The Direct and Downstream Impact of the Latest Sanctions on Russia

In the aftermath of Russian “President” Vladimir Putin’s full-scale invasion of Ukraine, the free world’s leaders announced fresh—and much tougher—sanctions Thursday. What have the US and its allies announced thus far, which institutions are most exposed, and is there much risk of a downstream impact for the US and Europe? Read on for the details.

Now, to be clear, this article is a discussion of the intended effects of Western sanctions based on trade statistics and the announcements to date. However, sanctions’ real impact rarely matches the intent. Even rogues like Vladimir Putin will find some third-party nation willing to trade with them, avoiding the sanctions for a small fee. Hence, sanctions’ likely economic impact—on Russia and the world—is smaller than the estimates that follow.

Until Thursday, the Western powers and their allies had refrained from some of the toughest measures in their arsenal, including banning Russia from the Society for Worldwide Interbank Financial Telecommunication (SWIFT) network, which facilitates international financial transactions, and cutting off semiconductor shipments. Instead, they opted for a gradual initial approach, promising to ratchet the punishment up if Putin didn’t back down. He didn’t, and now global leaders are starting to follow through on their earlier warnings.

UK Prime Minister Boris Johnson was first to announce a tougher response, including banning Russian companies from UK capital markets and widening asset freezes and sanctions against banks, businesses and individuals. The US, EU, Japan, Australia, Canada and New Zealand soon followed, as part of a coordinated effort hammered out at emergency G7 and EU summits. The S&P 500, meanwhile, rallied late in the day, flipping a steep morning decline to a 1.5% rise.^[i] We don’t love reading into short-term gyrations, but it is noteworthy that stocks turned up as the world got clarity on the Western response. As expected, Western leaders employed sanctions and stressed they would beef up defenses in NATO nations, an effort to deter violence spilling beyond Ukraine. As we wrote earlier this week, uncertainty is the primary stock market negative where geopolitical conflict is concerned. That uncertainty has fallen substantially over the past 24 hours, even if the human toll has worsened significantly.

Obviously, this situation is evolving quickly and there is a lot to track. To help, we made an omnibus table of everything announced thus far, keeping in mind that the EU has only issued a broad outline of its latest measures, with details to be ironed out Friday.

Exhibit 1: Sanctions Announced Through Thursday

Source: The Wall Street Journal, Bloomberg, The Telegraph, The Yomiuri Shimbun, Reuters, UK Government, European Council and US Commerce Department, as of 2/24/2022.

More sanctions could come, as could a Russian response. Some speculate Russia could retaliate by barring Western exports of key metals, gases and fertilizers, which could hamper production of catalytic converters (palladium), fighter jets (titanium) and semiconductors (neon).

One other notable omission is expulsion from SWIFT. In his speech to Parliament, Johnson noted that this remains on the table, but that “for all these measures to be successful, it is vital that we have the unity of our partners and the unity of the G7.” Biden’s statement later echoed this, implying some EU nations weren’t on board, perhaps tied to Germany’s and other EU nations’ reliance on Russian oil and gas. Now, in the unlikely event things escalate and the West does agree to bar Russia from SWIFT, this would probably be where sanctions hit hardest, as it would interfere with Russia getting money for energy and other commodities. Yet it would be a short-term effect in all likelihood, as there are other payment mechanisms they could use—and plenty of incentives on both sides to do so.

Wednesday’s measures were pretty light, as many observers noted. Some just extended sanctions applied after Russia’s 2014 invasion of Crimea and the poisoning of several high-profile individuals, including Russian opposition leader Alexei Navalny. The restrictions on debt issuance are new, but Russia has curbed its need for Western money since 2014. The Bank of Russia beefed up its foreign reserves from $486 billion in March 2014 to $630 billion at December’s end. That arsenal helped the bank put a floor under the ruble Thursday, halting a crash as currency and Russian stock markets swiftly priced in the latest developments.

As for debt sustainability, the sanctions and currency volatility impact external debt—Russian debt issued in foreign markets and currencies—only. Total external debt is down from $729 billion at 2013’s end to $491 billion in September 2021, the latest figure available.^[ii] Of that, only about $68 billion is federal government debt, and only about $2.1 billion matures over the next year, so Russia’s near-term financing needs are small.^[iii] The near-term interest burden, which is where a plunging ruble would hurt, is also tiny. Losing access to New York, London and Frankfurt will no doubt hurt Russian companies, but markets are already pricing this in, judging from the big hit Russian stocks have taken in recent days.

Thursday’s measures, particularly the export controls, will likely have a larger impact—on Russia, not the allied exporters. The Biden administration estimates the bans will vaporize over half of Russia’s high-tech imports and cause severe headwinds for the country’s aerospace, defense and shipbuilding industries. At the same time, Russia isn’t exactly a huge global consumer of these items—consistent with its economic clout being much, much smaller than its presence on the world’s political stage. The Semiconductor Industry Association estimates Russia buys less than 0.1% of the world’s computer chips. As for the broader restrictions, Russia received just $6.4 billion of the US’s total $1.75 trillion in exports last year.^[iv] Similarly, Russia accounted for just 0.9% of UK exports and 2.9% of the eurozone’s.^[v] In other words, this might be an incremental negative for some continental European nations, but likely nowhere near enough to render a regional or global recession.

As for potential financial contagion, at present, the risk seems miniscule. Like their Russian counterparts, Western banks have reduced direct exposure to Russia since 2014, limiting sanctions’ potential impact. European banks are the most exposed, given their closer geographic links, but even there, major banks’ loans to Russia and Ukraine range from 0% to just 12% of total lending activity, and the banks on the high end aren’t enormous institutions overall.^[vi] Given Russian banks secure the vast majority of their funding domestically—part of their efforts to reduce geopolitical risk to their operations after the Crimea invasion—Western banks’ counterparty risk to any problems in Russia’s banking sector seem small. Ditto for European banks’ Russian bond exposure, which ranges from 0.37% to 0.49% of total European bank assets.^[vii]

On the bond front, overall US residents—corporations and individuals—own just $14.3 billion worth of Russian bonds.^[viii] London real estate has some obvious exposure, given how many Russian oligarchs own mansions there, but most of that is through elaborate shell companies, and the government has had difficulty tracing ownership for years. There is now legislation in the works to address this, but it seems unlikely to prompt immediate change. The likelihood of a sudden wave of forced sales dragging property values into the gutter therefore seems low.

If sanctions were to spiral into a full-blown trade war that mucked up the commodity supply chain, that could bring some pain. However, markets move on probabilities, not possibilities. Russia’s government revenue depends on the export of natural resources, and cutting off the West would be a severe hit. It would also hit Putin’s oligarch friends where it hurts most, and their personal support is critical to his maintaining power. Never underestimate incentives in the country’s mafia-like political system. Furthermore, given a bit of time, commodities are pretty fungible and Western supply chains could shift—presenting a lasting headwind to Russia’s economy.

As with the conflict at large, we will continue monitoring and sharing updated analysis and viewpoints as needed. But as it stands, sanctions thus far fall far, far short of the scale necessary to materially harm the global economy and the likelihood violence spreads beyond Ukraine looks low. A few billion here and there is a far cry from the few trillion dollars in damage it would take to cause a global recession.