US and EU announce fresh sanctions against Russia – what does this mean for markets?

Russian President Vladimir Putin
Russian President Vladimir Putin chairs a meeting with members of the Federation Council at the Novo-Ogaryovo state residence outside Moscow, March 27, 2014. REUTERS/Alexei Nikolskyi/RIA Novosti/Kremlin

On Monday, the United States and the European Union announced additional sanctions against Russia in response to ongoing conflict over Russian action in the Crimean area of Ukraine.

The US has said it will impose sanctions against seven Russian officials, including the head of the Russian state oil company Rosneft, Igor Sechin, and other people close to Russian President Vladimir Putin. Sanctions will include travel bans that prevent the sanctioned individuals from visiting the US, and a freeze on various of their assets.

In addition to the individuals, the US named seventeen organizations that it will also impose sanctions on. These primarily construction and energy companies have had various foreign assets frozen. In addition, a number of other Russian companies will be affected by the decision to impose export restrictions on certain high-tech merchandise that could be used to improve Russia’s military.

The European Union did not provide specifics on its planned sanctions; the EU has much closer economic ties with Russia than the US does as Russia is a major supplier of oil and gas to Western Europe, and European companies have more to lose if stiff sanctions are imposed. Nevertheless, the EU will announce a list of 15 Russian individuals who will face EU sanctions on Tuesday. This will increase the number of Russians (and pro-Russian Ukrainians) that the EU has sanctioned to 28 since the start of the conflict in Ukraine.

According to Treasury Secretary Jacob J. Lew, “Today’s targeted actions, taken in close coordination with the EU, will increase the impact we have already begun to see on Russia’s own economy as a result of Russia’s actions in Ukraine and from U.S. and international sanctions.

Russian economic growth forecasts have dropped sharply, capital flight has accelerated and higher borrowing costs reflect declining confidence in the market outlook.  Our goal continues to be for Russia to deescalate the situation so that additional sanctions are not needed. However, we are resolved to continue to work with our international partners and take the steps required, including action against individuals and entities in specific sectors, if Russia continues to press forward.”

Impact

Despite these tough words, the MICEX Index, which tracks the 50 biggest and most liquid stocks on the Moscow exchange strengthened by over 1.5% on Monday as investors decided that the sanctions were less harsh than they might have been.  However, this may be a temporary bounce as the longer-term impact of the sanctions is likely to depress Russia’s economic performance over the next year.

Already, Russia has experienced a slowdown in its economic activity. As the chart below illustrates, Russia’s growth began to slow in 2012, and was just 1.3% in 2013. The IMF anticipates that the Russian economy will grow by 1.3% in 2014, a figure that has been revised down from earlier estimates as the year has progressed. The IMF recently warned that the situation in the Crimea is creating a number of downside risks to the Russian economy, including the risk of capital flight.

russia gdp growth imf

Russia has indeed seen an accelerated outflow of capital as the crisis in the Crimea has deepened. According to Goldman Sachs, the country has seen about $45-50bn flowing out this year, and that figure may grow to as much as $130bn, which is double the amount of capital that flowed out in 2013.

The outflow has resulted in a weaker rouble and rising bond yields. This mixture of bad news led ratings agency Standard & Poor’s to downgrade the country for the first time in six years, further hampering Russia’s ability to raise money and pay its debts. In response to all of this, the Russian central bank has raised interest rates three in a matter of months. On March 3 rates were raised to 7% from 5.5%, and they were again hiked on April 25 to 7.5%.

In other words, in spite of Russia’s denial that sanctions are affecting it, it does seem clear that the Russian economy is under strain. The MICEX is down 13.6% so far this year, and as economic growth slows, the currency depreciates, and interest rates rise, the outlook for the Russian economy seems muted at best.

On the positive side, some fund managers argue that the fall in Russian stock prices represents a buying opportunity. If you see value in the Russian stock market, remember that there are a number of ways for South African investors to acquire foreign equity.

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