WIIW The Vienna Institute for International Economic Studies - Wiener Institut für Internationale Wirtschaftsvergleiche

By Peter Havlik

• A newly announced round of US sanctions on Russia represents an important escalation of the conflict between the two countries.
• However, the new sanctions are more reflective of US domestic political infighting than new Russian actions.
• The impact on the Russian economy – lower GDP growth, higher inflation, capital outflow and less FDI - will be painful but manageable.
• The EU reaction will be important to watch, particularly the meeting between Russian President Vladimir Putin and German Chancellor Angela Merkel in Germany on August 18th.

The latest round of US sanctions was announced on August 8th, this time under the pretext of Russia’s alleged use of chemical weapons in the attack on Sergei Skripal (a former Russian military intelligence officer and Russian-British double agent) and his daughter Yulia in the UK in April 2018. The proposed US Congress bill on “Defending American Security from Kremlin Aggression Act of 2018” related to alleged Russian meddling in US elections, and cyberattacks. It calls for a designation of the Russian Federation as a state sponsor of terrorism. The new round of US sanctions is expected to come in force on August 22^nd, and will include additional bans Russian imports of dual-use electronic components from the US, overflight restrictions on Russian airline Aeroflot, and more sanctions on transactions related to the financing of Russian sovereign debt may come in three months.^[1]

Bad news for growth

As a first reaction to the above announcement, the Russian Rouble depreciated by about 6%, the shares of Aeroflot and Sberbank fell, and the spreads of Russian CDS increased by 50 basis points. Russian experts estimate that the latest sanctions may lower real GDP growth by 0.5 to 1.5%, meaning that the economy may stagnate in the worst case scenario. Credit financing will become even more difficult for private companies and capital flight will likely increase, while FDI inflows will further diminish. However, there will be no dramatic impact either on inflation, living standards, the state budget or Russian sovereign debt. Moreover, the negative effects of sanctions will be partly offset by the higher oil price, which is comfortably above US$ 70 per barrel, and may even rise further if more US sanctions on Iran follow.

In the first half of August as a whole, the Rouble lost about 10% of its value versus the US dollar, and depreciated below RUB 68/US$. Russian finance minister Anton Siluanov raised the possibility of reducing the role of US dollars in foreign transactions, echoing the calls of Russian hawks such as Sergey Glazyev, one of Mr Putin’s economic advisors. As of mid-2018, Russian total external debt amounted to US$ 486 bn (about 39% of GDP), of which about half was denominated in US dollars. Meanwhile government debt totalled less than US$ 60 bn (less than 5% of GDP), of which about 30% was denominated in US dollars. Forex reserves amounted to US$ 458 bn at the beginning of August 2018 according to the Russian Central Bank. The scheduled debt service for the rest of the year can be easily met.

Russian reaction likely to be muted

The official Russian reaction to the announcement of the latest sanctions has been predictably negative but cautious. Prime Minister Dmitri Medvedev characterised the sanctions as the ‘full-scale trade and economic war’ to which Russia will react accordingly. The prevailing domestic and foreign expert view is that US policies – not only with respect to Russia - are becoming ever more unpredictable, and increasingly affected by domestic political infighting, in particular before the forthcoming US midterm elections in November.

The scope for Russian potential countermeasures is rather limited, and any reaction will thus be cautious. Apart from diminishing the role of the US dollar in financial transactions, more trade reorientation towards China and Turkey, as well as closer policy coordination with these countries (and Iran) is likely. A symbolic related important step was the latest conclusion of an agreement with Azerbaijan, Iran, Kazakhstan and Turkmenistan regarding the legal status of Caspian Sea. Another important development to follow will be – so far rather measured - reaction of the EU, and in particular the results of the recently announced meeting between Mr Putin and Ms Merkel near Berlin on August 18^th where, apart from Syria and Ukraine, the fate of the North Stream 2 gas pipeline will also be discussed.

Footnotes

^[1] For an overview of the latest Russia-related US sanctions see: https://www.kommersant.ru/doc/3708709. More generally on sanctions’ impact see Gould-Davies, N. (2018), ‘Economic effects and political impacts: Assessing Western sanctions on Russia’. Bank of Finland, BOFIT Policy Brief, No. 8 (August).