For Putin, Oil and Sanctions Don't Mix

Decisions, decisions ...

Photographer: Sasha Mordovets/Getty Images

Cheap oil and economic sanctions are doing to Russia's economy what sanctions alone couldn’t. As the ruble collapses, President Vladimir Putin faces a stark choice: further isolation or tentative engagement.

Financial War

Putin has said he will not impose capital controls, limiting trade in the ruble and imposing moratoriums on the payment of foreign debts. But he will be sorely tempted to do so. Far better for him to view this currency crisis as an opportunity to agree to a settlement in eastern Ukraine and ease the sanctions that are helping to cripple the Russian economy.

Some countries, it is true, have had success with capital controls. And by using them, Putin would be able to save both face over Ukraine and his country's currency reserves. It's far from clear, however, that this particular medicine -- which Russia survived in 1998 -- would work today. Russia's economy is more centralized, making it more difficult for entrepreneurial activity to replace imports with domestic production. In addition, controls would force major Russian companies to renege on their external debts and undermine Russia's remaining credibility in credit markets.

So why not cut a deal on Ukraine? The sanctions that the U.S. and European Union imposed earlier this year to dissuade Putin from further aggression made it hard for Russian companies to borrow on international capital markets; triggered large-scale capital flight (an estimated $130 billion this year); and shriveled inflows of foreign investment. Since then, they have acted as a multiplier on falling oil prices. The mere promise of lifting sanctions would begin to change sentiment in the currency markets.

Once that happens, Russia's central bank would be in a better position to intervene by buying up rubles -- going with the tide instead of against it. Putin would, without question, come under attack from nationalists for betraying the rebel cause in Ukraine. Yet the authorities in Kiev are under even more economic duress. The U.S. and EU should use their leverage to get Ukraine to a deal that secures the country's independence while meeting some of Russia's demands.

The obstacles are mainly Putin's to remove. Blaming Russia's woes on the outside world has worked well for him politically, and so far he has repeatedly chosen to raise the stakes on Ukraine. The sanctions have hurt the EU's enfeebled economy, too. Many of the bloc's members -- including Germany, by far Russia's biggest foreign investor -- were reluctant to impose them in the first place and would be only too willing to lift them, under the right circumstances.

Any Ukraine settlement would have to be permanent, in part by including an international force to seal the border against future Russian incursions. There may already be signs of change. Only a month ago, Russia was sending new convoys of tanks and artillery into Ukraine as pro-Russia rebels promised a major new offensive. That assault never materialized, and today Russia has persuaded the rebels to abide by a temporary cease-fire.

If Putin is willing to take a step to end the conflict, he would surely find willing partners to end the sanctions. The alternative is the economic collapse and paranoid isolation of a major military power. And that's in nobody's interests -- not even Putin's.

To contact the senior editor responsible for Bloomberg View’s editorials: David Shipley at davidshipley@bloomberg.net.