What’s the cost of US sanctions on Russia?

What’s the cost of US sanctions on Russia?
How much damage has the new US sanctions done to Russia?
By Ben Aris in Berlin April 17, 2018

How much will the new US sanctions imposed on April 6 cost Russia? There is the $16bn that the oligarchs and their companies named on the sanctions list have already lost from the fall in share prices in the first week of the new sanctions, but a bne IntelliNews back of the envelope calculation suggests the real cost to the economy is a visible $65bn, and once you start adding in the lost opportunity costs of investments that should have arrived in Russia but now won’t, that quickly rises to at least $150bn. 

But the long-term costs of the new sanctions could be much more. Economists studying the problem argue that Russia will be increasingly isolated now and the reduced access to capital means slower growth – and that is expensive.

At the same time, the random nature in which some of the business names have been added to the sanctions list means a question mark now hangs over all Russian assets – who will be next? You can’t predict it, and that will drive up the cost of capital for all Russian businesses.

And that pipeline of IPOs and SPOs that was building up from last year? That is probably reduced or empty now. Detsky Mir has already cancelled a planned SPO for this year and other companies thinking about a listing will be forced to reconsider. That is several more billion dollars of lost business for the Russian economy.

The bond market has already felt the impact of worsening relations with the west in the first quarter of this year and the current quarter can only get worse.

Tightening sanctions also saw inflows into the secondary bond market by non-residents in the first quarter drop to $800mn from $7.3bn and $1.4bn in the third and fourth quarters of last year respectively. Russian bonds were the market hit in 2017, with the share of Russian debt held by foreign investors rising to an all time high of 34% of the total outstanding debt as of the end of the year.

Russian Higher School of Economics (HSE) experts Natalia Akindinova and Nikolai Kondrashov say sanctions have increased Russia’s technological lag, and cemented low growth rates. Russia's GDP, given an average oil price of $67/barrel, is set to grow by a fairly tepid 1.7% this year, lower than a potential 1.9%, the economists say, reports Bear Market Brief.

Capital outflow is also expected to rise. Capital flight has been falling for several years, but as Russian assets are in the crosshairs again, oligarchs have been moving their money about again – both into the country and out of it. The HSE forecasts capital flight will rise to $49bn this year, significantly higher than initially expected.

And the sanctions will hit trade – not directly other than defence sector exports, but more through the difficulty of raising trade finance and the skittishness of potential partners. Exports are expected to fall by $3bn-$4bn.

And the cost of borrowing has gone up for the government too. Sergei Pukhov at HSE’s Development Center says the secondary market for Russian sovereign bonds has been hurt as foreign bond traders begin to shy away from dealing with Russian sovereign debt: in the first quarter non-resident capital inflow into Russian bonds fell to $800mn versus $1.4bn in the last quarter of last year.

Finally the biggest costs are probably the "lost opportunity" cost — the investment that didn't come because of the sanctions fracas. It is impossible to put a number on this, but in the first quarter the inflow of foreign direct investment (FDI) to the country was $4.3bn. According to Development Center estimates, almost all this volume is reinvested earnings and no new investment came at all.

In the FDI peak year of 2008, Russia took in $74.8bn of FDI. Most of this was invested into retail and marketing, as Russia was booming and an attractive destination for consumer good producers. Even in the following crisis years Russian retail continued to outperform and investors kept coming. The party didn't finish until 2013 when the petro-fuelled growth model was finally exhausted and both GDP and wage rises finally ground to a halt.

FDI was still running at between $35bn and $70bn for the years after the 2008 crisis until 2013, but then tanked as the “silent crisis” of 2015-2016 really started to eat into Russians’ disposable income.

Prior to the new round of US sanctions FDI was beginning to pick up again and topped circa $25bn in 2017. But following the introduction of new sanctions FDI has fallen off to nothing. Russia earns a residual $3bn-$4bn of FDI every year from foreign companies already working in the country as in the national accounts the profits these companies reinvest from their (almost entirely) domestic business counts as “foreign investment”.

Adding the FDI losses from where they would be if Russia was again booming and a la mode in the rest of the world, a rough calculation of the money the showdown with the west will cost Russia this year would be on the order of $150bn, not including the cancelled IPOs, SPOs and bond issues.