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Russian economy bounces back despite sanctions

Russian economy bounces back despite sanctions article image

Russia’s growth is back in positive territory despite widespread sanctions imposed three years ago by western countries – but it may be shortlived.

GDP grew by 0.3% year on year in the last quarter of 2016 (the first expansion since Q4 2014), following a 0.4% contraction in the previous quarter.

Sanctions were initially imposed to Russia by the US, the EU and other western countries, in response to the annexion of Crimea in March 2014 and the alleged military assistance from Moscow to separatists in the Eastern provinces of Ukraine. They were enlarged and strengthened on a number of occasions, especially after the downing of Malaysia Airlines flight MH17 over Eastern Ukraine in July 2014.

Broadly, the measures ban transactions and financing for individuals and entities operating in Russia’s defence, energy and financial sectors.

However, Coface a global leader in risk management says the sanctions do not seem to be preventing the expansion of Russia’s economic activity.

However in a recent report it warns Russia’s pace of development and its longer term outlook for growth could be limited by the continuation of sanctions.

This is because there are no signs of willingness from Western countries to lift sanctions in a near future, even partially.

Conflict in Eastern Ukraine

In March 2015, the EU tied the lifting of sanctions to the implementation of the Minsk II agreement (dated Feb. 2015), designed to end the conflict in Eastern Ukraine.

The dozen conditions provided for in Minsk II are far from being reached – even the principal one of a full ceasefire being monitored by the OSCE. Although the hostilities have declined over the past two years, there has been no effective ceasefire, as fighting resurged in early 2017.

Further, other objectives (such as restoring control of the eastern border to Ukraine and constitutional reforms in Ukraine to grant some autonomy to Donetsk and Luhansk) will not be achieved in the near future. The persistent denial from Moscow that it deployed troops in the rebel areas is not easing the situation. In addition, the International Court of Justice’s decision, on April 19, to reject Kyiv’s request to order Russia to cease backing separatists, does not encourage a near term resolution of the conflict. ?

Growing tensions between the West and Russia over Syria

Although there is no direct link between Russia's actions in Ukraine and Syria, some hope did appear several months ago that Moscow’s support to the west’s fight against Islamists could pave the way for easing sanctions. However, the use of chemical weapons in Syria, in April 2017, has raised tensions again between the US and Russia.

Also, Russia is suspected of having intervened in the US elections, in favour of President Donald Trump. Any initiatives made by the US President in favour of Russian President Vladimir Putin could therefore be viewed as a sign of sympathy towards the Kremlin. ?

Even if the situation in Ukraine and relations with western countries improve before the elections, it seems doubtful that the EU and/or the USA will be willing to lift sanctions by the end of 2017, Coface notes.

Russia’s presidential elections are scheduled for March 2018 and a lift of sanctions would be regarded as a boost for President Putin.

All of these factors would indicate that EU and US sanctions are unlikely to end any time soon, says Coface. They will probably persist until at least the second half of 2018.

Economic risks

Coface says the ongoing sanctions and retaliation measures against the embargo could continue to weigh on short term growth.?

Despite the relatively positive data for Q4 2016, GDP in Russia contracted by 0.2% last year.

Net exports made the biggest positive contribution to economic activity in Q4, while household spending and investments contracted by -3.2 % and -0.3 %, respectively.

The sanctions are depriving some companies from financing, limiting business with foreign countries in some sectors and generally not supporting investment. The lack of dynamism in private consumption could also be due, in part, to poor visibility and lack of confidence in the economic outlook. Household consumption, previously the main driver of Russia’s economic growth, is faltering and could drag down the country's recovery.

Coface says investors could remain wary over the evolution of relationships with foreign countries, which would delay a rebound in investment.?

Long term economic growth constrained by sanctions

After three years, the impact of sanctions on the economy seems to be less severe. Many argue that they are no longer effective – or of use in coercing Russia into changing its behaviour, says Coface.?

It is undeniable that the slump in oil prices has had a greater impact on the contraction of GDP. Nevertheless, these effects have certainly been amplified by the lack of financing and the suspension of business projects with western companies. This is even the case in sectors not directly targeted by sanctions, due to the deterrent effect of the possible strengthening of measures.

Russian banks and companies have found some loopholes in order to obtain financing and improve their technical competences since 2014. The ban targeting Arctic offshore exploration and production has not discouraged Rosneft from drilling in the region.

Nonetheless, Russian companies are lagging behind western expertise in some sectors and the knowledge gap could take time to catch up on. Backed by financial support from the state, some sectors, such as agro-food (which was hurt by the embargo on food products imposed by Russia in response to sanctions) and chemicals have succeeded in import substitution.

The situation in other sectors is less positive (electrical, electronic and optical equipment), while poor performance in manufacturing could further constrain growth in the medium term.

Coface predicts GDP in Russia to increase by 1% this year, with a C-rated country risk assessment. 

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