On Tuesday, the European Commission announced a new set of sanctions to cripple Russia’s economy. The most important measure involves a restriction for Russian state-owned banks to access EU capital markets, while Russia’s energy and defense sectors are also targeted. Although the restricted access to EU capital markets will have a material impact, in our view, we think that the overall direct effects on the Russian economy are modest. That said, the indirect effects, ranging from increased uncertainty, to capital outflows are clearly leaving their mark and have – most likely – pushed the Russian economy into a mild recession. However, we believe that the threshold for Russia to endure economic pain is relatively high. This implies that the sanctions might not lead to a short-term solution of the Ukrainian conflict.
A new round of sanctions
On Tuesday, the European Commission announced a new set of sanctions. The centerpiece involves a restriction in Russia’s access to EU capital markets. In particular, EU nationals and companies are no longer allowed to buy or sell new bonds, equity or similar financial instruments with a maturity exceeding 90 days, issued by state-owned Russian banks, development banks, their subsidiaries and those acting on their behalf. The exact list of banks will be published at a later stage. IMF data suggest that 18 of the 923 banks in Russia are state owned. These 18 banks manage more than half of the banking system. In addition, IMF data suggest that two thirds of Russian interbank funds are sourced from abroad. So, the restriction to EU capital markets could have a material impact on the Russian economy, though there are two mitigating factors. One, Russian banks still have access to international short-term funding, although it is likely that this will be at a sharply higher costs. Secondly, according to the IMF, Russian firms only to a limited extent rely on bank lending to finance their investments.
The other sanctions are likely to have a smaller economic impact. There will be an embargo on the import and export of arms and related material from/ to Russia, while there will also be a prohibition on exports of duel use goods and technology for military use in Russia or to Russian military end-users. Finally, there will be restrictions in the exports of certain energy-related equipment and technology that is used in fossil fuel extraction, which will make deep-sea drilling and the use of shale technology more difficult. Crucially, according to our energy analyst Hans van Cleef, the export restriction will not hurt Russia’s energy supply in the short-run. However, it will impact Russia’s ability to improve its weak energy extraction infrastructure. Thus, the consequences may proof to be more significant in the longer-term.
Direct impact limited, but indirect effects tend to be larger
Overall, while difficult to assess, we judge that the sanctions will only have a modest direct impact on the Russian economy. That said, the sanctions are likely to have larger indirect effects. Although not having reached the highs that we saw a couple of months ago, Russian CDS spreads have continued to widen over the past weeks. This suggests that the country continues to suffer from capital outflows that will put additional downward pressure on an economy that is already in a dire state. Indeed, the economy shrank by 0.3% qoq in the first quarter of this year, and monthly indicators imply that another contraction is highly likely, suggesting that the Russian economy has most likely entered a modest recession. We expect the further tightening of sanctions to cloud the economic outlook further as they may once again impact confidence and borrowing costs and could well lead to higher capital outflows and a further delay of investment plans. Hence, we have lowered our 2014 growth forecast to 0.5% (from 1%) and our 2015 growth forecast to 1.5% (from 2%), with risks still tilted to the downside. The threshold for Russia to endure economic pain is relatively high, which suggests that a quick solution to the Ukrainian conflict is not an imminent prospect.