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

By Peter Havlik and Vasily Astrov
photo: St. Basil's on Red Square near the Kremlin, by Victor Nuno, CC-BY-NC 2.0

The last couple of weeks have seen several new rounds of sanctions imposed by a number of Western countries on Russia. As a reaction to the alleged poisoning of the former Russian-British double agent Sergei Skripal and his daughter in early March in Salisbury, the UK mobilised its Western partners and initiated the unprecedented expulsion of Russian diplomats. Altogether around 150 were expelled from the UK, US, a number of EU countries (Austria, among some other EU countries, abstained), Ukraine, Moldova, Canada, Albania, Australia, Macedonia, and Norway. In addition, the Russian consulate in Seattle, US, was closed. Russia retaliated almost immediately, expelling a similar number of western diplomats and closing the US consulate in St. Petersburg and the British Council in Russia.

One month later, on 6 April 2018, the US published an extended list of sanctioned Russian companies, banks and people, banning all types of business transactions with them for US citizens and businesses, freezing their assets subject to US jurisdiction, and extending sanctions to non-US citizens for knowingly facilitating transactions with sanctioned Russian companies, including trade and investment. On 16 April, Russia considered retaliatory measures which could include bans on pharmaceutical products, software and alcohol from the US, as well as a ban on access to the Russian labour market for US citizens (the introduction of these measures was postponed by one month pending deliberations in the Duma).

US sanctions on Russia reach a new level

Although the Western and particularly US sanctions on Russia are nothing new per se (at least since the outbreak of the Ukraine crisis in 2014), the new US sanctions announced on 6 April represent a novelty on at least two grounds. First, the sanction list includes for the first time individuals and private companies (including “designated Russian oligarchs” such as Mr Bogdanov, Mr Deripaska, Mr Kerimov, Mr Vekselberg, Mr Shamalov and others) whose direct links to the Russian leadership are far from obvious (except the latter who married Russian president Vladimir Putin’s daughter). Second, the newly imposed sanctions are not officially in response to a specific incident: in official wording by the US Treasury Secretary Steven Mnuchin, “the Russian government engages in a range of malign activity around the globe, including continuing to occupy Crimea and instigate violence in eastern Ukraine, supplying the Assad regime with material and weaponry as they bomb their own civilians, attempting to subvert Western democracies, and malicious cyber activities. Russian oligarchs and elites who profit from this corrupt system will no longer be insulated from the consequences of their government’s destabilizing activities.”

The newly imposed sanctions represent arguably the most significant step in the US strategy (followed by the EU) of putting increased economic pressure on Russia since 2014, when – among other things - several Russian state-owned banks and energy companies were subject to restrictions on borrowing (90 days, later reduced to 30 days) earlier. The effects of those sanctions were felt not only by the targeted companies but by the Russian economy in general, as perceived risks translated into a worsening of credit conditions for a wide range of Russian borrowers and led to increased net capital outflows and a general worsening of the investment climate. Some estimates suggest that financial sanctions cost Russia 2 percentage points of GDP growth for the period 2014-2017. This impact may appear to be rather modest compared to that of oil price decline (8 percentage points of GDP growth), but is still not negligible.

Economic impact of new sanctions

What will the economic impact of the newly imposed sanctions be? If the past experience offers any guidance, it strongly suggests that the impact might be similarly muted. However, the perceived risks of doing business with Russian companies will likely rise further, not only in the US but also in the EU, as European companies dealing with Russia may potentially face problems in the US. For instance, banks in the UK are reportedly already facing pressure in this respect, and the CEO of the Swiss-based commodity trader Glencore Ivan Glasenberg decided to step down from his position on the board of Rusal. More important however is that the new round of US sanctions is likely far from being the last one, and there is more to come, creating further uncertainties surrounding Russia.

More specifically, and apart from the reduced stocks valuation of affected Russian companies such as Rusal, Gazprom and Renova and the related meltdown of oligarchs’ wealth, the latest sanctions have already contributed to a depreciation of the rouble (that will result in a somewhat higher inflation and a delayed cut in the policy interest rate). For example, the latest estimates of the Development Centre at the High School of Economics in Moscow reckon with a reduction of GDP growth by 0.2pp in 2018 (1.7% instead of 1.9%), depreciation of the rouble by 5-7% on an annual average, and an increase in inflation by less than 1 percentage point. Most importantly, the net outflow of private capital from Russia is projected to increase by US$ 20bn (to nearly US$ 50bn) this year, and the inflow of FDI will diminish once again. The latter is of particular importance (as well as the related medium and long term effects) since without FDI and the related economic restructuring the Russian economy is condemned to near stagnation and falling behind its peers. On the other hand, the projected loss of non-energy exports (e.g. aluminium) may well be compensated by increased oil export revenues, since the Brent crude oil price is now back above US$ 70/bbl – far more than assumed in official growth forecasts and the recent analytic assessments.

Don’t expect Russia to change

Do these negative economic effects mean that the newly imposed US sanctions against Russia will be successful in terms of changing Russian behaviour? Most likely not. If economic damage were to be seen as evidence of success, the answer would be probably ‘yes’. However, the economic damage per se has not been the goal of the sanction pressure. Instead, the goals are political: to bring about a change in the Russian policy (especially foreign policy) or perhaps even an outright regime change; the sanctions are seen as a mere instrument to reach the political goals rather than as an end in itself.

From the political point of view, however, there is little evidence that Western sanctions have brought any desired benefits, at least so far. On the contrary, they have contributed to the Russian society consolidating around President Putin, who is increasingly viewed domestically as a guarantor of Russia’s sovereignty in the face of mounting external pressure. With a 76% support mandate obtained in the recent (March 2018) presidential elections (even assuming that a few percentage points may be due to other factors than genuine support), the Russian president feels now re-assured in his policies, including in foreign policy. There is little ground to expect that this time around things will be different.

A much more likely scenario is that Russia will continue fighting back by supporting the anti-establishment political forces in the West, increase counter-propaganda efforts and cyber-activities, and potential increased deployment of military capabilities in contested areas, such as Syria. In all likelihood, this will provide an excellent pretext for further US/EU sanctions, thus contributing further to the downward spiral in Russia-Western relations. The next likely impact of the sanctions war will be an official western boycott of the Football World Cup in Russia in the summer and a delayed/cancelled construction of the Nord Stream II gas pipeline. Lacking viable alternatives, Russia will respond by further pivoting to the east (China, Iran and India) and fostering the Eurasian Economic Union, expanding the scope of protectionist import substitution polices. It is to be hoped that the present ’cold’ conflict will be at least ‘frozen’ before it becomes ‘hot’.