Crimea Situation: Potential Damage to Russian Economy

by MXT Global

In response to the recent Russian invasion of Crimea, President Obama extended sanctions against Russia. The initial sanctions include blacklisting several wealthy businessmen who are close to President Putin and one of the country’s major banks. President Obama’s plan is to place economic pressure on the invading country. The targeted sanctions are unprecedented as this type of action wasn’t even done during the cold war. The following is a run down of the major factors and their repercussions.

The United States has placed sanctions against President Putin’s chief of staff, Sergei B. Ivanov, and billionaire investor Gennady N. Timchenko because he is linked to Russia’s president. In addition, America has sanctions against Yuri V. Kovalchuk who is a personal banker for several of Russia’s leaders. The European Union, or EU, has also imposed limited sanctions against Russia.

President Obama has cleared the way to enact tougher measures against the most successful sections of Russia’s economy, which include its oil and natural gas exports. President Obama did confirm that the sanctions could upset the world economy, but the action may be necessary to dissuade Russia from continuing its occupation of Ukraine.

Italy, Spain and France have warned the United States about enacting strict sanctions against Russia because of the potential impact to the global economy. However, Germany’s Chancellor reported that her country would manage without the energy sources that Russia provides to support the sanctions.

Russia’s invasion into Ukraine has caused officials like the European Union foreign policy leader, Catherine Ashton, to express concern regarding the precarious position of Ukraine’s economy. Currently, Ukraine’s government officials are reporting that the country is in desperate need of funds to cover gas imports and avoid a debt default. The United States is considering a $1 billion loan to Ukraine while the EU has agreed to loan the country $15 billion to assist its economy.

If the United States and the EU decide to enact stricter sanctions, then the action could force Russia into a major economic recession. The reason that the restrictions could affect the economy so severely is because the country relies heavily on credit.

Business confidence in Russia and throughout Europe is already starting to decline from the Ukraine crisis. In addition, foreign financiers and banks are re-evaluating the risk of working with Russian investors. If confidence continues to plummet or if more sanctions are implemented, then Russian investors could lose an estimated $50 billion in capital.

Since Russia is entirely integrated into the world’s economy, a number of economic markets could be affected. However, the energy sector is especially vulnerable from the financial restrictions as Russia is currently the largest oil producer in the world. The country exports an estimated $160 billion in natural gas and oil. Furthermore, Russia supplies the EU with much needed energy sources. Just last year, the EU, Switzerland, Turkey, Norway and the Balkan countries acquired 30 percent of their natural gas from Russia.

The Moscow Interbank Currency Exchange, or Micex, recently dropped by 1 percent to close at 1,307.34, which is equal to the NASDAQ losing 500 points in one day. In particular, Russia’s blue chip stocks saw major declines. Visa and MasterCard reported that they have stopped servicing Bank Rossiya and SMP Bank due to the restrictions enacted by the U.S. and the EU. With the two major credit agencies in the mix, several of Russia’s other banks are facing credit card processing disruption. The credit situation will likely exacerbate Russia’s economic problems.

Standard & Poor’s and Fitch Ratings decreased the country’s credit rating to a negative standing while the Russian ruble is down 10 percent to the U.S. dollar. President Putin vowed to open an account with Bank Rossiya to have his presidential salary sent to the bank to support his country.

The EU kept its sanctions a secret to prevent those affected from making plans to move their funds. In addition, several EU countries intend to wean themselves from Russia’s energy sources and are planning a new energy strategy.

The Crimea occupation may affect Americans who have Russian interests. For instance, Boeing Inc. obtains a large amount of the titanium that it uses to construct its planes from Russia. The company also has contracts with Russian airlines for about 100 planes. General Electric Company does business in Russia as it sells medical equipment and leases airplanes. However, it remains unclear whether Ukraine’s situation will have an impact on the USD.

Russia’s power in the energy market gives the country a commanding negotiating tool, but if the country ceases its trade agreements with Europe, then it will lose a considerable amount of goods and services. Therefore, extended sanctions will likely cause significant harm to Russia’s economy.