Shaily Mittal, an economist at MNI Indicators, a research unit of Deutsche Boerse’s news and intelligence subsidiary MNI, talks to EmergingMarkets.me about the European Union’s latest sanctions against Russia and the latter’s retaliation.
EM.me: It appears that the European Union has gone further with its latest anti-Russian sanctions of July 29 than most people expected. How do you see their effect on the Russian economy?
SM: Markets were not expecting the EU to enact Tier 3 sectoral sanctions as they had shied away from them in the past and they will most likely prove far more detrimental for the Russian economy than previous economic sanctions. Russia is certainly wary of the impact of these sanctions, however, they are not at the point of severe pain to be able to make President Putin reconsider his current policy as ever-increasing energy prices continue to support the financial situation of Russia.
The central bank has estimated that economic growth was close to zero in Q2, citing sluggish labour productivity growth and external political uncertainty as the primary causes. It has already hiked its benchmark interest rate for the third time this year by 50 basis points to 8% in order to try to stem capital outflows and dampen rising inflation amid geopolitical tensions. Following the EU’s decision to enact Tier 3 sectoral sanctions, it is likely that Russia will experience growth close to zero in 2014 despite the Russian central bank’s pledge to support the economy. With Russian banks and private companies already suffering from capital flight, the restrictions on Western capital will squeeze them even harder. Our survey shows that while the initial impact of the sanctions seemed to hurt our panel of companies [reference to monthly surveys of business sentiment in Russia in which executives at the same group of companies are interviewed], there has been a partial rebound in confidence over the past two months, suggesting that Russian companies are more resilient than originally thought.
EM.me: How do see the potential effects of the latest EU and US sanctions on Russia’s investment banking? One Russian banker has described the sector as effectively a Sberbank/VTB duopoly. If that is true, blacklisting practically all state-controlled banks of any significance seems a really heavy blow to Russian investment banking. Is that the way you see it?
SM: Among the latest round of sanctions announced, the capital restrictions are expected to have the most damaging effect on the Russian economy. A weaker flow of credit and slower economic growth will affect the asset quality of banks operating in Russia. The political uncertainty around Russia over the past several months has meant that investment banking activity has been muted with a very limited number of international investment banking transactions. The loss of Russia as a borrower will also hurt European banks, especially those in the United Kingdom. It also raises the prospect that Moscow could retaliate by defaulting on outstanding loans. Higher interest rates hurt the economy by making borrowing more expensive and the restrictions on Western capital will pinch Russian banks and private companies even harder, after already suffering from heightened capital flight. Russia’s central bank has promised to support banks targeted by the penalties. However, the sanctions will still hurt by fostering a climate of uncertainty, something which investors strongly dislike, compelling some of them to stay away from any sanctioned companies.
EM.me: How do assess the effects of the Russian retaliatory sanctions of Aug 6 on the EU?
SM: Russia announced bans on fruit, vegetables, meat, fish, milk and dairy imports from the US, the EU, Australia, Canada and Norway in spite of being heavily dependent on imported foodstuffs. In Russia, Moscow is the single biggest buyer of EU fruit and vegetables and the second biggest importer of US poultry. This comes in addition to a Russian ban earlier this year on pork imports from the EU over concerns about swine flu, causing domestic pork prices to surge by 40% year on year in H1.
It could be argued that these sanctions by Russia are a double-edged sword. Agricultural exports comprise about 7% of total EU exports and of this, 10% goes to Russia. The Netherlands, Germany, and Poland are currently Russia’s biggest food suppliers in the EU and are expected to be the hardest hit. For some European food producers, the loss of the Russian market comes at a difficult time, amid falling prices and Europe’s anaemic economic growth. Farmers across Europe could face big losses if they aren’t able to find alternative markets for their goods, especially for perishable fruit and vegetables. There will be potential indirect effects, via sentiment and risk appetite. Clearly, tensions over Ukraine have weighed heavily on EU equity markets, with previous gains being almost wiped out over the past couple of weeks. For Russia, the likely fallout will be higher prices for consumers (driving up inflation more broadly) and reduced consumer choice. The government has already started to look to increase food imports from alternative markets such as Ecuador, Brazil, Chile and Argentina in order to minimise effect on households. However, Russia’s central bank has previously warned that such bans on imports could make it harder to control inflation, which fell to an annual 7.5% in July, and remains well above the 6.5% in 2013. Consequently, it will become an even more arduous task for Russia’s central bank to lower inflationary pressures whilst keeping capital outflows in check.
Shaily Mittal had worked at the Economist Intelligence Unit, part of the Economist group, and MarketRx consultancy before joining MNI Indicators a year ago.
Sorry, comments are closed for this post.