- Financial markets reacted heavily to the new sanctions against Russia
- Investors were caught off-guard by the strictness of the new sanctions and the deteriorating geopolitical environment
- The new sanctions will not derail the Russian economy
1. Financial markets reacted heavily to the new sanctions
The new sanctions against Russia, announced on Friday 6 April, triggered a sharp correction on financial markets. The ruble lost 4% of its value against the dollar on Monday. While recovering somewhat on Wednesday, at time of writing the ruble still stands almost 7% below its value versus the dollar compared to last week. Bond yields (10y) jumped by 30bp on Monday and have not recovered since. The Russian equity index, MOEX, fell 8.3% on Monday, the biggest decline since March 2014. The MOEX did recover the following days, also on the back of the ‘cheaper’ ruble, which increases profits by energy/commodity exporting companies as their costs are in ruble while revenues are in dollars.
2. Investors scared by the depth of the sanctions and geopolitics
While new sanctions were in line with the general expectations outlined by the CAATSA framework in mid-2017, markets were surprised by the depth and the geopolitical uncertainty that accompanied the new sanctions. Investors saw the latest sanctions round doing far more damage than past ones as the new sanctions target existing investments of major corporations rather than prohibiting new investments. Furthermore, the sanctions where announced in the midst of rising geopolitical tensions. Over the past few weeks, tensions increased because of the Skripal incident in the UK and fears over a direct confrontation over Syria between the US and Russia. This week, Trump hinted at a missile attack on Syria whereas a Russian official stated Russia would react by downing the missiles and attacking the missile bases in case of such an event. While we believe that chances of a direct confrontation are low, it highlights the growing tensions between the two superpowers.
3. Sanctions will have little impact on the Russian economy
The lower ruble could have a pass-through effect on inflation, which currently stands at 2.4% yoy. Yet, as inflation has been standing comfortably below the target (4% yoy) of the Central Bank of Russia (CBR) for the last 9 consecutive months, inflation has room to trend higher without the average for the year breaking above target. Furthermore, the CBR may decide to postpone its easing path to lower price pressures. Russian government officials have already stated they will financially support businesses that face problems because of the new sanctions by implementing subsidies, tax breaks, and providing access to cheap finance through state-owned banks. As government finances are solid and government debt is low (12% of GDP), Russia has enough room to provide support without a significant fiscal deterioration.
4. But risks remain going forward
It is hard to assess the effect of the increasing uncertainty on Russia at this stage, as further sanctions are likely. Compared to 2014, when Russia was hit by sanctions because of the annexation of Crimea, this time several issues are on the table. A new round of sanctions may arise from the ongoing Mueller investigation in the US, the Skripal poisoning in the UK, Russian support for the Assad-regime or cybercrime allegations.
While we may see another set of punitive measures against certain individuals and companies, we think sanctions that could dampen economic growth, by targeting oil exporters or the sovereign, are unlikely. In fact, the US sanction framework (CAATSA) is specifically designed not to target the real economy, but to put measures in place against Kremlin associates, the so-called ‘specially designated nationals’ (SDNs). On 29 January, the US Treasury department concluded that Russia’s sovereign debt market is too important to impose sanctions against, without risking global financial turmoil. Furthermore, sanctions against the energy sector have thus far not been on the table as Europe is still significantly dependent on oil and gas exports from Russia.