RegionsBalticsRussian Sanctions Likely to Produce Cumulative Effect

Russian Sanctions Likely to Produce Cumulative Effect

The banking, defence and oil sectors are likely to feel the greatest impact from the planned escalation of economic sanctions imposed on Russia by the European Union (EU) and the US, according to analysts.

The latest raft sanctions will not produce an immediate liquidity crisis in Russia itself, as most debt issuers have sufficient cash and financial buffers, according to Moody’s Investors Service. However, the credit ratings agency (CRA) predicts that they will amplify the gradual downward trend in the country’s growth potential, and could over time erode creditworthiness across sectors.

“Russian companies and banks have sizeable amounts of foreign-currency debt due over the next 18 months, but their large cash buffers and ample financial assets cover most if not all of their refinancing needs,” says Moody’s. However the sanctions add to factors already weighing on Russia’s economy and financial system, which have been exacerbated by the conflict in Ukraine.

Moody’s report states: “Economic stagnation this year and next is unlikely to have a significant effect on Russia’s sovereign creditworthiness, given its ample external reserves and very high fiscal strength.

“However, a protracted conflict and/or widening sanctions would increase the demands on government resources and erode the country’s strong foreign exchange reserves and fiscal positions.”

Moody’s adds that prolonged adverse market conditions would have a significant negative effect on Russia’s banking system, raising its reliance on central bank funding and further lowering already weak profitability. Furthermore, cuts to fixed asset investment by companies aimed at reducing financing needs would have a negative effect on their production capacity and competitiveness in the medium term.

Squeezing the Banks

The latest measures are intended as a penalty on Russia for its continuing support for separatists in eastern Ukraine. Those agreed by the EU on 29 July include cutting off Russian state-owned banks from Europe’s capital markets, while the US is closing access to its economy for Russia’s state-owned VTB Bank, Bank of Moscow and the Russian Agricultural Bank.

About 30% of Russia’s banking sector assets are constrained following the latest round of sanctions, according to US officials. According to Antonio Timoner-Salva, senior economist with the HIS Banking Risk Service, in addition to damaging Russian state-owned banks the result will be heightened systemic banking risk.

He said that the sanctions are likely to squeeze Russian banks’ liquidity position, leading to tightening credit conditions, interest-rate rises, and weakening profitability of the sector. Russia’s three biggest lenders are Sberbank, VTB, and Gazprombank, which collectively represent the main channels for system liquidity to filter through to the rest of the sector through inter-bank lending or investment holdings.

Timoner-Salva said that not only will the sanctions limit the ability of these banks to extend credit to the domestic economy, but other banks will also be more hesitant to lend, particularly with the prospect of a rising share of non-performing loans in a struggling economy.

Oil and Defence

Another main target of the EU sanctions is Russia’s oil sector. EU president Herman Van Rompuy and European Commission (EC) president Jose Manuel Barroso announced that they would “curtail Russian access to sensitive technologies particularly in the field of the oil sector.”

The sanctions require companies subject to EU law wishing to export “certain energy-related equipment and technology” to Russia to gain approval first from a competent national authority. Export licences “will be denied if products are destined for deepwater oil exploration or production, Arctic oil exploration or production and shale oil projects in Russia.”

However, the EU stopped short of limiting oil and gas imports from Russia, which would impact just as heavily on countries that rely on Russian energy.

Platts, the energy and metals information service owned by McGraw Hill, cited Moscow-based analysts at Investcafe, who commented: “Russia is likely to see a major negative impact from constantly broadening sanctions, with a growing flight of capital and a further slowdown in economic growth,” although the immediate effect on the oil and gas sector was uncertain.

However, Platts added that the hardening Western stance toward Moscow has already prompted French major Total to suspend its plan to boost its holding in Russian independent gas producer Novatek, its partner in the Yamal liquefied natural gas (LNG) project, to 19.4%.

Another response came from Russian gas company Gazprom, which said that it would now source its gas turbine spare parts locally instead of relying on imports. According to Gazprom’s managing company, the combined value of these contracts is about 10 billion roubles (RUB); equivalent to £166m or US$280m.

The EU also banned any trade in arms with Russia, while the US prohibited transactions with the country’s United Shipbuilding Corp, which it classified as a defence company.

Analysts have noted that despite the size of the country Russia’s economy is relatively small and roughly equivalent to Italy’s However, its energy resources are massive. Russia’s exports are mostly raw materials, with about 60% comprising energy products. The EU is a market for more than 45% of Russia’s exports, but less than 3% of the EUs exports go to Russia.

Defiant Response

Russia’s immediate response was to dismiss the latest sanctions as “destructive and short-sighted”.

“Such decisions by Washington can do nothing but further aggravate US-Russian relations and create an utterly unfavourable environment in international affairs, where cooperation between our states often plays a decisive role,” declared the Foreign Ministry said in a statement.

A statement from Bank of Moscow said that as its business was focused on the domestic market it “wouldn’t suffer at all from the imposed sanctions”, while the Central Bank of Russia pledged to support banks hit by sanctions. “If necessary, appropriate measures will be taken to support these organisations in order to protect the interests of their customers, depositors and creditors,” it stated.

Nonetheless, Andrei Klepach, deputy chairman of VEB, departed from the general line by admitting that sanctions could halt Russia’s economic growth or even trigger a recession. While Russia currently predicts 1% growth in gross domestic product (GDP) this year, the International Monetary Fund (IMF) recently downgraded its own forecast to just 0.2%, citing the flight of capital and falling investment in the country amid western economic pressure.

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