Money Morning Article of the Week
by Michael E. Lewitt, Money Morning
Vladimir Putin had a chance to back down from his aggression in the Ukraine after Russian separatists shot down a Malaysian passenger jet.
Unfortunately, he didn't.
With no answer to the charge that the Malaysian jet would not have been shot down but for the course of events he set in motion, Mr. Putin has also shown no indication that he plans to change course.
Left with little choice, the United States and European Union imposed a new series of economic sanctions on Russia to express their disapproval. The new sanctions include restrictions on Russian state banks from financing themselves on a long-term basis in European capital markets. It also imposes an embargo on trading weapons and dual-use technology on Russian companies, and restricts exports of energy-related equipment and technology to Russia.
For the moment, the West hopes that economic weapons will create enough domestic political pressure on Mr. Putin to change his behavior. This may be an optimistic scenario.
If recent history is any indication, it will require far more severe steps to put an end to Mr. Putin's hegemonic dreams.
Mr. Putin is playing a very long game, one in which he's prepared to see the Russian economy pay a very high price. That will mean consequences for investors the world over...
Sanctions Could Damage Banking, but Russia Has Options
While the West could have done more, the new sanctions will bite. In particular, the restriction that limits Russian state banks from selling any financial instruments with a maturity of over 90 days could cause significant damage to the Russian economy. This is expected to affect about 30% of Russia's bank sector.
Last year, $10 billion, or about one-third, of the bonds issued by Russian state banks were sold in the European Union. Without access to Western lenders, Russian state banks will have to look to lenders in the Middle East and Asia to refinance this debt. They will likely be able to find lenders in these regions, however, and fall far short of imposing permanent damage on the Russian financial sector.
Over the next year, Russian banks and corporations reportedly have a combined $170 billion of debt coming due. Right now global markets are highly accommodative and likely to find a way to refinance this debt.
For example, Russian oil companies have been looking lately to China for financing. The biggest risk to Russia would be if markets were to experience some kind of dislocation - perhaps as a result of the Federal Reserve raising rates more aggressively than expected. In that scenario, the sanctions could have a more severe effect.
How Long Will Putin's Oligarchs Wait?
The sanctions could also have a serious impact if they remain in place for an extended period of time. Otherwise, however, they primarily pose an inconvenience to Russian banks and corporations and send a signal that the West is unhappy.
At this point, it remains to be seen whether these sanctions will create sufficient pressure on Mr. Putin from the oligarchs and other domestic forces to compel him to change his behavior.
The impact of sanctions could be limited for American investors but are likely to have a more significant impact on Europeans, particularly in view of the overall weakness of the European economy. Germany, for example, is already seeing its economy slow as a result of uncertainty about events in the Ukraine and the advent of sanctions.
Germany Is Prepared to Go the Distance with Sanctions
Germany's Deutsche Börse AG German Stock Index (DAX) is down over 400 points in July while its benchmark 10-year bund has seen its yield drop to a near record 1.17% primarily due to concerns about the effects on its economy of sanctions and events in Russia.
Germany, however, appears to be prepared to incur the economic pain necessary to stop Mr. Putin. After all, Germany has been willing to pay a very high price already to insure the survival of the European Union. That has been evident throughout the height and aftermath of the European financial crisis. German Chancellor Angela Merkel has made it clear that she views Mr. Putin's actions as a direct threat to the European ideal of unity without violence and is willing to have German business pay a high price to preserve that ideal. She has persuaded her allies in the United Kingdom, France, and Italy who have important commercial interests tied to Russia to go along with the most recent set of sanctions. If these sanctions do not work, Mrs. Merkel is likely to push for even stricter ones in order to protect the European Union and the purposes for which it was formed.
These Shares Have Taken the Biggest Hit
One widely traded stock that was hit hard by the sanctions news was BP Plc. (NYSE ADR: BP). While the company announced higher profits, the stock dropped by 3% after warning investors that sanctions "could adversely impact our business and strategic objectives in Russia."
BP had significantly reduced its investments in Russia last year when it sold its share in the Russia affiliate TNK-BP to Rosneft NK OAO (MCX: ROSN) for $12 billion plus Rosneft shares representing 19.8% of the company. Nearly one-third of BP's oil production - about 1 million shares a day - comes from Rosneft. BP is unlikely to fare well as long as sanctions hit the Russian energy sector.
The biggest risk facing investors from events in the Ukraine is not that sanctions will hurt the Russian economy or Russian-European trade. The biggest risk is that Mr. Putin will shrug off the sanctions and continue to intervene in Ukraine and other regions in Eastern Europe. That would require even sharper sanctions and potentially military intervention by the West.
That is a fight for which the West has shown little appetite but from which it may not be able to step away if Mr. Putin pushes matters beyond the point of no return...