Although most business have not been yet added to sanctions lists, they feel threatened and try to minimize risks in case these lists are expanded. In most cases, Russian businessmen use every opportunity to stress how they prioritize being loyal to their country above everything else but, most importantly, they try to remain out of the conflict. One of the largest Russian business owners was subjected to a house arrest for an alleged violation of privatization regulation of an oil company but one of the real reasons for prosecution despite closest ties with the government deals with
The impact of sanctions on the population has been different from what their designers probably had expected. The sanctions almost immediately affected the Russian population as it felt the change in prices, first, due to changes in the national currency exchange rate and then, second, due to food products price rising. Russians report being unable to travel internationally, purchase some of the products they used to buy and change their lifestyles in other ways. A recent wave of ruble depreciation caused a consumer boom as people went buying cars and real estate trying to turn their savings into assets before their money loses even more value. Although that was clearly the goal of sanction designers, there is hardly any evidence so far that economic downturns result in decreased support for the government. According to public opinion surveys, large majority strongly believe that all the negative changes in their lives are entirely the West’s fault and they do not demand any policy changes from their own government. Therefore, despite intense international pressure, there is no evidence that sanctions can have impact on Russia’s position on the Ukrainian crisis or foreign policy in general. International pressure creates challenges in terms of governance, corporate economic performance and citizens’ well-being, there is no indication that it can actually affect the national leadership’s position on Ukraine or other critical foreign policy issues.
Mutual Losses from Cancelled Projects
Long-lasting cooperation projects with the West were either cancelled entirely or put on hold, however, it is hard to evaluate exact cost distribution from every cancelled cooperation project. French shipbuilders constructed two Mistral class aircraft carriers for the Russian navy but have not delivered them despite contract obligations as that would contradict France’s overall stance on the sanctions policy. At the same time, the contract also contains penalty sanctions for delays and cancellations and if France officially refuses to deliver the ships, it would have to pay more than the ships actually cost. There is no unified position on whether Russia actually needs them but the position of confusion that France currently faces is rather challenging for Paris than for Moscow. In a similar fashion, Western oil companies are suffering losses due to cancelled or postponed joint projects especially in the shelf regions.
Russian response to the sanctions also went through several stages. First, there was an emotional reaction as the country officials were shocked and appalled with the West using the same mechanisms as used against alleged rogue states. Russian parliament members, for example, jointly asked to be added to the sanctions list in attempt to demonstrate how much they reject the very idea of sanctions. There were numerous discussions of how to compensate Russian companies and individuals for the sanctions losses but no universal solution was found as so far the direct economic impact has been limited to several individuals that did not request any compensation from the state so far. There were several rounds of official and unofficial responses by the Russian Federation. First, there appeared international travel restrictions for law enforcement officers and state-owned companies employees. The measure mostly dealt with security issues as it aimed at preventing law enforcement officers from disclosing state secrets or being detained by foreign countries.
In one of the following steps, the government introduced a trade embargo on food products manufactured by countries that had imposed sanctions against Russia. Although most European countries and the US have a very limited dependence on the Russian market, some of them, especially certain specific industries, do depend on it. Paradoxically, the issue became a challenge for the Russia-led Eurasian Economic Union as Belarus and Kazakhstan did not join the embargo and European goods are being illegally smuggled via these countries which already causes program for the integration.
In an attempt to limit Russian market access to foreign companies from sanctions supporting companies, regulators discuss restricting state-owned companies from purchasing services from International consulting companies. Although technically most of them are Russian companies owned by the management, there is still a possibility that at some point the restriction can be imposed. Meanwhile, state-owned companies are already trying to limit their cooperation with international strategy and management consultants. Similarly, there is a chance that other professional services, including auditing, may also be less
Finally, there is an increasing rhetoric on imports substitution and introduction of the national payment system that would supplement and, if necessary, substitute international payment systems, such as Visa and MasterCard if Russia I excluded from the by sanctions.
Overall, sanctions are unlikely to undermine political stability in Russia short-term although they are certainly creating financial issues. As a result, there are challenges for Russian and international companies and Russian people, but there are few reasons to believe that sanctions will result in any short-term policy changes. More importantly, the current political situation stimulates European countries to re-orient their energy systems to other sources, including hydrocarbons imports from other countries which may eventually undermine its dependence on Russia. The main policy outcome of the current sanction situation is the fact that China benefits most from the state of Russia-West relations.