Russia’s efforts to reduce its reliance on the global financial system have made it better prepared to weather the sanctions that the US and Europe have warned would follow a new attack on Ukraine.
The relative success of what investors have called Moscow’s “Fortress Russia” strategy is likely to make western threats less of a deterrent, analysts say. Meanwhile, the EU has not weaned itself off Russian gas, making any restrictions on Russian energy exports potentially self-damaging — and leaving the possibility for Moscow to retaliate by limiting supplies.
The western sanctions under discussion could go far beyond those passed following Russia’s annexation of the Ukrainian peninsula of Crimea in 2014. They could ape punitive measures used against Iran and North Korea that all but cut the countries off from the global economy.
But Russia’s finance ministry, which has stress-tested worst-case scenarios for years and set up a unit working to counter possible measures from the US Treasury’s Office of Foreign Assets Control, says Russia’s economy could withstand even those types of measures.
“Obviously, it’s unpleasant, but it’s do-able. I think our financial institutions can handle it [if] these risks emerge,” finance minister Anton Siluanov said last week.
The possibility of Russian aggression against Ukraine and subsequent financial retaliation from the US and Europe has increased after talks in Geneva and Brussels to defuse tensions were deemed “unsuccessful” by the Kremlin last week.
Russian president Vladimir Putin has deployed more than 100,000 troops along the Ukrainian border and threatened military action unless the west meets a series of security demands.
“When Putin asks what do we do if we get punished with sanctions for military actions, his officials can salute and say, ‘Yes, Vladimir Vladimirovich, we know exactly what to do’. And that gives them a sense of confidence that sanctions aren’t anything to worry about,” said Alexander Gabuev, a senior fellow at the Carnegie Moscow Center.
Since 2014, Russia has ramped up its foreign currency reserves and sought to start “de-dollarising” its economy.
Central bank reserves have soared more than 70 per cent since late 2015 and now surpass $620bn. Dollar reserves made up about 16.4 per cent of total reserves last year, from 22.2 per cent in June 2020, according to data published last week. About a third of the reserves are in euros, 21.7 per cent are in gold and 13.1 per cent are in renminbi.
In 2017, Russia gave its coffers another boost by merging its reserve fund with a newly created National Wealth Fund that accumulates surplus oil and gas revenue.
Surging oil prices, which have climbed beyond Russia’s budgetary break-even price of $43 per barrel, have boosted the fund to $190bn as of the third quarter of 2021. Russia expects it to grow to $300bn by 2024. Meanwhile, government debt is equivalent to about 20 per cent of GDP and is forecast to fall to 18.5 per cent by the end of 2023, according to credit agency Fitch Ratings.
Russia has also learned to lean less on foreign investors. Foreign ownership of Russian government bonds has dropped to 20 per cent after Washington barred US investors from trading in newly issued state debt last year. The measures have reduced foreign investment but also made the country less vulnerable to future external shocks or a sudden sell-off. The finance ministry sold most subsequent issuances following the ban to state-owned banks.
Russian companies have learned the lesson of the first sanctions, when many struggled to raise funds to pay off loans from western banks: corporate loans from foreign lenders have slumped from $150bn in March 2014 to $80bn last year.
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The 2014 sanctions and those sanction-proofing efforts have had a cost: The Russian economy has grown 0.8 per cent annually on average since 2013, compared with 3 per cent for the global economy. The conservative fiscal policy has restricted social spending and infrastructure investment. Real incomes have plummeted in the same time period.
Putin declined to spend the National Wealth Fund on pandemic relief, favouring a more limited stimulus than most western countries and a faster easing of Covid-19 restrictions, which epidemiologists say contributed to one of the world’s highest death tolls per capita.
The stability of Fortress Russia “is a sort of post-Soviet style stability, where you sacrifice economic growth for the sake of stability”, said Maria Shagina, a visiting fellow at the Finnish Institute of International Affairs.
While Russia worked at reducing its dependence on foreign financing, the EU did little to reduce its reliance on Moscow’s energy exports — running the risk that sanctions could backfire.
The bloc imports more than 40 per cent of its gas and a quarter of its oil from Russia — leaving it exposed to shocks.
“The EU hasn’t learnt from its mistakes since 2014,” said Shagina. “It aimed to diversify from Russia in terms of gas, it aimed to become more resilient and more geopolitical. But we don’t see it.”
The west also relies on Russia for other important natural resources such as titanium. This could deter any sanctions against VSMPO-Avisma, the largest supplier of titanium for Boeing’s aircraft.
That interdependence may even make it more difficult for the west to pass broader sanctions against Russia’s financial sector. The US and EU are discussing a ban on transacting with major Russian state banks or cutting the country off from the SWIFT global payments system — but could only do so effectively if they stopped buying its exports, Gabuev said.
“You have to leave a channel open to pay Russia for oil and gas. [Sanctions] won’t make Putin change his mind, because any damage will be acceptable and the Kremlin thinks it has an answer,” Gabuev said.