Briefing Influence

As EU member states announced tougher economic and financial sanctions on Russia due to its role in the Ukrainian crisis, questions about what EU countries would bear the largest burden of those sanctions became increasingly relevant. Open Europe provided a timely analysis of how the so-called ‘Stage Three’ sanctions could impact both the European and Russian economies – while also taking stock of the potential retaliatory options in the hands of Moscow.

1 August 2014

The impact of ‘Stage Three’ EU sanctions: the UK is set to bear the largest burden

The UK is set to bear most of the burden of the tougher economic and financial sanctions on Russia. Between 2004 and 2012, Russian firms raised $49 billion on the London Stock Exchange, of which $16.4 billion was raised by state-owned Russian banks (Sberbank and VTB). However, this has been dwindling in recent years. In light of the current climate, it would be unlikely for any large Russian issuance to take place in Europe – so EU sanctions are broadly just formalising this. Furthermore, the fees generated from services such as these provided to Russian firms only tend to account for a small percentage of UK’s services to foreign firms. The fees lost from sanctions on specific state-owned firms are likely to be manageable.

EU 37%
USA 28%
Switzerland 6%
Japan 3%
Canada 2%
Australia 2%
Singapore 2%
Russia 1%
Hong Kong 1%
China 1%
Other 17%

UK exports of financial services, business services and insurance (2012)

Contrary to claims that the City of London would suffer major losses in case of financial sanctions against Russia, this graph shows that only around 1% of UK exports of financial services, business services and insurance went to Russia in 2012. Source: ONS Pink Book 2013.

Direct financial impact on Russia likely to be limited, but indirect impact may be greater

The impact in Russia is limited to a few banks that are state-owned: Sberbank, VTB, Gazprombank, VEB and Rosselkhozbank. Of these, the first two will be hardest hit, since they both have listings on the London Stock Exchange. The last two are essentially entirely state-owned and funded, while Gazprombank can rely on the sizeable banking of its parent company’s income and cash buffers. VTB in particular faces a challenge rolling over its sizeable dollar-denominated debt in the coming year(s).

Most Russian banks that issue bonds internationally have already dipped their toe into other currencies and capital markets. As such, the response of countries such as China and Singapore to the sanctions will be important.

The most likely outcome of the new EU sanctions is higher funding costs for these banks and an erosion of any cash buffers – this extra cost will likely total in the tens of millions or low hundreds of millions of dollars. Ironically, EU sanctions may actually have had a larger impact if these banks were listed under the previous stage (the so-called ‘Stage Two’), where they would have faced asset freezes and travel bans, making it almost impossible for them to do any business in the EU.

Although the direct financial impact of the sanctions on Russia is likely to be fairly limited, the indirect impact may be larger. We are likely to see greater capital outflows, which have already totalled $364 billion since the financial crisis. There is also likely to be greater stock market (MICEX) and Rouble volatility, which in turn will cause more pain for the already flagging Russian economy.

More generally, we are likely to see firms and investors hesitant to do business with Russia. In particular, this could be a problem in terms of ordinary lending. Russian firms have a significant amount of external debt, mostly in the forms of loans, to roll over ($85.4 billion in the rest of 2014 alone). Russian state-owned banks also have $114 billion worth of foreign deposits. If these loans dry up and foreigners begin to withdraw deposits from the sanctioned banks, it could cause a serious lack of liquidity and capital in the Russian economy.

How might Russia react?

One of the key tools will likely be for Russia to further cut off the Ukrainian economy, by both directly reducing trade and supporting on-going fighting and instability in the country. Russia could use its position to force Kiev to seek further financial assistance from the West. This could result in further bailouts for Ukraine, possibly totalling double digit billions. Politically, further bailouts are going to be a difficult sell, not only in struggling Eurozone countries but also in emerging market IMF members, who may not support the sanctions.

Other potential retaliating options for Russia include:

  • Impose its own sanctions, particularly against assets held in Russia by large Western firms – including oil giants such as BP, Shell and Total.
  • Diversify energy partners, in particular by striking bilateral deals with China.
  • Leverage its energy power. This would be a risky approach, given that Russia remains reliant on income from energy exports. However, Russian President Vladimir Putin has shown himself willing to use this option if necessary.
  • Encourage Eastern pullback from global political institutions – a trend which has already begun with the new BRICS bank.