On March 1, France’s Minister of the Economy, Bruno Le Maire, had to back down on comments he made declaring “an all-out economic and financial war” against Russia. As understandable as his caution might be, one can also see why he went that far in the first place. The West’s answer not even to Putin’s invasion, but already to his recognition of the independence of Ukraine’s Donbas region came in a stronger, much more united manner than expected. Unwilling to engage directly in a war against Russia, fearing an escalation that could indeed lead to a third world war with a high risk of atomic catastrophes, the West focused on countering Russia financially and economically, and did so fiercely.
Starting with Germany’s blockage of the Nord-Stream-2 pipeline on February 22, harsher measures kept being unrolled as Putin marched deeper into Ukrainian territory. As of now, the G7 nations and the European Union have imposed personal sanctions on Vladimir Putin himself and his foreign minister Sergey Lavrov, closed their air space for Russian airplanes, banned many Russian banks from SWIFT (the only relevant organization able to facilitate international financial transactions), froze almost $500 billion worth of foreign currency reserves of the Russian Central Bank, banned exports of technological equipment to Russia and even confiscated yachts and other properties of Russian oligarchs close to Putin.
The question now is, however, not only how resilient Russia can be faced with these economic constraints, but for how long the West can keep them up. Forcing such a harsh break with the world’s 11th largest economy will be economically challenging for companies with investments in Russia and nations dependent on Russian exports of raw materials. When analyzing both sides of the dispute, much speaks to the strengths of the West, especially if united, but the question of who will prevail in this ‘economic war’ is still up for debate, not only for economic but also for political reasons.
The Russian Economy
Starting with the Russian economy: it is clear by now that Russia was not prepared to face this level of economic backlash, and the consequences will be felt hard. Shortly after the first sanctions were imposed, the shares of Russian companies listed abroad started plunging. In London’s stock market, Sberbank, Russia’s biggest lender, saw its shares fall by almost 70%, and the state-owned Gazprom, one of the world’s largest oil and gas companies, fell by 37%. The only reason why the damage was perhaps less significant was that Russian companies were suspended from trade on the Nasdaq and the Moscow stock exchange has remained closed since the beginning of the invasion. Moreover, the sanctions imposed on the Russian Central Bank cut off a large chunk of the country’s public savings available and, together with the overall climate of instability, prompted a steep fall in the ruble’s value and led to bank runs in all of Russia’s major cities. With its foreign reserves frozen, Russia’s Central Bank cannot purchase Ruble to stabilize the currency and the bank runs only add fuel to this loss of monetary control.
If that alone was not enough, dozens of companies, from oil giants such as ExxonMobil and BP to financial service providers such as Visa and Mastercard, have pulled out of investments and halted their economic activities in the country. International rating agencies were also quick to downgrade Russia’s sovereign debt, with S&P and Moody’s moving Russian credit to the “CCC-” category, a status labeled as “junk” by financial experts.
Overall, Goldman Sachs estimates a 9% fall in Russia’s GDP as a consequence of the war and the sanctions. Formerly expected to grow by 2% in 2022, Russia is now likely experience a deep recession.
Since the invasion of Crimea in 2014 and the economic sanctions imposed by the West at the time, Russia had been working to increasingly decouple itself from the West, trying to economically become what some have dubbed “fortress Russia.” From December of 2013 to December of 2021, Russia has increased its foreign reserves from US$ 510 billion to US$ 630 billion, mainly by increasing its amounts of gold, which grew from US$ 40 billion in 2013 to US$ 132 billion in 2021. Moreover, by running a current account surplus of 5% a year and having one of the world’s lowest debt to GDP ratios, at 20%, Russia put itself in a position that allows it to borrow large quantities of money without compromising its financial capabilities and reputation.
Fact is, however, that these protective measures were clearly not enough. The freezing of Russian assets in the West means that at least 50% of Russia’s reserves are now not accessible to Moscow. As they were held in government bonds of western nations, they can no longer be liquidated by Putin’s government. The Russians are claiming this constitutes nothing but default by the West, which is at least temporarily true, but the moral condemnation of Putin’s invasion is being clearly backed by financial authorities and the western economies as a whole, as the abovementioned voluntary exits of the Russian economy indicate. This means that the freezing of assets will not be interpreted by the markets as a default and will not negatively impact trust in the sanctioning nations.
Russia’s problems go further, reaching even its current abilities to liquidate its gold reserves and contract new debt, the two safety measures it tried to establish in the last years. The only big player still willing to buy Russian gold and bonds – and with it further finance the war – would be China, but even the Chinese will probably be skeptical towards doing so. As Yu-hsiang Wang analyzed here at The Paris Globalist, China has been facing a diplomatic dilemma with this crisis and will not fully embrace Putin’s plans despite its proximity to Russia.
To try to counter the consequences of the sanctions, the Russian government has already enforced harsh mechanisms, raising interest rates from 9.5% to 20%, blocking the sale of securities held by foreigners, and banning the sale of foreign currency, but compared to the size of the damage, these will hardly compensate.
Finally, more than these short-term shocks to the Russian economy, its biggest problem lies in the long term. The longer the war lasts and the longer the sanctions remain in place, the deeper the wounds. More than running out of reserves, facing inflation, and having to pay for expensive military expenditures, the lack of investments, and especially of access to technology, will decrease Russia’s economic competitiveness and its people’s relative standard of living. Here, the Russians could appeal once more to China, seeking its investments and market. However, even with China being the world’s second-largest economy, its size cannot compensate for the loss of Europe, Canada, Japan, and the US.
Even more significant will be the loss of revenues coming from the oil and gas sectors, which currently account for 60% of Russia’s exports. The greening of the world had already imposed limits on the long-term viability of these economic activities, but the war has, in some ways, hastened the green transition considerably. The US and the UK have decided to no longer import Russian fossil fuels, and the EU has set an ambitious plan to reduce its dependency by two-thirds until the end of 2022, but that is not even the biggest concern. The pledges to invest in renewable energies even faster than previously planned – with Germany announcing the investment of 200 billion Euros until 2026 for this purpose – lead Russia to a point of no return. Even after the war, a potential lift (or softening) of sanctions would not bring much. Lasting damage has been done.
The Western Economy
On the other side of this economic standoff, the time component bears just as much significance, but in different ways. For the West, and especially for Europe, it is not the short or the long-term that pose a danger but the grey area in between, the middle-term.
In the short-term, even if Russia decides to counter-sanction by blocking its exports of gas and oil, the West would be able to provide for itself at least until the next winter. With temperatures about to rise again and sufficiently filled reservoirs, even the coldest nations would not face significant shortages.
Even if a situation of absolute scarcity can be avoided, however, prices for oil and gas will still rise due to the uncertainties that come with the war, and this will lead not only to a rise in fuel and heating costs but to overall real inflation, as a rise in transportation costs will increase the prices of all products. Russia delivers 40% of the natural gas consumed in Europe and is responsible for 10% of global oil production. In such a tight market like the one for fossil fuels, any economic and political hindrances to accessing these exports has worldwide consequences. Moreover, Russia and Ukraine account for 1/3 of the world’s wheat production, and Russia and Belarus are amongst the world’s leading producers of fertilizers. This means that prices will rise, especially for food, a sector that disproportionately affects the poorest.
The backlash against this rise in prices seems, however, to still be contained. Both Emmanuel Macron of France and Viktor Orbán of Hungary, who face national elections this April, went up in the polls, profiting from benefits that crises such as this one provoke, such as the so-called ‘rally around the flag effect’ and the ability to introduce popular extraordinary measures, like Orbán maintaining his price cap on gas and Macron’s energy checks. Even the poorly-evaluated US President Joe Biden could recover part of its approval (even if paradoxically by blaming bad inflation results from before the crisis on the crisis), and a poll by the Infratest institute of Germany found that 66% of Germans said they would still favor sanctioning Russia even if it risked incurring a rise in prices at home.
The picture in the long run is also much brighter in the West than in Russia. As mentioned above, the break of trust between Russia and its economic partners in the West will accelerate a process that was already troubling for Russia’s economy, namely the greening of the world and the increasing economic sovereignty of European states. Furthermore, even in the not-so-long-run, Europe can look into other sources of oil and gas, such as Norway, Algeria, Qatar, the US, and even increase its own pool of liquid natural gas terminals.
Moreover, Europe will not face such a shortage of investments as Russia will in the future. Even as the 11th largest economy on the planet, Russia only accounts for 1.5% of global GDP and only 2.9% of the Eurozone’s exports. Being largely cut out of the international economy will have its impact, but it won’t be a fatal one. As published by the Guardian, the Eurozone’s and the UK’s GDP might grow around 0.5% less because of the crisis but not much more than that.
Nevertheless, as stated before, it is the middle-term that can become a problem for the West. If the news cycle moves on and people start feeling the consequences of higher prices on their wallets, especially if they stay this high until the next winter, public opinion might begin to change. High energy prices were already a political problem before the war – take the Gilets Jaunes movement in France as an example – and they are reaching record highs, with oil recently almost reaching the US$140 per barrel mark. Public pressure can then become unsurmountable, make the sanctions unsustainable, and even propel extremist parties.
Polities and Politics
What is striking about this middle-term weakness of the West is that it is rooted in the principle of democracy. To sustain his government in times of crises and internal political divergence, Putin can arrest thousands of protesters, persecute politicians of the opposition, ban foreign media and control the domestic press – all things he has done during this crisis. It is deplorable and unfortunate, but the West’s national democratic principles might make its policies less resilient and endanger its own democratic structures in this period, even if Russia’s position is overall much weaker.
When it will begin, when it will end and for how long this middle-term will last is impossible to predict. It will depend on how long the war and possible peace talks afterward will last, how quickly the next winter will come, and any other potential crises that could challengeWestern politics. These are all complicated variables to predict, but they will define how disruptive and lasting the sanctions will be for Russia and the West. Their consequences could go from empowering Western democracies and discouraging Russia and any other nation from waging war to weakening democracy and encouraging such violations to happen anew. The longer the West can keep the short-term going and the quicker it can pass through the middle term, the better. For Russia, the long-term seems doomed to be negative but depending on how long it will take to get there, it could still remain in the game for a while in a longer-lasting middle-term. The answer to who will win the game of sanctions could therefore not be clearer: only time will tell.