The downing of Malaysian Boeing 777 bolsters Europe’s resolve to impose tougher and broader sanctions. If so, how will Russia’s economy adjust?


L-R: Britain's Prime Minister David Cameron, Portugal's Prime Minister Pedro Passos Coelho, Germany's Chancellor Angela Merkel and Finland's Prime Minister Alexander Stubb attend an European Union leaders summit in Brussels July 16, 2014. Photo: Reuters

Sanctions imposed by the EU against Russia have already had a significant impact on the Russian economy, mostly in the form of capital outflows out of Russia. After the downing of the Malaysian Boeing that killed nearly 300 people, it now appears that these sanctions may be further strengthened – and that has officials in Moscow working out a plan to withstand the next wave of sanctions.

On July 24, the EU decided to add 15 individuals and18 companies to its sanctions list, including senior officials from Russia's security services, and prepared to put oligarchs close to the Kremlin on the list as well.

A major supporter of tougher sanctions against Russia is Washington, which is demanding that its European partners take more decisive steps, in terms of imposing tougher measures against Russia. These tougher measures may include far-reaching sectoral sanctions, which would effectively sever economic relations in many sectors of current cooperation.

However, Europe is not ready for a full cessation of relations with Russia, as such a move could boomerang on many EU countries. For example, Germany has decided that the introduction of sectoral sanctions against Russia may result in losses for the German economy of about 4 billion euros, as well as a loss of about 300,000 jobs.

Moreover, Russia’s trade turnover with the EU should not be forgotten. It’s now at a level of about 410 billion euros per year. Do Europeans really want to lose such volume of trade? This is the big question.

In comparison, as of 2013, Russian trade turnover with the United States is about 23 billion dollars. This past May it increased by 23 percent, compared with the preceding year. Therefore, American corporations have a lot to think about as well – and a lot to lose. Nevertheless, the potential losses for the European economies, most of which recently came out of recession, are significantly higher, in comparison to the United States.

Therefore, it is unclear whether the EU will be taking any decisive actions with respect to Russia. Most likely, they will just expand the “blacklist” of Russians who will be blocked from travel in the EU countries and will have their accounts in European banks frozen (if they have any). The EU may not take sectoral sanctions against Russia at this stage, as this may turn out to be unprofitable for Europe – just as they are unprofitable for the United States.

Probably, the new restrictions will affect a number of military contracts.

They may restrict, or even prohibit, the export of weapons and dual-use products to Russia. Despite Russia having its own powerful military-industrial complex, Russia buys significant amounts of military products from other countries – for example, the Mistral helicopter carriers from France.

The French president currently intends to fulfill the country’s contract obligations and deliver the first Mistral ship this year, but the delivery of the second will depend on the results of the investigation into the causes of the downing of the Malaysian airliner in Ukraine. From France, Russia buys night vision goggles and much more, and for now, the French intend to fulfill their obligations under existing contracts.

As for the UK, where Russia buys sniper rifles, body armor and other ammunition used by domestic special forces, it now appears that previously concluded contracts will not be torn up.

Thus, we can say that at the current stage, U.S. and European sanctions against Russia have had a limited direct impact on the economy of our country. Nevertheless, the indirect effects on the economy of the Russian Federation are acting with a greater destructive force.

In the real business world, managers do not know how far this situation with sanctions will develop, thus Russian corporations have noticeably reduced their investment programs. Foreign corporations have decided that the risks of doing business in the Russian Federation have increased, i.e., they may continue to work there, but only if they can count on obtaining large premiums on their business activities in Russia. As a consequence of this, Russia has seen increased capital outflows from the real sectors of the economy, as well as from the financial markets.

As for the Russian stock market, foreign capital outflows here are still sporadic, and do not threaten the collapse of the market. Moreover, it is supported by correlated responses to developments in other regional markets, and in above all – in the U.S. market.

In the U.S., the S&P 500 and DJIA are reaching record levels. While the bullish trend in the U.S. markets is maintained, no great threat exists for the Russian market. However, when U.S. markets reach a consolidation phase and experience a subsequent correction of about 12 percent (and this event is just around the corner), the Russian market could fall by 20 percent or more. Then, many people will associate this drop with the effectiveness of the imposed sanctions against Russia.

A difficult task is awaiting the Bank of Russia, which at the end of this week will be holding its regular meeting. Most likely, monetary policy will not change: The interest rate will remain unchanged at around 7.50 percent, and the required volumes of liquidity will be provided to the market in due course.

Of course, in order to restrain inflation and support the ruble, it would be good to tighten monetary policy by raising rates to 8 percent. However, this would seriously undermine the economy of the Russian Federation, which requires exactly the opposite – a reduced rate.

As for inflation, its growing dynamics are finally starting to show signs of slowing down. It is currently at the level of 7.3 percent per annum. We can boldly predict its eventual reduction by the end of the year – to about 6.8-7.0 percent. This is generally a good thing, if we recall the jumps in commodity prices during the winter months and in March of this year.

The ruble exchange rate is likely to remain at the current level of the bi-currency basket set by the Bank of Russia until the end of this year. Moreover, considering the bearish dynamics of the euro/dollar exchange rate, the ruble-dollar exchange rate may drop to the 37.00 mark.

However, in general, the dynamics of the Russian ruble is fully in trend with emerging market currencies. For example, at the moment, we can observe a correlation between the Russian ruble and the South African rand.

Thus, we can see that the Russian economy is showing resilience, as are the country’s financial markets. A serious challenge for the Russian economy could be a prolonged phase of U.S. and European sanctions, which could restrict access to Western technology and block access to credit financing. That is when Russia will enter into a deep recession – but so will Russia’s Western European partners – leading to the boomerang effect. And this is something no one needs or wants.

The opinion of the author may not necessarily reflect the position of Russia Direct or its staff.