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SANCTIONED: a look at the consequences of EU and US sanctions on the Russian economy

The initial response of the Russian authorities and state-run media to the sanctions imposed by the European Union and other Western countries for actions allegedly taken in the east of Ukraine was brave. There were countless episodes of statements made by high-ranked authorities and members of the Russian Duma that the economy of the country will not deteriorate as the results of restrictions imposed, and that those, in turn, will have a boomerang effect – Europe and the United States themselves will undergo greater losses than the object of their punishments. This rhetoric that invokes the image of the self-sufficient Soviet Union which only thrives in spite of the crafty plots of its ever-vigilant nemeses was warmly welcomed by the portion of the Russian population still oriented towards the besieged fortress model of global politics.

However, as recent developments have shown that the discourse quite likely targeted the internal audience rather then sent a signal to the rest of the world. Even though the impact on individuals and groups ostensibly responsible for decision making in the Russian political establishment did not reach the desired level, the effects on the well-being of the general populous appears to be somewhat more sensitive.

So what is it exactly that arose in the consequence of the sanctions? Upon the announcement of the implementation of what is now known as the first round of sanctions, the Russian largest market index MMVB fell by approximately eight per cent over the course of several days. It is worth mentioning that initial restrictions were yet of a mild character, as they mainly concerned suspension of negotiations on certain joint projects, and established an entry ban for concrete officials. The strength of the market response to the measure is motivated by the ephemeral nature of investor confidence in the Russian economy. According to the World Bank, Russia is placed 93rd in the Business Confidence ranking, neighbouring such states as Jamaica and Albania.

Uncertain investors

The intrinsic political risks associated with lack of transparency and accountability implies a higher cost of business conduct for enterprise, which not everyone can afford to bear. Thus, receiving a signal of impending confrontation, the market reacted by withholding. The respective sentiment is enforced by the model of a closed country with marginalised private market that the world could observe not so long ago. The fright that there may be movement towards restructuring the existing construct with the usage of late-soviet templates impacts not only foreign market entities, but also national businesses and individuals who may prefer to discontinue their activities.

A decrease in investor and business confidence results in an outflow of capital from the country. This is, in turn, consequential in several respects. A diminished supply of foreign currency causes the exchange rate to drop and the rouble to weaken. Since the beginning of the Crimean crisis, the rouble lost approximately twenty per cent of its value with respect to the euro and the dollar. This development is rather crucial for a major exporter. On one hand, it can temporarily improve the budgeting due to the ability of the government to simply throw in more Roubles into the Economy and thus dilute some of the pressuring issues and appease certain displeased elements. However, in the medium run and long run, such currency drop has its detrimental implications.

Problems for consumers

Certain conditions, such as high maintenance cost of production due to the local climate or the Soviet neglect of consumer industries, cause Russian production of consumer goods to be scarce and uncompetitive. Thus, lack of domestically produced consumer goods is compensated through purchasing from abroad, making them the largest component in the Russian import. A strong decline in the national currency results in a decrease of relative purchasing power of those in its possession. Thus, there is an almost immediate direct income effect on those used to purchasing Norwegian salmon and German cars. Furthermore, weaker Rouble implies a rise in prices of production factors, which now affects domestic manufacturing costs. In the end, this promotes inflation and, hence, deterioration in living standards. Besides that, the trick of throwing in cheap roubles employed by the government is hardly efficient anymore – the additional value accumulated is eaten up by the increasing meaninglessness of papers in your wallet.

The diminishing of the purchasing power was reinforced by the response ban on food imports imposed by Russia. Reducing supply from abroad brought up domestic prices and created a lot of uncertainty in the market, since the ban also concerned raw materials used for much of domestic production. These disturbances in the food market resulted in food inflation rising from 5.3% at the beginning of the year to 11.5% in accordance to the recent estimates. It is, however, not only consumers that suffered. The total external debt of the Russian private sector is, according to the country’s Central Bank, 343 billion USD. This is sizeable to the external debt on the public sector. Denominated in foreign currencies, it is going to increase in its real value making repayment more complicated, specifically for private sector companies who, unlike the government, cannot rely on previously accumulated reserves. This implies further turmoil in the market associated with supply drops reducing the output and pushing up the prices.

The estimate of the Russian inflation as of the end of September is 8%, which is almost two per cent larger than the respective value in 2013. The announced target for this year was 5%. After each round of the sanctions, the monetary authorities would inform that they were consistently working on balancing the inflation growth, and working to commit to their pre-set goal. However, given the previous dynamics and market developments, this promise is unlikely to be fulfilled.

What the future holds

The further path for the Russian economy, as well as the society, is now very dependent on the strategy that the authorities will select to tackle the issue. The tactics of gradual diminishing of the Russian military involvement in the Ukraine with further easements from the Western Countries could constitute the moderate scenario of gradual alleviation. However, the negotiations held over the conflict have suggested this outcome as unlikely. Maintenance of the status-quo is unlikely: Europe, United States and several other countries have demonstrated their commitment to advancing with the punitive strategy given lack of compliance. Recently imposed restrictions are starting to affect international operations of government-owned gas and oil companies that are the primary source of income for the Russian budget, which can have a range of consequences, from cuts in social welfare to inability to meet debt obligations.

There is also a possibility of speeding up the deterioration that is frequently observable in left-populist proposals on governmental or parliamentary level. Amongst those were ban on Western clothing and cars, elimination of foreign companies from particular industries, sharp rise in income taxation, VAT and corporate taxation complemented by imposition of a 10% sales tax. The latter measure has already been approved by the parliament and is to take place starting next calendar year. It is difficult to forecast the development associated with this path due to vast uncertainty involved. However, it is clear that heading this direction cannot stabilise the situation in the Russian economy, which may have far-reaching consequences for a large and resourceful country somewhere on the periphery of Europe.

The sanctions caused food price inflation to go up to 11.5% according to recent estimates


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