Sanctions Impact on Russia – Step by Step?

By Chris Weafer, March 12, 2014

The following is an analysis of how a four-staged imposition of sanctions by the EU-US could affect the Russian economy should the east-west standoff over Crimea worsen. The author, Chris Weafer, is a long-time Moscow-based analyst and is a highly respect Russia watcher in international investment circles.

Russia — For investors and businesses there are three key questions:
    •    Will there be further sanctions and, if so, how damaging will they be?
    •    Regardless of sanctions, how long will the crisis concerning Ukraine last and how distracting will it prove to the hoped for policy response to fix the already weakening economy?
    •    What will be the legacy risk to reputation and capital flows?

Ukraine — For investors and businesses in Ukraine the key questions are:
    •    Once the Crimea issue is resolved (either way) will the government be able to stabilize the country and prevent factionalism?
    •    Beyond the expected emergency financial aid, what will be the size and conditions attached to the larger financial package required by Kiev and what will be the impact on economic and earnings trends over the medium and longer term?
    •    Can a debt restructuring be avoided or is it inevitable as part of the larger bailout package? 

Four stage sanctions

The EU will decide on additional sanctions measures on March 17, after the Crimea referendum on Sunday March 16 and after Moscow’s response to the referendum result. EU officials talked about a further three- stage sanctions response, i.e. in addition to the measures announced last week, with the first two only falling into the inconvenience category rather than directly disruptive.

Stage 1, the already announced suspension of visa liberalization and trade talks, has no immediate consequence. Stage 2, which is likely if Moscow opens talks to admit Crimea into the Russian Federation, is expected to involve travel bans and asset freezes. Here also there should be minimal disruption to cross border trade or financial flows, albeit there will be a further deterioration in domestic confidence and, probably, a further slowing of economic activity.. Stages 3 and 4 are, presumably, only likely when Moscow crosses whatever “red-line” the EU/US has identified. A physical incursion into East Ukraine is thought to be top of that list.

But while Stages 1 and 2 are inconvenient in terms of an immediate impact on economic activity, Stage 2 would exacerbate an already difficult economic backdrop in Russia. If the economy was growing strongly then these sanctions would be hardly noticed. But the economy has been sliding since the middle of last year and any sanctions will have some impact on sentiment, confidence and activity, albeit more slow-burning than an immediate cessation of trade.

It will be that much harder for the government to pull the economy out of the current slump if;

    •    it is distracted for many months with Ukraine and geo-political issues
    •    domestic confidence drops further and consumers slow spending
    •    FDI slows and Capital