Russia Facing Recession as Sanctions Likely to Intensify

Sanctions imposed by the U.S. and the European Union are pushing Russia toward a recession as the intensity of their economic penalties increases after the annexation of Crimea earlier this month.

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, said Mircea Geoana, Romania’s government representative for diplomacy and economic projects.

“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.”

Stocks, Ruble

Russia’s Micex stock index has plunged 13.7 percent this year compared with a 5 percent decline for the MSCI Emerging Markets Index. It was down 0.7 percent at 6:50 p.m. in Moscow.

The ruble is the second-worst performer against the dollar behind Argentina among 24 developing-market currencies tracked by Bloomberg, weakening 9 percent. It rose 0.4 percent today.

Investors pulled out $5.5 billion from Russian equities and bonds this year through March 20, already approaching the total outflow of $6.1 billion for the whole 2013, according to data compiled by EPFR Global, a Cambridge, Massachusetts-based firm tracking fund flows.

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.

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.

Crisis Signs

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.

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.

‘Mosquito Bite’

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.

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.

No Retreat

“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.”

Russia imposed retaliatory sanctions on 13 Canadians today, banning them from entering the country. In a possible escalation, U.S. President Barack Obama has authorized potential future penalties on Russian industries, including financial services, energy, metals and mining, defense and engineering.

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.

Threat Effect

The declines in Russian stocks, weakness in the ruble and the risk of downgrades to the country’s credit rating show threats of future sanctions can erode business confidence and hurt the economy, according to Fredrik Erixon, director of the European Centre for International Political Economy.

“Investors and ratings agencies are basing their views not on what’s happened with sanctions so far but on what may happen,” he said March 21 by phone from Brussels.

The benchmark Micex stock index has lost 13 percent and the ruble is down 8.4 percent against the dollar since Nov. 21, the start of protests that ousted Kremlin-backed former President Viktor Yanukovych and triggered the crisis.

Capital outflows from Russia may reach $70 billion in the first quarter, more than the $63 billion recorded in the whole of 2013, London-based Capital Economics Ltd. said last week in a report.

Outflows of $100 billion this year would risk zero growth, Herman Gref, chief executive officer of Russia’s biggest lender, OAO Sberbank, said today.

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