Sanctioned oligarchs have also been hit by earlier moves amid a wave of Western retaliation for the invasion of Crimea, Russian interference in the 2016 US election, malicious cyber activity, the attack on nerve agent against a former double agent and his daughter. in the UK and a range of other perceived transgressions.
While new Russian debt issues will be shunned by Western investors, limiting Russia’s access to new offshore borrowing and increasing its cost, so far the bans do not appear to affect secondary market trading.
After the Crimean sanctions, Russia reduced its dependence on foreign bond investors and built up a foreign exchange reserve of $600 billion ($830 billion). He also devised a workaround to existing sanctions on primary debt issues – his banks bought the issues and resold them in secondary markets.
While the sanctions so far are designed more to send a message than to harm the Russian economy, they are weak.
The US, EU, UK and their allies have much more firepower in their arsenals though, although there would be significant self-inflicted damage to their own economies if they were to unleash it. .
Only the United States could exclude Russia from the global financial system by militarizing its own currency. The Russian economy depends on its oil and gas sales, with almost all transactions (except some of those with China) being denominated in US dollars.
Even without excluding Russia from the SWIFT global financial messaging system that underpins global financial transfers – seen as a “nuclear” option due to the chaos it would create within the global financial system – the United States could seriously harm to energy sales from Russia.
This would have adverse consequences for the rest of the world.
Oil prices, which are already hovering around US$100 a barrel, would likely climb towards US$150. Europe, which is heavily dependent on Russian gas – Russia supplies more than 35% of European gas – would face massive price increases and probably quite severe energy shortages.
Targeting Russian oil and gas revenues, however, would be the most damaging option should Russia invade Ukraine as a whole. It would devastate its economy even if, as is likely, China tried to help it by buying more of its oil and gas.
The steps taken by the West so far are indicators of what could happen.
There is no need to remind Putin of the vulnerabilities created by Russia’s dependence on oil and gas (it has been described as a giant gas station) or how destructive it would be if Russia’s biggest banks were targeted and were to be bailed out by the Kremlin.
Given the relatively modest nature of the sanctions deployed so far, it is not surprising that financial markets, which feared worse, reflected an uneasy calm even as the situation in Ukraine grew more threatening.
Equity markets focused more on inflation and interest rates and bond markets – the havens in times of turmoil and uncertainty – were undisturbed by developments in Ukraine.
Oil prices, already high due to the lagged response of supply to the rebound in demand as economies recovered faster than expected from the worst of the pandemic, rose slightly.
Russia is one of the world’s leading aluminum producers. Aluminum prices have climbed around 10% this month to near-record highs in line with heightened tensions.
In terms of the direct impact on Russian financial markets from the Ukraine crisis, there has been heightened volatility but no sign, so far, of panic selling.
Trade in the Russian ruble has been extremely volatile – its value depreciated sharply last week – but, given that it has lost more than half of its purchasing power since the invasion of Crimea, it is unlikely to unduly disrupt the Kremlin.
Interest rates on Russian bonds, already high relative to global interest rates, rose this month. They started in February around 9.35% and were returning around 10.5% this week, but the deleveraging of Russian public finances since 2014 is limiting the effects of rising borrowing costs.
All of that would change if Russia invaded and the United States and others applied the toughest sanctions available. Russian banks and markets would be on the brink of collapse, the wealth of the oligarchs and other Russian elites (and Putin) would be decimated, and an already impoverished population would experience further hardship as their incomes and savings would be devalued against a backdrop runaway inflation.
This is the option of last resort, given the pain that the rest of the world, especially Europe, would experience if this option were exercised.
While the response to Russian aggression must remain proportionate, however, if sanctions evolve from deterrence to punishment, it is almost inevitable that it will be exercised, either in part or in full.
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