Alec Luhn in Moscow
theguardian.com, Wednesday 30 July 2014 05.59 EDT
As the US and the European Union adopted tougher economic sanctions against Russia over the conflict in eastern Ukraine and downing of Malaysia Airlines flight MH17, Russian officials struck a defiant note, promising that Russia would localise production and emerge stronger than before. But analysts in sectors that could be affected by the sanctions – finance, defence and energy – predicted that they would suffer in isolation from the west.
The EU reached a deal on Tuesday evening to cut off Russian state-owned banks from European capital markets and was quickly joined by the US, which denied the state-owned banks VTB Bank OAO, Bank of Moscow and the Russian Agricultural Bank access to the US economy.
In addition, the EU banned any trade in arms or “related material” with Russia, and the US prohibited transactions with Russia’s United Shipbuilding Corp, which it classified as a defence company.
Both the EU and the US will also ban technology exports to Russia for deep-water, Arctic or shale oil drilling. The sanctions imposed by the EU, which does far more trade with Russia than the US, will be reviewed in three months.
Shares in VTB, Russia’s second-largest bank, dropped by 3% at the start of trading on Wednesday but later regained most of that. The Russian stock market on the whole grew, with the MICEX and RTS indices rising by about 2%.
The Bank of Moscow said in a statement it was focused on its domestic market, and its business “wouldn’t suffer at all from the imposed sanctions”. Russia’s central bank promised to prop up banks hit by sanctions. “If necessary, appropriate measures will be taken to support these organisations in order to protect the interests of their customers, depositors and creditors,” it said in a statement.
But the measures are likely to raise the cost of credit in Russia and likely take their toll on the economy. Andrei Klepach, the deputy chairman of the state-owned bank VEB, said on Russian television on Tuesday that sanctions could halt economic growth or even lead to a recession in the country. Previously, Russia has forecast a 1% growth in gross domestic product this year – although the IMF this month downgraded its forecast to 0.2%, citing capital flight and falling investment amid western economic pressure.
Reacting to the sanctions on Wednesday, Dmitry Rogozin, Russia’s deputy prime minister, who is in charge of Russia’s defence and space industries, wrote on Twitter: “Obama’s decision to impose sanctions against the United Shipbuilding Corporation is a clear sign that Russian military shipbuilding is becoming a problem for Russia’s enemies.” Alexei Pushkov, chairman of the parliament’s foreign affairs committee, tweeted: “Obama won’t go into history as a peacemaker – everyone has already forgotten about his Nobel peace prize – but as the US president who started a new cold war.”
Sergei Lavrov, Russia’s foreign minister, said on Monday about the expected sanctions that Russia for now would not “fall into hysterics” or take retaliatory measures. “I assure you, we will overcome any difficulties that may arise in certain areas of the economy, and maybe we will become more independent and more confident in our own strength,” Lavrov said.
But despite Lavrov’s statement, a group of ruling party lawmakers said on Tuesday they would introduce legislation to ban auditing and consulting companies from “aggressor countries”, including the big four auditing firms Deloitte, KPMG, Ernst & Young and PricewaterhouseCoopers. In addition, Russia’s consumer watchdog, which has been known to wield import bans for political purposes, placed a ban on some fruits and vegetables from EU member Poland.
Vladimir Tikhomirov, chief economist at BCS Financial Group, said that such measures against “aggressor countries” is not likely to pass because it would have little impact on western economies but would be disastrous for traded Russian companies, which are all audited by international firms. Instead, Russia could adopt asymmetric measures to ban foreign companies or cut off its export, Tikhomirov said.
In response to sanctions, Russian state-owned banks will probably try to sell more debt on the domestic and Asian markets, but will nonetheless have to increase the cost at which they lend money, Tikhomirov added.
For now, Russian banks are not taking steps to ward off the effects of sanctions, because they expect the situation to be short-lived.
“It will be a burden on Russia’s central bank and sovereign fund,” he said. “The issue for Russian banks and the market in general is not catastrophic, but macroeconomic pressure will increase, as will growth of inflation and of cost of credit.”
State-owned banks Sberbank and VTB declined to comment for this story.
In one example of the import substitution sought by the Kremlin, Russia’s president, Vladimir Putin, said at a meeting with representatives of Russia’s military-industrial complex on Monday night that the country would replace imported components for its arms production, and the impending “technological difficulties” would in the end be beneficial for the country.
“Our task is to insure ourselves against the risk of our foreign partners not fulfilling contracts, and this includes political risks,” Putin said. “We need to provide for the reliable and on-time delivery of vital parts and components and carefully keep track of their quality.”
The remarks appeared directed toward the effects of the expected western sanctions, as well as the end of cooperation with Ukraine, which has been a major manufacturing base for arms components, especially engines for aircraft and ships. In addition, Russia has a large arms trade with France, having ordered not only two Mistral warships from the country but also licensing to produce thermal imagery devices and electronics for its Su-30 fighter jet. Although the Mistral warship contract will go through, new trade in arms components with Europe will be halted. In light of sanctions Russia will likely turn towards the Asian market to supply such components, Igor Korotchenko, editor of the National Defence journal, told the newspaper Izvestia.
But independent defence analyst Pavel Felgenhauer said that despite Putin’s optimism, replacing many of the foreign-sourced components was a “sheer impossibility”. He said 90% of defence-industry electronics were produced in the west, arguing that even intercontinental ballistic missiles are not fully Russian-made.
“Self-dependence and doing everything on your own soil, that didn’t work even in medieval times, and right now practically all Russian weapons systems use foreign components or materials,” he said.
The restrictions placed by the EU on the oil industry are also likely to be painful but not crippling. BP, which owns nearly 20% of Russia’s state-owned oil major Rosneft and has been cooperating with it to explore Arctic deposits, said further sanctions “could have a material adverse impact on our relationship with and investment in Rosneft, our business and strategic objectives in Russia, and our financial position and results of operations”.
A drilling rig that ExxonMobil and Rosneft will operate as part of its exploration project in the Arctic Ocean left port in Norway two days after MH17 was downed. But further Arctic exploration projects will be put into doubt.
Ildar Davletshin, an oil analyst at Renaissance Capital, said western technologies to drill in the Arctic would not be needed until conventional reserves begin to dry up by 2020, he added.
In response to sanctions, Rosneft is will probably seek to divest from non-core assets and decrease its participation in projects in Venezuela and other countries, he said.
“It’s a very connected industry, [high-technology] components could be produced in Russia or China but it will take time to re-orient,” he said.