Fruit glut.

Russia Sanctions Are a Race to the Bottom

Leonid Bershidsky is a Bloomberg View columnist. He was the founding editor of the Russian business daily Vedomosti and founded the opinion website Slon.ru.
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As Europe and Russia head into another round of sanctions, economic data are driving home an important point: Nobody stands to win in this tit-for-tat battle.

The International Energy Agency's September Oil Market Report offered bad news for Russian President Vladimir Putin, calling a recent slowdown in oil demand growth "nothing short of remarkable." The IEA noted that the pace of growth was at a 30-month low in the second quarter and cut its 2014 and 2015 forecasts, blaming economic weakness in Europe and deceleration in China.

This matters for Russia because hydrocarbons made up 70.6 percent of exports last year and 50 percent of budget revenues. The government starts to worry about its ability to finance its obligations when the price of Urals oil drops below $100 per barrel. It is now at $96, dangerously close to the $93-to-$95 range neededto support Russia's budget plans for 2014 to 2016.

Oil is not the only raw material whose price is declining. Goldman Sachs Group Inc. issued a report titled "The End of the Iron Age," citing a "dramatic" drop in iron ore prices -- mainly because of a decrease in Chinese demand -- and predicting that prices would be even lower through 2017 because of "structural oversupply." The price of steel has been falling, too. Metals accounted for 7.7 percent of Russia's exports last year.

Europe is also vulnerable. Declines in raw materials prices are only going to compound the deflationary effect of the Russian food embargo, introduced in response to the European Union's Ukraine-related financial sanctions. Europe faces a glut of fruit, vegetables, milk products and fish, which is weighing on prices at a time when the European Central Bank is taking extraordinary measures to boost inflation closer to its target of 2 percent.

Tomorrow, a new set of EU sanctions will take effect, cutting off European debt financing for Russia's state-owned energy and defense companies and banning European oil service companies from participating in Russian projects. In response, Russia will likely ban the import of European cars and some types of clothes, according to presidential aide Andrei Belousov. Like the food embargo, this will drive European prices down and Russian prices up.

In this race to the bottom, Russia may prove the more resilient, if only because Putin's authoritarian regime has a mandate from a majority of Russians to wage a new cold war. The food embargo and the price increases it caused in Russia did not drive down Putin's approval ratings, and Russians have stoically accepted the ruble's recent losses against the dollar. The currency depreciation can also help the government weather low raw materials prices by boosting the value of foreign-currency exports in ruble terms.

Europe, on the other hand, cannot take much more economic pain. A new slump could send some governments tumbling. In France, 62 percent of the population already wants President Francois Hollande to resign.

The world is too interconnected economically, and the European recovery too fragile, to keep using trade disruptions as weapons. Even Ukraine is taking a hit from slumping metals prices: Steel and iron ore account for about a third of its exports.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Leonid Bershidsky at lbershidsky@bloomberg.net

To contact the editor on this story:
Mark Whitehouse at mwhitehouse1@bloomberg.net