Russia Sanctions Guide by Chris Weafer
What difference have sanctions made and, is that about to change?
Economy has adjusted to new conditions. The economic impact of the sanctions applied against Russia by the US, EU and other states in 2014 has been relatively slight. The reason is because the government was forced, due to the combination of sanctions, counter-sanctions and lower oil revenues, to address problems in a real way and not just “kick the can down the road” as before. The economy has now adjusted to (pre-August 2017) sanctions and lower oil revenues and is on course to grow by 1.4% this year.
Sanctions helped in many respects. Sanctions removed, or made more difficult, the soft options of borrowing and spending as the oil price collapse pulled the economy into recession. The combination forced the state to be much more fiscally disciplined and more flexible with monetary policy.
The ruble free-float would not have happened without sanctions. The ruble would not have been allowed to free-float, or certainly not so soon, if it were not for sanctions. The decision to stop supporting the currency in early 2015 was the single most important action taken by the government.
Big energy companies were forced to become more efficient. The restricted options, because of sanctions, also forced sectors, such as the oil industry, to become more efficient and to look for alternatives to Western-debt financing. The result was a jump of 740,000 barrels per day in Russian oil output from mid-2014 to late 2016.
What happens next will be much more difficult. But the good news may be about to end and the economic recovery more difficult to build on. That is because of the threats contained in the recent US law. While the law does not materially alter the existing sanctions regime, it contains a significant threat of sanctions expansion in the future and a great deal of ambiguity in the wording. “What exactly does “significant” mean?” is one question that springs to mind.
Sword of Damocles created. Section 241, in particular, requires the Treasury Dept. to present a report listing potential new sanctions targets and also an assessment of expanding the existing funding restrictions against state banks and energy companies to sovereign debt. That report is to be presented to Congress by late January next, i.e. just ahead of the Russian presidential election. Many investors and businesses are expected to delay investment plans to see what is in the Treasury Dept.’s report and, much more importantly, whether the recommendations are actioned.
Moscow will wait before reacting. The Kremlin is not expected to take any (significant) retaliatory actions against the latest sanctions law at least until it becomes clear how such agencies as OFAC actually interpret and implement it and also how the Treasury Dept. report will be used. Then the wait-and-see stance may change.
Ukraine and the INF reports may lead to retaliation. That wait-and-see stance would likely change sooner if the US sends lethal weapons to Ukraine. Although it would not materially alter the military situation, Moscow has made clear it would regard it as a provocation. The EU is also opposed to such a move. Separately the US Congress has requested a report about Russia’s alleged violation of the Intermediate-Range Nuclear Forces Treaty (INF). This is due by 1 April next year and Congress has said that it may result in fresh sanctions, probably using the information in the Treasury report.
New era of uncertainty. Russia risk has entered a new phase of uncertainty as a result of the collapse in political rapprochement with the US. How long that lasts today unknown. Investors will have to carry out a lot more due diligence about, e.g. trade and investment partners, that they would have had to pre 2 August. That will also slow FDI for sure.