Russia and the EU economy

Speaking on Reuters TV earlier this week, we discussed the risks from further sanctions on Russia in the context of last Thursday’s EC proposals for targeted sanctions against Russia.
Targeted sanctions would represent a marked shift in the EU’s approach towards Russia, which until now has been perceived as tardy and ineffective but getting agreement will be tricky not least because the costs of any sanctions are not likely to be evenly spread across EU member states and all 28 EU members must agree on sanctions. Part of the problem is that with targeted sanctions, the sectors under threat are in many instances considered to be ‘strategic’ by national governments. Thus with the UK, the banks act as counterparties for roughly 28% of Russian interbank loans and deposits and there are significant fees generated from the management of Russian assets and issuance of primary securities. Similarly German industry has close links with Russia whilst Italy is involved significantly in energy. As widely reported, France has contracts to supply two helicopter carriers worth €2bn and at the company level, with Holland, for example, both Heineken and Shell have significant direct business involvement in Russia. Frank-Walter Steinmeier, Germany’s foreign minister, summed up the problem when he said that Germany was ready to push forward with harsher sanctions but “If there are negative consequences, then they must be borne across Europe as a whole.”
As an aside, history suggests that it would require a significant shock to the Russian economy to undermine domestic support for Vladimir Putin’s government and to achieve that would require such severe sanctions that they would likely impose significant costs on the EU’s own economy and this at a time when the Europen economy is already weak. Thus Gaddy & Ickes of the Brookings Institute suggest that sanctioning the energy sector would have the greatest impact on Russia but access to energy is Russia’s strongest power lever over Europe given that Russia has a significant share of global energy reserves – particularly natural gas and these far outweigh those in Europe. With inflexibilities in short-term gas supply, eastern European nations are particularly exposed, with some relying on Russia for the entirety of their supplies, and bilateral deals that Russia’s negotiated with EU nations have strengthened its bargaining position.
If there’s a continued lack of robust action from Europe, the US could up the ante imposing more sanctions with a sideswipe on Europe because US$’s reserve currency status could leave Russia short of trade finance – and we’ve seen the like of this before when the US fined BNP Paribas €8.9bn for circumventing Iranian financial sanctions and threatened it with a ban on dollar clearing, despite protests from the French government.
In addition if Russia’s economy weakens on the back of capital flight, exports to Russia will decline and Der Spiegel report than a third of respondents to Germany’s IFO survey expect some adverse effects, with some suggesting customers are already looking for suppliers outside Europe to avoid potential sanctions.
In chatting on air with Reuter’s legendary Axel Threlfall, we concluded that whilst co-ordinated and meaningful sanctions that could ‘move the dial’ on Russia would be tricky to get agreed within Europe, the longer the troubles persist, quite apart from the obvious humanitarian crisis for those directly involved, the greater the risks for Europe’s economy and markets.

James Bevan is chief investment officer of CCLA, specialist fund manager for charities and the public sector. CCLA launched The Public Sector Deposit Fund in 2011 to meet the needs of local authorities and other public sector organisations. You can follow James on twitter @jamesbevan_ccla