What sanctions have been imposed?
Over the course of last weekend, the G7 bloc ex-Japan (France, Germany, Italy, Britain, Canada, the US and the European Union) imposed tough sanctions in four areas that they had previously held back from – a sign that Russia’s invasion of Ukraine has already changed the West’s strategic calculus.
First, they removed selected Russian banks from Swift, the global banking system that facilitates financial flows and trade.
Second, they announced a freeze on foreign assets of Vladimir Putin, his inner circle and their families. Those targeted included the veteran foreign minister Sergei Lavrov, the rest of the Russian security council, and 11 more named officials. Putin’s wealth is famously obscure, and the move may have limited effect in practice. Targeting a head of state in this way is highly unusual and has symbolic value: Putin joins a select club of murderous kleptocrats alongside Kim Jong-un, Alexander Lukashenko of Belarus and Bashar al-Assad of Syria.
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Third, they announced limited sanctions against a number of oligarchs, such as limiting the sale of so-called golden passports to wealthy Russians. Fourth, and most important, were the unexpected and game-changing sanctions on Russia’s central bank.
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Why’s that so significant?
Because the sanctions are aimed at blocking Russia’s access to its own $630bn (£473bn) reserves of foreign currency. Until that move, many commentators were predicting that those carefully built-up strategic reserves would cushion the impact of economic sanctions and let it ride out the crisis. Now they are not so sure, since almost half those reserves are in the form of “electronic debt” held by Western central banks.
“The most recent measures targeting the Central Bank of Russia have completely changed the picture,” reckon JPMorgan analysts. “Russia’s large current-account surplus could have accommodated large capital outflows, but with accompanying CBR and Swift sanctions, on top of the existing restrictions, it is likely that Russia’s export earnings will be disrupted, and capital outflows will likely be immediate.”
The upshot is that some economists are now predicting a double-digit contraction in GDP – and the lesson is clear, says David Frum in The Atlantic: “Do not fight with countries whose currencies you use as a reserve currency to maintain your own.”
Will the sanctions work?
There are no guarantees that the pain inflicted on Russia by sanctions aimed at isolating and hurting it economically will change its policies or government. Yet there’s no doubt that serious economic pain will be inflicted – slowing growth, limiting Russia’s ability to develop and produce advanced military equipment, and potentially causing Putin to alter his domestic calculus – or foreign policies – if discontent rises and the Ukraine war proves unsustainable.
The Kremlin has prepared for this moment, but could do so only up to point. Since 2016, the Russian central bank has diversified its foreign reserves, cutting exposure to western Europe and the US, and increasing holdings in Japan, China, and monetary gold. Ten years ago, 90% of Russia’s foreign exchange and gold reserves involved Western counterparties or issuers, according to Sven Behrendt, of GeoEconomica, a German political risk consultancy.
Now, he reckons that’s true of less than 45% of an estimated $622bn reserves. That’s a big shift, but it hasn’t been enough to insulate the Russian state from the financial fallout this week – which included a 30% collapse in the rouble, and such a global exodus from Russian assets that Moscow ordered the suspension of all trading in stocks and derivatives.
How else has Russia responded?
It more than doubled its key interest rate to 20% on Monday and introduced capital controls, while the central bank’s governor said sanctions had stopped it selling foreign currency to prop up the rouble. It also closed down the stock exchange and derivatives trading, rather than accept what could be a historic rout (Barings analysts this week wrote down the value of Russian shares to zero).
The state also ordered exporting companies, including state-backed energy giants Gazprom and Rosneft, to sell 80% of their foreign-exchange revenues on the market to help prop up the rouble. And this points up the glaring omission in the sanctions to date: the oil and gas sector. Germany might have “de-certified” the Nord Stream 2 pipeline – for now – but not the pipelines through which gas is continuing to flow to Europe.
How will this affect the economy?
Overall, Russia’s economy is relatively small and globally unimportant. Italy’s is twice as big with half the population. Poland exports more goods to the EU than Russia does. But Russia’s energy sector is vast, accounting for more than half of Russian exports and dominating government revenues.
That makes the country ultimately vulnerable, but right now it gives Moscow leverage. Europe relies on Russia for about a quarter of its oil and more than a third of its gas, so an outright embargo would incur massive costs, including spiralling inflation and a potentially deep recession. Ultimately, the EU is willing “to freeze Russian banks – but not German homes”, says Lex in the Financial Times.
The West has announced some new restrictions on high-tech exports to Russia, including equipment connected to extracting oil and gas. Firms such as BP and Shell have rushed to dump stakes in Russian energy firms. And Germany announced a long-term pivot away from reliance on Russia. But for as long as Europe still relies on Moscow for a big slice of its energy, the Kremlin has cards to play. In fact, the main macroeconomic consequence of the war, says Rana Foroohar in the FT, may well be to accelerate Russia’s financial decoupling from the West, make Moscow much more dependent on China, and hasten the shift to a bipolar global financial system based on the dollar and renminbi.
