Marc Jones and Sujata Rao

LONDON, (Reuters) – Russia spent seven decades building financial protections. But, Russia’s long-term economic prospects are unlikely to withstand Western coordinated sanctions.

Europe and the USA are launching reprisals against President Vladimir Putin’s sending tanks into Ukraine. This is in addition to the sanctions already imposed as a result of his recognition of the independence two independent Ukrainian provinces.

The view that Russia is unaffected by sanctions is false. While the negative consequences may not immediately be evident, they will continue to impact Russia over time,” explained Christopher Granville, managing Director at consulting TS Lombard who is a well-known Russia watcher.

The West has taken steps to freeze assets and sanctions on Russian businessmen and banks, stop fundraising overseas, and to block the $11 billion German gas pipeline. It also froze a project that would have brought about the construction of a new oil pipeline.

Russia denies that sanctions are incompatible with the interests of their imposers. They won’t affect an economy that has $643 billion worth of currency reserves, and is booming in oil and gas revenue.

Russia has been called a “fortress economy” due to these metrics. It also boasts a current surplus of 5% annually and a ratio of 20% of GDP to debt, both of which are some of the lowest anywhere in the world. Only half of Russian liabilities is in dollars, compared to 80% 20 years ago.

GRAPHIC: Russia’s currency reserves have increased by more than 75% over 2015

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These stats are the product of many years worth of financial savings, since Putin’s 2014 Crimea Annexation.

Granville says that Russia’s surging oil price will give Russia an extra 1.5 trillion rubles ($17.2billion) in tax revenue from its profits.

However, this autarky can come at a steep price: deeper isolation from global markets, economies, and investment.

Russia will be treated as an enemy state, cut off from international flows, investment, and any other normal economic interactions that increase living standards and productivity.

Already, signs of economic vulnerability exist. Russian households have lower incomes than in 2014. Before the COVID-19 pandemic hit, their annual economic output was $1.66 Trillion. That’s far below 2013’s $2.2 Trillion.

Sergei Guriev (economist at France’s Sciences Po) pointed out that the Russian per capita nominal GDP was double China’s 2013 in 2013.

Russia, which was a country of high income in 2013, was actively pursuing OECD membership. He said that Russia has now returned to middle income status.

GRAPHIC – Russian GDP per capita

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DIMINISHING CLOUT

Russia is home to a small number of foreign investors.

JPMorgan (NYSE 🙂 reported that foreign holdings of rouble bond were at their lowest point in over 20 years. Copley Fund Research also estimated that equity investment had never been back to pre-Crimea levels absolute terms.

Investors are now demanding a premium to own Russian Dollar debt. It jumped to 13 percent above U.S. Treasuries on Thursday, nearly triple that of emerging markets.

Jeffrey Schott (a Peterson Institute for International Economics trade and sanctions expert) stated that Russia will be forced to finance itself more. This would limit investment in the industry.

Severe attacks could also include the blocking of Russian access for international payments SWIFT or outright banning Russian investments.

Access to SWIFT could cause problems with export and import payments. It may also prevent the payment of bond coupons. This would trigger technical default. JPMorgan predicts that sanctions could cut GDP growth by up to 3.5 percent in the second quarter of 2022.

Oil companies are limited in foreign capital access, leaving them dependent on prepayment agreements and facing significantly greater capital costs.

Slow erosion of living standards could also lead to popular discontent. This would threaten an administration already subject to sporadic protests. It is possible that spillovers will be inevitable.

Berenberg’s analysts wrote, “Autarky cannot be a recipe for success.” The United States will continue to face a difficult task in coping with Russia, which is heavily armed and has suffered relative economic decline.

GRAPHIC — Foreign holdings in Russian government debt

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($1 = 87.0620 Roubles