EU and US target Russian banks in new sanctions

By bne IntelliNews July 30, 2014

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The EU and US expanded sanctions against Russia late on July 29, hitting the country's banking, energy and defence industries. Talk of even further action threatens to weigh further on the sluggish Russian economy.

EU governments agreed to limit Russian state-owned banks' access to European capital markets, restrict the export of equipment for the oil sector and the sale of sensitive "dual-use" technologies, as well as impose an arms embargo. The list of additional designated individuals - including eight individuals and three entities - is expected to be published July 30, but reportedly includes Russia's two biggest banks, state-controlled Sberbank and VTB.

US President Barack Obama announced a similar set of sector sanctions later the same day. The US Treasury will now restrict VTB, Bank of Moscow and Russian Agricultural Bank on top of development bank VEB and Gazprombank, on which it had already acted. However, the US is apparently sparing the ultimate giant, Sberbank. 

The US president insisted in a statement that the co-ordinated actions of the US and EU will "have an even bigger bite" and make "a weak Russian economy even weaker". The European Commission warned in a statement that "destabilizing Ukraine, or any other Eastern European neighbouring State, will bring heavy costs to [Russia's] economy.

The added sanctions see the West moving further towards "phase three" measures targeting whole sectors of the Russian economy, as both Washington and Brussels had suggested they would. The action comes as the pair looks to raise pressure on Moscow to halt what they say is increased support to the separatists in eastern Ukraine, and to ensure access to the crash site of Malaysian Airlines MH17.

The EU signalled on July 28 that it had secured preliminary agreement on new measures, despite continued discrepancy between the 28 members. Many states - particularly those in Central and Eastern Europe (CEE) with high dependency on Russian gas and trade - are reported to have sought to block sanctions over recent weeks.

Headed south

Meanwhile, the West's efforts to pressure Moscow have clearly been widening. An arbitration court in The Hague ruled on July 28 that Moscow must pay $50bn in damages to former shareholders of defunct oil firm Yukos. The same day, Washington claimed Russia had violated a key arms control treaty by testing a nuclear cruise missile.

All of which had investors on tenterhooks through July 29. The expectations of sanctions put pressure on the ruble and saw Russian equities fall. The announcements "soured sentiment towards Russian stocks in after-hours trading," note analysts at Uralsib, forecasting a sharp drop for Russian stocks on July 30.

That's little surprise given funding is a particular weakness of the Russian economy. The country's shallow capital markets leave Russian banks hugely dependent on western loans. While the flush Central Bank of Russia is likely to step in, Uralsib worries "this type of funding can be expensive for both banks."

"The risks to the already unexciting domestic economic growth outlook for 2H14-2015 are becoming more pronounced," say analysts at VTB Capital. "The downward pressure on [the ruble] is set to continue."

"Investors are likely to push the Russian markets further south today," Uralsib says. "The key thing to consider with the new sanctions is what kind of macroeconomic effect they will have. Clearly, the cost of capital and risk premiums will rise for Russian businesses in general, not only those that were sanctioned."

On top of that, the accelerated action from the West casts a further and huge dose of uncertainty over the Russian markets. "Casting a broader net just two weeks after the pervious sanctions action is surprising, and shows that it would be imprudent to call an end to the current cycle of sanctions escalation," writes VTB Capital. Both Obama and EU leaders suggested just ahead of the announcements on July 29 that further action is likely.

Although they're on the frontline in terms of potential blowback, CEE economies are unlikely to suffer from the upgraded sanctions, note analysts at KBC. "We believe that the new sanctions may worsen sentiment on global markets and consequently weigh on the CEE currencies but all in all they should not pose a serious threat for the Central European economies," they write. 

"The most important trading partners for the CEE, Germany in the first place, lie in the EU. Exports to Russia make up only 3-4 % of total exports of the Czech Republic, Poland or Hungary and Russia ranks on place 14 to 20 among their major foreign outlets," KBC says. 

While Hungary has some exposure to the Russian banking market (through OTP) it's not large enough to create a crisis. "[A]s long as gas and oil supply are not abruptly interrupted, economic sanctions against Russia should not seriously threat CEE economies," KBC sums up.

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