Sanctions imposed on Russia so far have cost Russia a loss of annual GDP growth of 1-1.5 percentage points. New sanctions may lead to further losses reaching 0.7-0.8 percentage points.
President Trump has signed the law entitled “Countering America’s Adversaries Through Sanctions Act” on 2 August 2017. The act itself does not specify the sanctions, but instead indicates the course of future action, including the timing, in line with which the US Department of the Treasury has been obliged to present to the Congress proposals and reports on the matter. Nevertheless, among other things, the document does provide for a shortening of terms of loans granted to Russian banks from 30 to 14 days, and in the case of entities from the energy sector, from 90 to 60 days. The ceiling on financing infrastructural projects in the gas sector has been vastly reduced (USD5m during one year or USD1m at a time).
At the end of October 2017, the US State Department published a list of Russia’s special services and 33 companies, groups and organizations from the military industrial complex, with respect to which a ban on implementing any significant contracts entered into force at the end of January 2018. Most of them were already subject to sanctions, but unlike the previous measures, this time the threat of sanctions was also extended to entities cooperating – including on markets of third countries – with those featuring on the list (read more).
In general, the restrictions against cooperating entities apply to all connections with the Russian companies that are subject to sanctions, including the systemically important energy and banking sectors. The possible penalty imposed on such cooperating entities may include:
- restrictions on exports of goods and services to the US market;
- blocked access to any financial services in the United States and any financing with the participation of American banks and investors;
- restrictions on the possession of property and a ban on the issuance of visas;
- ban on entry into the United States for the management of the entities breaking sanctions and their key shareholders.
Such a formula for the sanctions poses a particularly serious threat to the operations of the largest Russian banks, which have handled the financing of Russia’s military-industrial complex. The expenses of the Russian Ministry of Defense alone under government procurement amounted to RUB1.4 trillion, i.e. approx. USD25bn in 2017. All the operations associated with this financing have thus far been serviced by eight banks, including i.a. Sberbank, Vneshtorgbank and Gazprombank (read more).
The real threats of the new sanctions involve: a freezing of Russian assets in the United States, severing of the cooperation with Visa and Mastercard, and finally damage to reputation. In general, such a development would significantly curtail the ability of Russian banks to cooperate with foreign partners.
In order to protect the interests of the threatened banks, Russian authorities have decided to create a new bank that will take over the task of financing industrial and military entities. The new bank will be established on the basis of Promsvyazbank, which until recently was one of the leading Russian banks, and was taken over by the Central Bank of Russia in December 2017 as part of a bailout and restructuring procedure (read more).
In January 2018, the American administration presented to the Congress the so-called “Kremlin report”. It includes a list of Russian businessmen and officials whose business and its success have been underpinned by connections with the Kremlin. The list, comprising the names of 114 officials and 96 oligarchs whose assets exceed one billion dollars, constitutes an unclassified part of the report. It is supplemented by a list of further 69 Russian companies with close ties to the government and a state shareholding of at least 25 percent and with incomes over USD2bn.
According to analysts, the previously adopted sanctions are resulting in a loss of 1-1.5 percentage points in Russia’s annual GDP growth, and the new sanctions may cause additional losses amounting to 0.7-0.8 percentage points. The new sanctions also increase uncertainty and risk of investing in Russia.
In the case of new investors, especially foreign ones, this will probably lead to withholding investment decisions, while in the case of existing investors, this could lead to a reassessment of the feasibility of their implementation, especially as some of them may have been launched under the assumption that president Trump would exhibit a positive attitude to the development of economic cooperation between the United States and Russia.
Until the final extent of the sanctions is clarified, foreign investors are signaling the necessity of freezing investments both in Russia and abroad, which especially applies to investments carried out with the participation of Russian entities subject to sanctions. They have become “toxic”. This will additionally result in a reduced scale of economic and technological cooperation with global economic leaders.
What about the capital that was siphoned out of Russia
The possibly broad scope of the sanctions poses a serious threat to the wealthiest Russians and their assets stashed abroad, on various bank accounts, in real estate and in investment funds. The value of such assets is estimated at USD2 trillion.
The prospect of restrictions on access to these funds may cause concern among their owners. On the other hand, in Russia itself, average citizens see this as an opportunity for a partial repatriation of the capital that was once siphoned out of the country. There is even a statutory amnesty in the works for capital returning to Russia, with incentives such as exemptions from taxes on income obtained from the shutdown of investments abroad and the possible exchange rate differences. The government is also considering issuing several billion dollars’ worth of Eurobonds for investors with returning capital.
The legislation that is being prepared at an accelerated pace is an extended version of regulations adopted in 2015. The previous act, which was announced as a one-off amnesty, did not enjoy any significant take-up because, as is widely believed, the state was not trusted and the true value of the guarantees was doubted, primarily when it came to the protection of property rights.
The scale of distrust has not decreased, and despite the added fear of sanctions, it is judged that even under current circumstances a vast majority of Russian citizens holding significant assets abroad do not believe in the official declarations of the authorities that Russian capital can only be safe in Russia.
Threat to the financial market
After the previous sanctions, imposing restrictions on lending to Russian state-owned banks and enterprises, analysts believe that the most likely new measure will include a ban on investment by American residents in Russian government debt securities. This may apply to both foreign currency Eurobonds and bonds denominated in the RUB. At the end of the Q3’17, the value of Russian government debt was approx. USD160bn, including USD38.8bn in Eurobonds and USD122bn in internal debt, mainly in the form of bonds.
The sanctions would pose a significant problem for the Russian budget. In the period January to November 2017, Russia’s Ministry of Finance acquired RUB1.06 trillion on the market, of which RUB715bn, i.e. almost 70 per cent, came from non-residents. Their withdrawal would lead to a significant increase, estimated at 2 percentage points, in the cost of obtaining funds for the budget. The possibility of Russian banks taking over the segment abandoned by non-residents, posted by some analysts, does not seem to be a fully effective way of absorbing the impact. The increased exposure to government debt securities would result in a commensurate reduction in banks’ activity in financing the real economy, thus leading to a further decline in investment and the subsequent deepening of the stagnation.
A sell-out of bonds by non-residents could lead to a collapse in the RUB exchange rate. It is believed that in such circumstances it could depreciate by up to 10 per cent.
The Bloomberg agency has disclosed the classified part of the documents prepared by the US Department of the Treasury concerning the expediency and effects of a ban on investment in Russian government debt instruments. The document indicates that such a ban would have a negative impact on the Russian economy, but that American investors involved in trade in Russian debt instruments would also suffer. This applies in particular to instruments such as CDS (credit default swaps) and currency swaps, in which the American investors are particularly active, also as market makers.
The Russians were pleased to note the distanced attitude of the American administration towards the extension of the sanctions to Russian public debt. They are worried, however, about the emerging synchronization of activities undertaken by the Americans and their European partners.
New sanctions will deepen old problems
Russia has exhausted its potential for retaliation. Russia’s helplessness in the face of the new sanctions is all the more acute as the country is aware that such measures will persist for a very long time. A similar act from 1974, known as the Jackson-Vanik amendment, was in effect for 38 years.
The Russians have also realized that they cannot count on their “friends” in Europe and bet on a split between the United States and Europe, the latter losing out, due to the sanctions, and more favorably inclined towards Russia. After the first reactions of the European companies, which managed to soften the sanctions through lobbying efforts (among other things, the accepted participation of Russian companies subject to sanctions in investment undertakings was raised to 33 per cent, while the original proposal provided no such limit), fundamental economic considerations took precedence. The possibility of losing American customers, access to technology and the capital markets has considerably weakened the lobbying efforts and has highlighted the necessity of cooperating with American agencies responsible for the sanctions. The potential losses resulting from any conflicts with the American sanctions system are disproportionately higher than any benefits from continued cooperation with Russian entities.
The new sanctions are exacerbating Russia’s old problems. They strongly affect its economic interests, energy security and the possibility of modernization of its economy.