FLOOD OF SANCTIONS

A new package of sanctions against Russia amid the confrontation with Ukraine is dubbed ‘the toughest in history'. Although a number of experts refused to call the situation unprecedented, showing North Korea and partly China and Russia as examples, the comparison is indeed inappropriate. Perhaps it will be difficult to avoid the collapse of the Russian economy, which may have an incomparably greater impact on economies of all the countries connected with Russia. In fact, it is not about nullification of the economy so often mentioned by the fans of conspiracy theories, but about its complete reset, revision of economic relations, agreements and systems. The world of economy will definitely not be the same as before.   

Market reaction

The list and coverage of sanctions are so extensive that they would hardly fit into one article. Russian web-portal РБК grouped them as follows: government debt and investment, exports and imports, air travel, banks, disruption of business relations, sanctions against individuals, media and internet, visas and diplomatic relations, cancellation and postponement of sports events.

Thus, the US banned its financial institutions from any transactions in primary and secondary markets with Russian rouble-denominated federal loan bonds (OFZs) or sovereign Eurobonds issued after 1 March 2022 in foreign currency.

The EU also introduced restrictions on deposits in European banks (more than €100k in one bank) for rich Russian individuals and Russian companies, as well as a ban on sales and purchases for Russian clients (both individuals and legal entities) of financial instruments in Euro. At the same time European depositories are now prohibited to provide any services to Russian individuals and organisations for sale of securities to be issued after April 12, 2022. The UK has also banned Russians from holding deposits of more than £50,000 in British banks.

There has been a series of targeted sanctions against major Russian businessmen and state officials in Russia and directly against President Putin. Sanctions also affected major Russian companies, including Rosneft, Gazprom Neft, Transneft, Novatek, Rostech, Alrosa after the US vetoed any funding of these companies, for 14 days for now.

Russia was more or less ready for trade sanctions, although the US declared the sanctions as the largest ever and intended to decrease more than two-fold Russian imports of high-tech products, from electronics and computers to avionics and components for the aerospace industry. The UK has also announced the withdrawal of export licences for high-tech goods to Russia.

Closed skies

Perhaps the largest negative effect of sanctions, with little predictability, was the complete closure of European airspace to Russian aircraft and a series of stringent aviation requirements.

Firstly, Russian aircraft will have to urgently look for alternative flight routes to countries that are still open, which means additional fuel and maintenance costs. Europe can only be reached by transit through third countries. Now imagine how expensive flights will be...

Incidentally, Russian aviation officials indicate Azerbaijan and Turkey as transit countries, which means the loading of international airports in these countries will increase significantly during the sanctions.

It's also important to note that the Russian media outlets claim that soon the country might feel a real deficit of aircraft. Because the EU, following a meeting with the Irish Prime Minister Micheál Martin, decided to completely ban deliveries and leasing of aircraft, helicopters and other aircraft to the Russian Federation, as well as ensuring their insurance and maintenance. Note that the majority of European aircraft are registered in the jurisdiction of Ireland with major international lessors. In total, the ban applies both to new and old contracts (with a transition period until 28 March), which means, inter alia, that all Airbus aircraft will have to leave Russia or may not be fully operated.

In general, sanctions can decrease the fleet of Russian airlines more than twice in a single month. More than half (55%) of the entire Russian fleet is leased to international companies, according to the latest report by Cirium. Almost 80% or 90% of aircraft operated by Russian airlines are made abroad.

“We expect that the repair and maintenance of aircraft outside the EU will also become more difficult or impossible for Russian carriers,” indicates the document regulating the sanctions.

Thus, the sanctions threaten not only a particular sector of the Russian economy, but also the air transportation within the country, let alone external flights. Given the area of the Russian Federation, this will not only lead to a collapse of the aviation industry, but will also disrupt deliveries between businesses, cargo deliveries, etc.

So far experts believe the question ‘how can Russia get out of this situation?' sounds rhetorical...

Disconnecting from SWIFT

The biggest and toughest package of sanctions hit the financial sector. This led to what had been talked about since 2014, but did not look real until the last minute—large Russian banks were disconnected from SWIFT. Several European countries were against the decision due to risks to their own economies (sanctions will affect payments for Russian oil and gas). However, on February 27, the US and the EU announced that the decision would apply to financial institutions already hit by sanctions, but did not specify which ones (there are different types of sanctions). “This will ensure that these banks are disconnected from the international financial system and damage their ability to operate globally,” says a joint statement issued by EC, France, Germany, Italy, Britain, Canada and the
US. “If necessary, this will also affect other Russian banks,” President of European Commission, Ursula von der Leyen, said.

SWIFT is a private institution operating since 1973, a system that allows for uninterrupted transfer of money from one part of the world to another. It is a kind of global interbank association for financial telecommunication. The system is an umbrella for more than 11,000 participants from 200 countries and territories, meaning all the major banks in the world. Roughly speaking, without this system, you cannot transfer money from one country to another at the push of a button. More than 40 million messages are sent through the system every day to ensure the transfer of trillions of dollars between companies or governments.

So far, Iran has been the only state disconnected from SWIFT in the world. It faced restrictions in 2012, re-connected to the system in 2016 after the Iranian nuclear deal, and disconnected again in 2018.

How will this eventually affect the Russian economy? As explained by a deputy of the Milli Majlis of Azerbaijan, economist Vugar Bayramov, disconnection from SWIFT will seriously affect the international payments of Russian companies, as they will face serious difficulties with non-cash payments. This will create difficulties for Russia mainly during the export of strategic goods, that is—this will increase the cost of and slow down financial flows (from a week to more), which, in the era of globalisation and existing trade chains will cause a protracted recession in Russian business. “By comparison, Iran's disconnection from SWIFT in 2012 made our southern neighbour lose a third of its trade turnover with us. THerefore, disconnection from SWIFT will decrease Russia's foreign trade turnover, which in turn will lead to a decline in company shares,” Bayramov said.

According to the World Trade Organisation (WTO), Russia's total exports and imports in 2020 and 2019 were $332.2bn and $240.4bn, and $426.7bn and $247.1bn, respectively. Russia's main trading partners are China, the Netherlands, Germany, Belarus and Turkey. China, Germany, the US and Italy are the main import partners of Russia.

Analysts at Fitch and Moody’s set the risk of Russia’s disconnection from SWIFT to the US sanctions against major Russian banks. Such measures “are likely to have a significant impact on the economy and the financial system,” Moody's warned, noting that the sanctions would make it extremely difficult for Russian banks to participate in international operations, including export support.

Loss of confidence in banks

Another huge negative effect on the Russian economy could be the freezing of the assets of the Bank of Russia. Central Bank of Russia has $640bn in foreign exchange reserves, most of which are held in Western central banks (New York, London and Frankfurt etc.). The Bank’s lack of access to foreign exchange reserves makes it impossible to support other banks as well as to intervene in the market and regulate the exchange rate of the Russian national currency, rouble.

Measures against the central bank could lead to financial chaos in Russia provoking massive withdrawals from banks, collapse of rouble and panic among Russian entrepreneurs.

The process has already started. According to the Russian media, there are long queues at almost all Russian banks, with customers trying to withdraw their money from the banks. This can have serious negative consequences for Russia's banking sector. “After new Western sanctions, the Russian banking system will enter a free fall,” a White House spokesman told during a press briefing.

On February 24, the US imposed restrictions on a number of large Russian banks. VTB, FC Otkritie, Sovcombank, Promsvyazbank and Novikombank were included on the blocking sanctions list (SDN), which provides for maximum possible restrictions and complete freezing of their assets.

What does this mean for the customers of these banks? They will not be able to pay with Visa and Mastercard cards abroad, it will not be possible to use the cards of these banks in Apple Pay, Samsung Pay and Google Pay, and it will also be impossible to pay with the cards of sanctioned banks for purchases on foreign websites.

Meanwhile, a dramatic fall in confidence in the banking sector is quite natural. And it is possible that the outcome of this move feels not only in the post-Soviet countries, but all over the world. In fact, all arrangements and systems that for years have served the normal operation of global financial institutions are being destroyed. Central banks in other countries may wonder about the sustainability of the system in the future. Eventually, one will question the relevance of diversifying financial resources and the ways of exchanging them. That will mean reformatting the entire global system of financial and economic relations in general.

Kristalina Georgieva, Managing Director of International Monetary Fund (IMF), said bluntly: “Situation in Ukraine threatens to cancel out the economic progress reached after the pandemic and, as it continues, to cause serious consequences for economies around the world.”

Collapse of rouble and commodity markets

The extent of chaos on the financial markets in the coming days will depend on the scale of massive selling of shares and withdrawals of deposits from bank accounts, especially foreign currency deposits, as well as the amount of resources at the Central Bank.

As of writing this article, the Russian currency has lost more than 30% of its value against the US dollar and Euro, and the process continues. On February 28, the Central Bank of Azerbaijan (CBA) set the exchange rate of the Russian rouble against manat at ₼0.0157, which is 21.5% lower than the previous rate effective on February 25. Rouble lost 28.3% of its value compared to the exchange rate at the end of last month and 31.45% at the end of last year.

According to Russian experts, the Moscow Stock Exchange has experienced its biggest fall since its inception. Stock indices fell by about 35% - during the 1997 financial crisis, when Russia announced default, stock indices were slightly higher.

Board of Directors of the Bank of Russia decided to raise its annual rate to 20% starting from February 28, 2022, the regulator said in a statement. The previous rate was 9.5%.

The worst thing that can happen in this case is the rise in food prices both in Russia and in the importing countries. Dmitry Vostrikov, CEO of Rusprodsoyuz Association, said that all the technological chains of food production in Russia depend on foreign currency. Russia is Azerbaijan's largest non-oil import partner. By the end of 2021 (1H 2021-2022 harvest season), Azerbaijan has been among the top five buyers of Russian grain, the fourth largest buyer of Russian wheat...

Meanwhile, prices of various commodities have risen as Western sanctions against Russia increase the likelihood of supply disruptions, Bloomberg reported. Wheat price has risen to almost its highest level in more than 13 years, while the price of aluminium has reached a record high. Gold, which acts as a secure commodity during any international tension, is also rising in price.

Russia and Ukraine together account for a quarter of global wheat exports and a fifth of corn sales. The Russian Federation is a major supplier of raw materials such as aluminium, nickel, palladium, oil and gas.

Even without considering fluctuations in oil and gas prices, expected disruption in fuel supplies, etc., the state of the global economy resembles a shot from a disaster movie. It is still very difficult to grasp and analyse the scale of the ongoing situation, but no country, no matter how far it is located from the epicentre of events, will be able to avoid its effects.