Russia Sanctions To Have Major Impact on Global Economy
The United States and Europe have avoided direct military conflict with Russia amid its invasion of Ukraine. But they are using a powerful tool to try to push back against Russia and create consequences for its aggressions: an unexpectedly fast and powerful set of financial sanctions meant to shock the country’s economy and hamstring its access to financial resources.
While Russia may have anticipated the measures, what the country perhaps did not anticipate was for so much action to be taken so swiftly. The US and European allies have limited its ability to transact in foreign currencies such as dollars and euros, frozen the assets of multiple Russian banks, and cut off Russia’s banks from the SWIFT messaging system banks use to transmit information globally. Japan said it would join in freezing the assets of Russian leaders and some banks and freezing Russia’s foreign reserves in yen. Even Switzerland, a historically neutral country in conflict, has agreed to join sanctions efforts.
In turn, Russia has taken action to try to shore up its economy and finances. Its central bank has doubled its interest rate in an attempt to stabilize the ruble after the currency sank against the dollar. The country, which has been facing sanctions since its invasion of Crimea in 2014, has over $600 billion in foreign reserves, meaning money in other countries’ currencies and gold. It built up those reserves specifically to help fend off sanctions. As the New York Times notes, a lot of that money isn’t actually in Russia but is essentially on paper in banks around the world. So now, the country could have a hard time accessing that money. Sanctions are likely to hurt the Russian government; they are also hurting the Russian people, who were already in a tough spot before now.
These developments have major implications not only for Russia’s economy but potentially for the world’s; it’s unlikely their impact will be contained to one country’s borders.
This is a unique combination of measures that have been taken. Each individual measure is not unprecedented. What is historically unprecedented is the degree of multilateral coordination and the fact that they’re using these nuclear options at the same time.
It definitely will have a dramatic impact on the Russian economy, but at the same time, there’s room for further escalation.
What does this mean for Russia’s economy?
We are looking at a double-digit economic contraction already. We have seen extreme measures applied by the [Russian] government in terms of capital controls and blocking transfers of foreign currency to non-residents. Exporters have to convert 80 percent of their proceeds to the domestic market, and Russia’s central bank has more than doubled interest rates. Russia is also undertaking banking sector support, releasing some capital for the banks.
All these measures are just basic crisis management. But this crisis will grow larger for the Russian economy and common Russian people than whatever we can forecast or expect at the moment.
What’s going on with the ruble?
There’s definitely been movement on the ruble. Markets closed last week, and there have also been changes this week. The rate hike had an effect — the central bank more than doubled interest rates from 9.5 to 20 percent, and capital controls should also help.
Here, it is critical to see what individual and corporate depositors will do, whether they will accelerate dollarization of deposits, meaning they generate a big demand for dollars. If you have a 10 percentage point increase in the dollarization of domestic deposits — and we have seen that in the past, in the 2008 crisis — then you have pressure to have $100 billion on reserve, and they do not have that. In the extreme, if these rate hikes do not work, capital controls do not work, you could see the risk of foreign exchange deposits being frozen [by the Russian government].
For basic domestic Russian economic participants, what they’re trying to do is to prevent them from converting their rubles into dollars and to stop them from withdrawing cash from the banking system. For non-residents, they have effectively put up the Iron Curtain, you’re no longer able to pay as a resident in foreign currencies to a non-resident.
What does it mean for the people on the ground in Russia?
This is the worst economic crisis that many of them have seen. Those who remember the early ’90s, this is comparable to that.
It’s complete devastation for regular people in Russia because they’ve had years of austerity. The government has been trying to protect themselves with the Fortress Russia strategy [to bulk up its economy to protect itself from sanctions]. That requires not spending on infrastructure, social spending, and education, but instead accumulating all of its coffers to try to protect itself against sanctions. The person on the street has already been suffering and doesn’t have much in savings, if anything. But at the moment, they risk not even receiving their pension payments.
We’re not talking about the crisis in 2014 or 2008 or 1998, it’s closer to the early ’90s in the economy — losing savings, having capital controls, not being able to transact in foreign currencies, potential double-digit contraction in the economy, the inability, potentially, to get transfers for your salaries and pensions. Could we get to barter trading? That is also what happened in the ’90s. It was devastating for the Russian people.
Impact on Global Economy
Sanctions will likely have knock-on effects via financial channels, trade channels, and pure contagion.
In trade, we are likely to see an effect on commodity prices, and we are already seeing that. Russia is an important exporter of oil and gas, various metals and mining commodities, and agricultural products. Ukraine is also a very important exporter of some metals and agricultural products. We’ll see the effects there, we’ll see the effects on global inflation, and then the question is how global central banks will react in each individual country’s conditions.
In the financial channel, Russia is not as significant as some other emerging markets in terms of foreign investor participation in the local market. So, I think it might not have massive direct effects. But Russian financial institutions, its central bank, they are important players in certain global markets. They have $640 billion in foreign exchange reserves, so they have positions still, or were hedging via financial instruments. So that’s something to watch for as the situation develops.
And then there’s pure contagion if there is a risk of high inflation and tightening of global financial conditions. There is definitely a high risk posed for global repercussions from this war.