Economic Sanctions: What Do They Mean for Russia? ICEUR-Vienna OUTCOMES Seminar Vienna, November 11, 2014 Sergey Afontsev Department Director, Institute for World Economy and International Relations, Moscow, Russia Professor, MGIMO-University Advisor, EU-Russia Industrialists Roundtable

Economic sanctions imposed in the context of the ongoing political crisis in Ukraine have dramatically affected both the current dynamics and the future prospects of Russia’s economic relations with the rest of the world. Although no binding resolution of either the UN Security Council or the UN General Assembly concerning Russia’s involvement in the political crisis in Ukraine was adopted thus far, most developed economies took actions intended to influence decisions of the Russian leadership. Retaliatory measures introduced by Russia in August left no doubt that the quest for cooperative solutions will be more than problematic. Introduction

Structure and Timing of Economic Sanctions against Russia  Targeted (‘smart’) sanctions directed against particular persons and legal entities in Russia whose actions could be interpreted as threatening territorial integrity of and political stability in Ukraine (March 17 – July 15);  Sectoral sanctions with a shift from ‘punishing’ agents who contributed to the Ukrainian crisis to action against wider sectors of Russian economy irrespective of the role played by companies operating in these sectors in the Ukrainian crisis (July 16 – September 11);  Escalation of sectoral sanctions (September 12 onwards) with a clear ‘decoupling’ of measures taken and the dynamics of political conflict in Ukraine, as new sanctions were imposed exactly at the time when the first signs of crisis de-escalation became visible.

Although any systematic assessment of the impact of economic sanctions and retaliatory measures on the Russian economy should wait for results of a formal exercise in general equilibrium modeling, two sets of economic indicators can be addressed to get preliminary conclusions. On the one hand, currency and stock market indices provide the idea on immediate reaction of economic agents on news concerning new restrictions on Russian economy. On the other hand, dynamics of such basic economic variables as GDP, gross fixed capital investment, and external sector indices shed light on sanctions’ impact on the growth potential of Russian economy. Consequences for the Domestic Economy

Correlation of economic sanctions and market dynamics is limited (almost nonexistent since mid-September). This suggests that market agents in Russia cared more on the internal dynamics of the Ukrainian conflict and their own expectations concerning domestic/external developments rather than on any restrictive measures. Russian stock and currency market (March 15, 2014 = 100).

Consequences for the Domestic Economy Key macroeconomic indicators (year-on-year growth rates, per cent)

Dynamics of the key macroeconomic indicators reveal three major trends that were not known a year ago.  Gross fixed capital formation collapsed in Q and did not recover afterwards. Financial restrictions together with capital flight (which is expected to reach $100–$120 bn in 2014) work to further suppress investment activity since Q  Russian imports suffered a major drop by 6.3 per cent in Q1–Q This can result from both the slowdown of the GDP growth in Russia and deterioration of trading climate. Irrespective of the exact contributions of these factors, consumer welfare is to be affected negatively.  Growth in consumer prices has accelerated remarkably, contributing to the overall drop in real disposable income by 0.2 per cent in H Consequences for the Domestic Economy

Consequences for the Domestic Economy: Prices

Consequences for the Domestic Economy: Business Most companies (even those not directly affected by sanctions) complain that sanctions…  restrict access to finance (capital markets in the EU and the US are actually closed, alternative markets are more expensive with limited supply);  reduce consumer confidence and thus contribute to further drop in demand;  create problems with foreign partners even in fields not covered by sanctions.

Russian companies should repay/refinance $106,7 bn by the end of 2015, incl. $84 bn by companies under sanctions:  oil & gas companies under sanctions – $84 bn ($35.4 bn by Rosneft only);  financial sector companies under sanctions - $22 bn. Most companies (probably not Rosneft) will be able to repay/refinance their foreign obligations without addressing the Russian government for financial assistance (Source: Sberbank Investment Research, Moody's Investors Service). Consequences for the Domestic Economy: Business

 Keeping sanctions intact will cost Russia 0.1 per cent of GDP growth in 2015 and 0.4 per cent of GDP growth in 2016 (Source: Central Bank of Russia).  Further escalation of sanctions will reduce GDP growth by 1.2 per cent of GDP in 2015 and 0.8 per cent of GDP in 2016 (Source: The World Bank). As a result, Russia will face an economic decline by 0.9 per cent in 2015 and 0.4 per cent in Consequences for the Domestic Economy: GDP

Pessimistic GDP forecasts Optimistic GDP forecasts Consequences for the Domestic Economy: GDP

Consequences for the External Sector  Restrictions on trade, finance and technological cooperation made diversification challenges even more pressing.

Consequences for the External Sector  Extensive reliance on US dollar and euro is seen as a problem, but is not easy to overcome. Source: Bank for International Settlements, 2013

 New incentives for ‘Russia’s pivot to Eurasia’ to find new energy markets as well as trade and investment partners in technologically advanced economies. Russia’s key trading partners, 2014 (per cent of total trade). Consequences for the External Sector

Consequences for the Domestic Politics Results of the opinion poll on objectives/reasons behind foreign sanctions against Russia (multiple choice), per cent (WCIOM, ).

 Hopes that economic ‘pain’ caused by escalated sectoral sanctions will invite popular protect and a sort of ‘colored revolution’ in Russia appeared to be futile not so much because the Russian government has enough control over domestic political processes (and mass media in particular), but because the experience of the neighboring countries (and especially that of Ukraine) clearly shows what kind of consequences these revolutions generate.  Escalated sanctions are widely seen as an external threat, which claims for political consolidation and fuels the ‘revenge of justice’ feelings among the Russian population. Recent opinion poll showed that 84 per cent of people supported retaliation measures, and 80 per cent felt that their net effect will be favorable for Russia. Consequences for the Domestic Politics

Results of the opinion poll on expected consequences of Russia’s retaliatory measures (multiple choice), per cent (WCIOM, ). Consequences for the Domestic Politics

 Public consolidation against the ‘external threat’ worked to smoothen cleavages on foreign policy issues among different elite groups in Russia created by targeted sanctions, thus eliminating chances for outside actors to affect decision making in Russia over its involvement in Ukrainian crisis.  The ill-chosen timing of the new EU sanctions and spectacular inability of the EU member countries to withstand political pressure by the US make Russian elites even more inclined to look for more reliable (Eastern) partners.  Under Russia’s current political system, subjecting it to more economic ‘pain’ will result in further alienation from the West without any contribution to de-escalation of the Ukrainian conflict. Consequences for the Foreign Policy