June 2014 Issue
One of the overarching stories of 2014 has been the developing crisis in Ukraine, which, along with historical and geopolitical issues, has resulted from economic concerns. It was Ukraine’s worsening debt crisis that pushed the country’s now deposed President Viktor Yanukovych to foster closer ties with Russia and turn away from the assistance being offered by the European Union. That decision ultimately brought about the mass protest that presaged his removal from office and the unfolding crisis.
However, Ukrainian financial ruin and sovereignty notwithstanding, the Russian economy may prove to be one of the biggest casualties of the Ukrainian crisis. With the country facing political isolation, it is looking increasingly likely that Russia will descend into an economic crisis of its own. Indeed, the events in Ukraine and amplified tensions between the West and Russia have already begun to heavily impact the Russian economy.
In April, the Russian central bank noted that around $64bn in assets held by Russians exited the country in the first three months of 2014 – roughly on par with the total amount of capital flight for the whole of 2013. This estimate amounts to roughly 12 percent of the country’s GDP. A capital flight of this nature last occurred in 2008, when Russia and its former satellite Georgia engaged in a brief and bloody conflict which saw investors pull at least $290bn out of the Russian economy. Furthering the economic gloom, Russia’s economy contracted by approximately 0.5 percent in the first three months of the year, compared to the fourth quarter of 2013, according to data released by the Russian economy ministry. As a result, it is entirely possible that Russia may actually sink into a full recession in 2014.
“$64bn in assets held by Russians exited the country in the first three months of 2014.”
The World Bank sets out a dim forecast for the remainder of the year. Although the Russian government believes that capital outflow could reach around $100bn for the year in total, the World Bank warns that $150bn of capital could leave Russia in 2014. Russia’s economy could shrink by up to 1.8 percent, even without expected Western trade sanctions. The sanctions in place at the time of writing have been aimed at a handful of Russian officials, diplomats and businessmen close to President Putin. Visa and MasterCard have also stopped providing services for payment transactions for clients at Bank Rossiya, also under US sanction.
The question of whether further economic sanctions will materialise is debatable, and much depends on President Putin’s actions in Eastern Ukraine. Should Russia move to annex further eastern regions, or attempt to further destabilise Ukraine’s interim government, it is likely that Western powers will quickly enact the wider asset freezes and broader economic sanctions they have already threatened.
However, such potential sanctions are complicated by Europe’s complex relationship with Russia. Economically, there are many links between the two regions. Europe is heavily reliant on Russia for its gas supplies. Roughly 30 percent of Europe’s gas, half of which flows through Ukraine, could be shut off or restricted by Russia. The country does have a history of carrying out such restrictions, and state-controlled gas company Gazprom shut down its crucial gas supplies to Ukraine, and by extension Europe, during disputes throughout the winters of 2005-2006 and 2008-2009.
Despite the political and financial sanctions that Russia may face it remains unlikely that the country will become completely isolated. Already, some multinational companies, such as Royal Dutch Shell and Siemens, have moved to strengthen their ties with Moscow. It is likely those companies’ decisions to foster closer relationships with Russia have been predicated upon fears that US and European-led sanctions could create significant openings for rival firms. Competitors, particularly from Asia, could attempt to exploit the deteriorating relationship between the West and Russia to strengthen their own position. A newly found economic connectivity between Russia and Asian markets would no doubt be beneficial to both parties. Russian industrial giants including Gazprom, Rosneft and Sukhoi Company are all understandably keen to increase exports to key Asian markets, as those exports could help offset any potential losses which may be incurred in the West.
Russia’s economy was in a comparative state of decline before the Ukrainian crisis began. Slowing consumer spending, declining levels of investment and a weakening demand for its energy exports have all taken their toll on a once booming economy. However, despite these domestic economic struggles, it may be Mr Putin’s activities abroad which have the most damaging effect of all.
© Financier Worldwide
BY
Richard Summerfield