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a blog from young economists at Nova SBE

The impact of the European Union sanctions on Russian economy.

“About 40 billion dollars a year are lost due to geopolitical sanctions imposed by EU” – said recently Minister of Finance of the Russian Federation Anton Siłuanow appearing on the International Economic Forum.

In relation to the involvement of Russia in the conflict in eastern Ukraine, the European Union have imposed sanctions on Russia, including economic ones that cover restrictions on access to capital market by russian banks and state companies from the oil and defence sector.

One of the entities sanctioned is Rosnieft, one of the biggest oil companies in Russia. The restrictions include a ban on the purchase, sale, provision of interest services or assistance in the issuance of securities and other financial instruments with maturities greater than 30 days. Those movements will strongly inhibit further investments and the growth of  the whole oil sector in Russia.

Since 2006 Russia started a controlled opening-up of energy sector to foreign investors in order to attract modern technologies and capital inflows into Russia and to gain access to foreign assets that can help corporations like Rosnieft to reinforce their positions in international markets. It was the turning point in foreign investors’ policy towards Russia and significant capital inflows began.

In 2012 Rosnieft signed a co-operation agreement with three leading foreign corporations. In exchange for access to Russian oil fields on the continental shelf as minority shareholders, those investors started financing and carrying out explorations there. Estimated costs of joint projects are about 500 billion dollars.

Intensive capital inflows, especially from direct foreign investments, might be a great chance for a developing country like Russia to increase industry’s efficiency, transfer new technologies from abroad and better allocate capital. On the other hand, if capital inflows are not managed correctly they can lead to overheat of the economy, increase of exchange rate volatility and eventually to huge unexpected outflows that harm the economy. Former change in Russian policy towards foreign investors encouraged them to invest and transfer capital to Russia. New macroeconomic policy, recently introduced, resulted in lack of confidence in domestic markets and external effects that are global sanctions led to large outflows from Russia that are estimated at over 100  billion dollars this year.

Current situation in Russia is exacerbated by the global decline in oil prices. Now, it hovers around 70 dollars (04-12-2014) per barrel. Price below 90 dollars forces the government to increase the debt or cut spendings because tax revenues are based on oil export. Low price of oil influences the rouble huge depreciation as well as sanctions imposed by the West and associated outflows of foreign investors from Russia.

In response to sanctions, Russia restricted imports of food from abroad which now will be an additional challenge. Imports will be even more expensive, and food prices will affect less affluent Russians. Problems are also indebted Russian banks in foreign currencies. According to analysts, the Russian banks should pay off in the last quarter of 2014 55 million dollars from interest and loan installments.

Because of western sanctions now virtually the only source in the Russian currency market is the Bank of Russia. Exporters reduced the sale of foreign currencies to a minimum, because we need the dollars and euros to settle their obligations. Russia has a foreign debt of around 130 billion dollars, which will have to be paid back by the end of 2015. However, due to the sanctions imposed by the EU, Russian companies have no access to international markets.

These sanctions led to a sudden slowdown of foreign capital inflows into Russia, phenomenon known as a sudden stop. This was then followed by a severe fall in GDP, private spendings and credit to the private sector, as well as an appreciation of the real exchange rate. The Central Bank says it expects no economic growth for Russia in the next two years, and an increase in the inflation rate. A large slowdown in capital inflows can be met either by a loss of international reserves or a lower current account deficit.

A lower current account deficit can be achieved through a decrease in the internal demand for tradable goods, translating into a reduction of imports. Since tradable and non-tradable goods are complements, the demand for non-tradable goods also fell, leading to lower output and a real depreciation of the currency, meaning that the relative price of non-tradable to tradable goods decreased. The value of the Russian rouble, which closely tracks the oil price, has already decreased 30% in respect to the dollar since the beginning of the year and a weak rouble makes the foreign debt even more expensive than what it already is.

Bez tytułu

Similarly to South Korea during its crisis in 1997, Russia is also now facing a slowdown in capital inflows, even though the reasons for this slowdown are different in the two cases.

In the case of Korea, the government opened up their capital markets to capital flows from abroad, which resulted in a lending boom. But because of weak bank regulator supervision, losses on loans started to mount. Big companies and banks became highly leveraged, because they were not effective in allocating money to best investments.

Just like South Korea, Russia also has a liquidity problem to pay back its huge external debt. The rouble also depreciated a lot compared to the US dollar. Russia should learn from the Korean case and allocate the money they have available in the best possible way, without influences from interest groups. Due to the uncertainty in bank lending, banks should be more careful to whom they lend money.

Today Russia is nowhere close to the sovereign default of 1998, since it is still running a current account surplus of about 50 million  dollars because it is importing less. The drop in oil prices should be met with an increase in government spending, and the low available reserves should be made available for bail-outs. Otherwise, some big companies and banks risk going into bankruptcy.

The Russian government should increase interest rates in order to attract foreign investment, and for this to be possible the EU should, of course, remove the sanctions imposed. Russia should also reform its financial system, but what the country needs the most is more competition, and so far nothing has been done by the actual government to achieve these goals.

Afonso Queiroz Aguiar 722
Maciej Kimel 763


Author: studentnovasbe

Master student in Nova Sbe

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