Today’s Headlines: Will the Downing of MH17 Finally Produce Sanctions with Teeth?

Economic News you can Use

Today’s Headlines: Will the Downing of MH17 Finally Produce Sanctions with Teeth?
July 29, 2017
Has Russia Finally Gone Too Far?

Entering July 2014, Russian actions in Crimea and Ukraine had produced little in the way of meaningful sanctions by the US and its European allies. The first round of US sanctions, targeted against individual Russians and their holdings, had little effect and were even mocked by Russia, which issued symbolic reciprocal sanctions against U.S. Senators and Obama administration officials. EU nations with economic dependence on Russia had no appetite for meaningful sanctions, either. As a result, MICEX (the Russian stock market) dipped briefly but soon recovered.

The US ratcheted up the sanctions on Russia on July 16th. In this round, specific banks, energy and defense firms were also targeted – including the oil producer Rosneft, natural gas producer Novatek, the financial branch of Gazprom (Gazprombank), and the economic development bank VEB. These sanctions moved beyond travel restrictions and freezing of individual’s assets to block the named firms from accessing dollars in the US capital market for anything but short-term financing.

Then on July 17th, Malaysian Airlines flight MH17 was shot down over Ukrainian rebel-held territory, killing 298 passengers and crew. It is widely believed that Russian-trained Ukrainian rebels using Russian-supplied missile technology mistakenly shot down the plane thinking it was a military aircraft; some think that Russian involvement is even more direct.

Will the outrage over MH17 produce even tougher sanctions against Russia, or sanctions that are primarily for show?

What’s The Final Objective?

While everyone clamors for tougher sanctions, the objectives are not always the same, or clearly spelled out. Is the goal for Russia to relinquish claims to Crimea? That seems unlikely. Is it for Putin to take visible steps to disarm or otherwise rein in Ukrainian separatists?

From the US side, the goal appears to be stopping the flow of Russian weapons and training into Ukraine – a pretty easy target for Russia to meet and then subtly violate later as the world moves on to other crises.

One the EU side, there is finally a push for tougher sanctions, thanks in part to an emotional speech by Frans Timmerman, the Dutch Foreign Minister. The majority of the passengers on MH17 were from the Netherlands, some of whom Timmerman knew personally.

Outlines have been proposed for EU capital market restrictions, as well as sanctions on energy and defense technologies. While EU Ministers agreed on many of these broad items last Friday, there is not yet firm agreement on the implementation of these proposals. Apart from concerted EU action, individual nations need to act on their own complex relations with Russia. France, for example, has a $1.6 billion deal it is reluctant to break to sell Russia two sophisticated warships. In addition, both Spain and Italy have shown unwillingness to jeopardize their own frail economic recoveries by substantially threatening their important economic ties with Russia.

Despite these mixed signals from European capitals, the Russian business community has much to fear. Aside from potential revenue losses, Moody’s reports that Russian companies have $112 billion in maturing debt that requires financing over the course of the next four years. Restrictions to both the EU and US capital markets would be hard to supplement elsewhere.

Meanwhile, the MICEX is down to 1388 over the weekend, from readings in the 1500’s in the week prior to the newest US sanctions and the MH17 tragedy. The IMF has revised growth estimates down to 0.2% (Russia still predicts greater than 1% growth). The prime interest rate was increased from 7.5% to 8% due to the higher risks affecting the ruble.

Clearly, prolonged sanctions aimed at financing will hurt the Russian economy.

The Takeaway

Capital is likely to continue to leave Russia and Russian stocks are likely to continue a slow decline while the final form of the EU sanctions takes shape.

As of this writing, it is not clear whether the ministers are targeting specific firms or entire sectors. Sector sanctions seem less likely given the collective EU interests – diplomats will craft sanctions that minimize, or at least distribute, the pain among EU members. The UK fears a financial backlash, while most of the rest of the EU fears loss of Russian energy supplies.

Once the picture becomes clear, Putin is likely to respond quickly. History suggests sanctions will bring defiance and retribution – but Russia is not in the strongest of economic positions to retaliate. Russia can receive some financial help from China; otherwise, Russia’s options are turning off the gas supplies and retaliating on EU trade – depriving themselves of cash. Russia has significant cash reserves, but not infinite ones.

Putin has proven to be aggressive yet reasonably astute on how far he can push his luck. It is more likely that there will be some form of short-term strategic retreat by Putin – just enough to satisfy reticent Western powers and relieve sanctions within a short time. However, sanctions will not solve the long-term issue of Russian expansion.

While it is not yet clear what will happen, the majority of possible scenarios suggest a rough time for Russian investments in the short term. Investors would be wise, therefore, to steer clear of them until the dust settles. As leader of one of the world’s two nuclear superpowers – and basking in sky-high approval ratings among his countrymen – Putin is still very much a wild card, much to the discomfort of the US and its European allies.

  Conversation   |   0 Comments

Add a Comment

By submitting you agree to our Terms of Service
$commenter.renderDisplayableName() | 12.11.16 @ 14:17
{comment}

  Our Professionals Are Available to Help!

  Can't find What You're Looking For?