'If Russia is embroiled in a war with Ukraine, our economy will be destroyed'

What do we have for today?

It should be noted that so far we see a moderate version of the sanctions package without particularly sharp movements that can shake not only the Russian economy, but also the entire world system. In particular, the United States added VEB State Corporation, Promsvyazbank (bank for defense sector) and 42 subsidiaries of these organisations to the SDN sanctions list (blocking assets, isolation from the dollar system). For example, Eximbank of Russia, Project Finance Factory, Angstrem-T JSC (manufacturer of microchips), InfraVEB, PFC CSKA, Russian Export Centre (REC), Sibuglemet Coal Holding, EXIAR Export Insurance Agency, VEB Asia Limited, VEB-Leasing, PSB AviaLeasing, PSB Leasing (including five vessels associated with the company that will be arrested).

By introducing such a large number of subsidiaries, the United States wants to stop the practice when the parent company that was sanctioned changed the ownership structure of controlled companies, reducing participation to less than 50%. This allowed the sanctions to be lifted from the subsidiaries. Now this trick will not work out. This, of course, is a tightening of the rules.

Sanctions have also been extended against the Russian public debt (the so-called sovereign). American financial institutions are prohibited from any transactions on the primary or secondary market with Russian ruble-denominated federal loan bonds (OFZ) and with Russian currency sovereign Eurobonds (in fact, government bonds in foreign currency traded on the markets of other countries) issued after March 1, 2022.

The Russian financial services sector is included in the list of industries against whose participants blocking sanctions are possible in case of further aggravation of the situation.

Besides, personal sanctions have been imposed against the sons of three high-ranking officials who themselves hold fairly high positions.

As for sanctions from the EU, we should expect about the same set, since positions and decisions are agreed between the United States and Europe, they act as a united front.

Consequences of new sanctions

It should be noted right away that so far this is a very moderate reaction from the West, since sanctions have not been imposed in full force. The restrictions have affected the banks that do not function as classical banks in their essence. Both VEB and PSB have a narrower focus than the largest state-owned banks. VEB in recent years has changed the funding structure (from external sources to internal), reduced the external debt and ceased to be significant for the government in terms of financing costly political projects. Sanctions against VEB will not have a significant impact on the banking sector. PSB was reformatted to meet the needs of the defense sector with the clear understanding of a high risk of sanctions and was ready for further blows.

In earlier the proposals on “disconnecting Russia from the dollar”, 12 banks were named as potential targets of sanctions, including Sberbank, VTB, Gazprombank, Alfa-Bank. Perhaps, with further escalation, we will see them on the sanctions lists. It's going to be a lot of fun, in quotes. Now we are seeing the introduction of a ban on processing transactions in American banks for two banks. This is intended to damage state-owned banks, but does not affect commodity exports, since Russian companies can continue to be serviced through other banks.

The complete disconnection of the entire Russian financial system from settlements in dollars will lead to an automatic refusal to settle in other currencies and will hurt our foreign trade, we will buy and sell goods through Chinese banks, for example. But consequences of a possible further disconnection of our country from the SWIFT system will be even more catastrophic, namely:

• Impossibility to make international payments. It will be extremely difficult to do this. Our export-oriented companies immediately come to mind, it will be a shock for them. We depend on SWIFT because of the multi-billion dollar export of hydrocarbons denominated in US dollars. A disconnection will lead to a serious slowdown in international settlements, which will entail disruption of supply chains, rising import prices, and a temporary shortage of some goods. Small and medium-sized businesses will face a slowdown in payments and settlements with suppliers and buyers. Due to that all three SWIFT data centres are located outside of Russia (Netherlands, Switzerland, USA), all messages from Russian banks go to them, even if the payment is intended for another Russian bank. It is possible to replace it with a letter or fax and go to the stone age of banking. A rise in prices and a sharp slowdown in financial flows in the era of global trade and international technological and supply chains will deal a decent blow to business. For banks, a decrease in transactional activity and the need to find alternatives will lead to a drop in income and an increase in expenses.
• Reputation will suffer. We will join the ranks of the club along with Iran and North Korea. Many foreign banks and companies will refuse to work in the country automatically.
• Currency shock. Disconnection will send the ruble into a knockdown. The Central Bank will either have to raise the key rate several times, or spend foreign exchange reserves, saving the ruble. Devaluation will lead to an increase in the cost of imports and, as a result, to inflation. Here it is worth drawing a parallel with Iran, it was disconnected from SWIFT in 2012. Since then, the local currency has depreciated 3,4 times. GDP fell three times due to the loss of half of budget revenues from the export of hydrocarbons and the loss of 30% of foreign trade. If we apply this scenario to Russia, then by the end of 2023, a dollar will cost 150 rubles.
• Sale of Russian securities by investors. This will lead to a serious drawdown of the Russian stock market and to losses of banks, which are large holders of corporate and government securities, and private investors.

As for the sanctions against the Russian public debt, this will further limit the possibilities of the Ministry of Finance to place Eurobonds. If the EU joins the US sanctions against transactions on the secondary market of Russian government debt, then the sense and opportunities for issuing Eurobonds will disappear (the share of European investors in them has always been high). The last time Russia borrowed in this way was in May 2021 in euros, since it was no longer possible in dollars. Whether the EU will also prohibit its investors from participating in the ruble-denominated OFZ market remains an open question. So far, no official sanctions acts have been published.

In general, the OFZ market has been living under restrictions since 2019, when the United States banned the purchase of Russian debt issued in foreign currency during initial placements. In 2021, the sanctions also covered initial placements in rubles. As a result, we see a drop in the share of foreign investors from 34,9% in 2020 to 19% at the end of 2021. But it should be noted that in the conditions of a fiscal surplus and a large volume of reserves, these restrictions will not affect the international rating of the Russian Federation.

At the same time, tougher sanctions will affect the country's rating, which will be followed by the ratings of large banks and companies. Together with the weakening of the ruble, this will complicate the servicing of external debts. At the end of 2021, the total debt of the private sector amounted to $381 billion (approximately 27% of the country's GDP). Of these, 80 billion dollars are banks, the rest are companies. In 2022, it is necessary to repay the obligations of companies for $69 billion, banks — for $44 billion.

In conclusion, I would like to note that three sectors of the Russian economy that will be hit are clear. This is technological, defense, financial sectors. So far, we see limited sanctions in these sectors. The technology sector has not been limited in any way so far. Depending on the further development of events in Ukraine, we may see full-scale restrictions in all these sectors, disconnection from the SWIFT system, tightening of export controls against Russia with the accession of Asian partners of the United States and the EU to these measures.

If the situation freezes in the current state, then in the short term we will see a fall in the ruble, a collapse in the Russian stock markets. There won't be much damage to the economy. But if Russia is embroiled in a war with Ukraine, our economy will be destroyed. China's assistance is ephemeral in this case, it is possible only in the form of fragmentary and will not solve all problems. Whether we need the east of Ukraine at such a price is a question for all citizens of the country.