Russia encounters toughest sanctions ever

• The EU has imposed new sanctions on several sectors of the Russian economy.

• The United States has sanctioned more Russian state-owned banks.

• Geopolitical risks may trigger cuts in Russia’s sovereign debt ratings.

Assessment and outlook

Yesterday (29 July 2014), the European Union introduced new sanctions on the Russian economy, ‘targeting sectoral co-operations and exchanges’ with Russia. Full details are due to be released tomorrow (Thursday, 31 July). The sanctions are set to impose limits on Russian state-owned banks accessing EU capital markets. EU nationals and companies may no longer trade ‘new bonds, equity or similar financial instruments with a maturity exceeding 90 days issued by major state-owned Russian banks, development banks, their subsidiaries and those acting on their behalf. Services related to the issuing of such financial instruments, e.g. brokering, are also prohibited.’ Yet, The Wall Street Journal quoted two European officials as saying that five Russian state-owned banks and their non-European subsidiaries would be sanctioned. This means that Russia’s Sberbank – Eastern Europe’s largest bank – could well be on the list but not its subsidiaries present in the EU markets.

An embargo on trade in arms has been introduced and exports of dual-use goods for military end-users have been banned. However, this will be implemented for future contracts only. The EU is also restricting access to oil production and exploration technologies. Trade and investment restrictions for Crimea and Sevastopol have also been agreed. Infrastructure projects in the transport, telecoms and energy sectors cannot receive new investments. Finance and insurance services related to such transactions are banned, too. The total number of Russian corporations sanctioned is 23.

In addition, the EU has put into force more individual sanctions freezing assets and banning visas for eight new persons ‘for providing support to or benefiting from Russian decision makers responsible for the destabilisation of Eastern Ukraine and the illegal annexation of Crimea.’ Thus, the total number of Russian individuals sanctioned by the EU has risen to 95.

At the same time, on 29 July, the US Department of the Treasury unveiled new sanctions on Russian financial institutions and on a Russian defence technology corporation. Among the sanctioned entities are some Russian banks where the state is the major shareholder: the second-largest VTB, the fourth-largest Rosselkhozbank and the fifthlargest Bank of Moscow. According to the Treasury, the new sanctions ‘will severely limit these banks’ access to medium- and long-term US dollar financing’. Yet, the Treasury says that it has ‘not blocked the property or interests in property of these banks, nor prohibited transactions with them beyond these specific restrictions. However, the scope of prohibited activities and the number of sanctioned financial institutions may be expanded.’

We believe these new sanctions will worsen sentiment towards Russia’s financial and oil sector but not influence directly unsanctioned sectors such as agriculture or retail. We also emphasise that the new sanctions do not affect any payments or cash management operations with Russian banks where those payments and operations are not related to new debt or equity issuance by sanctioned entities.

We think that uncertainty among Russian companies that co-operate with Western peers could increase and affect investment and consumer goods imports to Russia. Together with tightening monetary policy by Russia’s central bank, the new sanctions could push up prices for loans and decrease their availability to both Russian corporations and private consumers as the state-owned banks have the largest share of the banking system in Russia.

If the situation escalates further, we cannot rule out the possibility of more cuts to Russia’s sovereign debt rating. On 25 April 2014, Standard & Poor’s (S&P) cut Russia’s sovereign debt rating to ‘BBB-’ from ‘BBB’ preserving its negative outlook. This is just one notch above junk level. S&P claimed in its statement that the main reason for the downgrade was the tense geopolitical situation, which could trigger additional large capital outflows. For the same reason, on 10 April 2014, we cut our 2014 GDP forecast from 1.0% y/y to -0.3% y/y after the central bank released its capital outflow data. We see a significant supply-side shock hitting the Russian economy in H2 14. The shock is likely to curb fixed investments further and have a significant impact on business sentiment and productivity growth, dragging 2015 GDP to -1.8% y/y.