Forget Sanctions; What Could Really Hurt Putin Is Investor Backlash

Western governments may not have to make good on their threat to punish Russia for invading Crimea. Investors are doing it for them.

Moscow’s Micex stock index plunged more than 11 percent today, the first day of trading after President Vladimir Putin got parliamentary approval to send troops into Ukraine. The ruble sank to a record low against the dollar, even after Russia’s central bank unexpectedly hiked its key lending rate from 5.5 percent to 7 percent.

Russia can’t afford to let this go on. Even before the Ukraine crisis, it was hemorrhaging investment capital. Outflows totaled $17 billion in January alone, undermining efforts to jump-start an economy that grew only 1.3 percent last year. The ruble is one of the world’s worst-performing currencies. “If investors begin to boycott Russia, that would be a far more damaging sanction” than any penalties meted out by the U.S. or the European Union, says Chris Weafer of Moscow investment group Macro-Advisory. He predicts that Putin, in an effort to limit economic damage at home, won’t make a grab for other Ukrainian regions after Crimea.

Since Putin first became president in 2000, Russia has relied on cash flow from energy and mineral exports to fuel domestic spending. That model is now clearly broken. Growth has been decelerating for four years, as consumer spending fails to offset sagging investment and a decline in demand for Russian oil and gas. The bottom line: Russia needs to lure more foreign investment, not drive it away. And while Putin’s political dominance is unchallenged now, he can’t let the economy get much worse if he wants to win another term in 2018.

Even Ukraine—a puny economic and military player—could inflict pain on its neighbor if the crisis continues. Russia relies on Ukraine for such crucial imports as steel and chemicals, and Russian banks have some $30 billion in exposure to Ukraine. “Sovereign and nonbank corporate exposure pose further risks,” analyst Gillian Edgeworth of UniCredit Bank in London wrote in a note to clients.

The risk of economic sanctions by Western governments, by contrast, doesn’t look all that menacing. The EU is unlikely to crack down on trade with Russia—for one thing, Europe needs Russia’s gas, and for another, Russia is a major market for EU-based companies that supply the bulk of Russia’s imports. Russia’s trade and investment relationship with the U.S. is far smaller, although some U.S. oil companies have major investments there.

Weafer of Macro-Advisory points out that Crimea has little economic importance but is militarily significant to Russia as its chief Black Sea naval base. The Kremlin may seek to make Crimea a nominally independent state under Russian control, as it did previously in the Georgian regions of Abkhazia and South Ossetia, he says. “The [Russian] government takes the view that so long as their action in Crimea is relatively short-lived, then the damage would be relatively containable. You take the punches, you get up afterwards, and you’re OK.”

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