Russia Staring at Recession on Sanctions That Could Get Tougher

Western sanctions are pushing Russia toward recession and the pain could intensify if U.S. and European leaders turn the screw over tensions in Ukraine.

Banks including state-run VTB Capital say the world’s ninth-biggest economy will shrink for at least two quarters as penalties for annexing Crimea rattle markets, curb investment and raise the cost of borrowing. Sanctions that have so far focused on individuals via visa bans and asset freezes may be expanded to target specific areas of the economy.

President Vladimir Putin sent his popularity surging to a five-year high by making Crimea a part of Russia again after 60 years and says he won’t be swayed by foreign retaliation. Even so, the costs of the decision are starting to unfold, with Russian stocks this year’s worst performers and the economy set to suffer more than the West, Mircea Geoana, Romania’s government representative for diplomacy and economic projects.

puuutin_small Russia Staring at Recession on Sanctions That Could Get Tougher

“We’re witnessing the start of a new geopolitical and economic Cold War and I think it will take at least two to three years to establish some sort of equilibrium,” he said. “The ones who’ll pay the bill for this aggression, no matter how popular and patriotic it looks, will be the Russian people because there’s a huge difference between the economic force of the EU and the U.S. and that of Russia.”

Russia’s Micex stock index has plunged 13.1 percent this year compared with a 5.8 percent decline for the MSCI Emerging Markets Index. The ruble is the second-worst performer against the dollar behind Argentina among 24 developing-market currencies tracked by Bloomberg, weakening 9.3 percent.

Billionaires Targeted

After the U.S. expanded sanctions March 20 to include businessmen linked to Putin, such as billionaires Gennady Timchenko and Arkady Rotenberg, Standard & Poor’s and Fitch Ratings cut their outlook on Russia’s credit grade to negative from stable, suggesting a downgrade is most likely next.

It’s Personal: The Individuals Targeted by U.S. Sanctions

The two companies, which said Western banks are becoming reluctant to lend to Russia, rate the world’s biggest energy exporter at BBB, the second-lowest investment grade and on par with Brazil and South Africa.

Even before the standoff with the West, the worst since the Cold War, Russia’s economy was facing the weakest growth since a 2009 recession as consumer demand failed to make up for sagging investment. The current situation in the economy “bears clear signs of a crisis,” Deputy Economy Minister Sergei Belyakov said March 17 after the first European Union and U.S. sanctions.

Russia will probably dip into a recession in the second and third quarters of this year as “domestic demand is set to halt on the uncertainty shock and tighter financial conditions,” according to Moscow-based VTB.

Borrowing Costs

Russia’s central bank unexpectedly raised its benchmark interest rate by 150 basis points after the armed takeover of Crimea triggered a rout in the ruble. Putin completed his annexation of the Black Sea peninsula March 21.

Russia may shun foreign debt markets in 2014 because of higher borrowing costs, according to Finance Minister Anton Siluanov. He expressed frustration at disruptions to MasterCard Inc. and Visa services for cards issued by banks on or linked to persons on the U.S. sanctions list.

“Some people say these sanctions won’t affect Russia’s financial system but they already are,” he said March 21.

Even so, the measures may not have much effect on the individuals targeted or on Putin’s thinking on Ukraine, whose government accuses the Russian leader of stirring up unrest elsewhere and planning an invasion of the country’s east.

‘Mosquito Bite’

The sanctions represent “a mosquito bite” because most officials on the list aren’t permitted to travel abroad privately and have most of their business in Russia, said Konstantin Kostin, a Kremlin adviser who heads the Civil Society Development Fund. Government members featured in a new EU list March 21 include Putin aides Sergei Glazyev and Vladislav Surkov.

Putin, meanwhile, would require stiffer penalties to budge, according to Ariel Cohen, senior fellow at the Republican-leaning Heritage Foundation in Washington.

“You’re dealing with an individual who won’t be easily intimidated,” he said March 21 by phone from Washington. “The West is escalating sanctions but Russia isn’t going to back off on Crimea and Ukraine that easily. It will take more than pinpointed individual sanctions to start rolling this back.”

The EU, which relies on Russia for a third of its energy imports, has struggled to find ways of punishing Putin because trade steps risk damaging Europe’s economy. Banking curbs would hurt Britain, an arms embargo would bar France from selling Mistral-class helicopter carriers to the Kremlin and cutbacks in gas purchases would harm a swathe of EU nations.

Capital Outflows

Western officials can get around this by talking up the possibility of future sanctions, which erodes business confidence and hurts Russia’s economy, Fredrik Erixon, director of the European Centre for International Political Economy, said March 21 by phone from Brussels.

Capital outflows from Russia may reach $70 billion in the first quarter and there’s “a real risk that this could push Russia into recession,” London-based Capital Economics said last week in a report. Outflows were $63 billion in 2013.

“Investors and ratings agencies are basing their views not on what’s happened with sanctions so far but on what may happen,” according to Erixon, who sees Western measures against Russia being tightened, led by the U.S. “I’m convinced sanctions will escalate and the main decision-maker will be Barack Obama. If he escalates the EU will almost have to follow.”