Sanctions won’t worry Vladimir Putin

“There will be significant costs and consequences” following Russia’s intervention in Crimea. So said Foreign Secretary William Hague yesterday. But what can the West actually do to challenge Vladimir Putin’s Russia? How far are we prepared to go to determine the future of a small, sun-kissed territory that juts out from Southern Ukraine?

Crimea lies at the heart of a region that is, and always has always, hugely strategic. This picturesque peninsula has seen centuries of conquest, be it at the hands of Greeks or Scythians, the Byzantians or the British. It was the importance of the Black Sea ports to the grain trade, after all, which provoked the Anglo-Russian Crimean War under Queen Victoria, with its glorious, yet ultimately doomed Charge of the Light Brigade.

Today, too, the economic and geo-political stakes in Crimea are sky-high, if not focused on agriculture (although Ukraine is once again among the world’s top grain producers). It’s the West’s fear of a resurgent Russia that now prevails, our determination to contain the old Cold War enemy. Mixed into this complex post-Soviet rivalry, as well, are nagging concerns about West European energy security and the systemic fall-out if a near-bankrupt Ukraine defaults on its sovereign debt.

The West’s response to Russia’s Crimean adventures has so far centered on rhetoric and symbolism. The likes of the US, Germany and Britain are threatening to boycott June’s G8 summit, set to be hosted in Russia. Along with Hague’s strong words, the UK has also cancelled a visit by the Earl of Wessex to Sochi, which he was due to visit next week as Patron of the British Paralympic Association.

Like Hague, US Secretary of State John Kerry has condemned Putin’s “brazen act of aggression”, warning of harsh retaliation in the form of a diplomatic and economic squeeze. While there has been no detail, such measures would presumably include visa bans, asset freezes and restrictions on Russian investment and trade with the West – actions that would no doubt provoke an instant tit-for-tat response.

Such sanctions are theoretically possible given that Russia, unlike the Soviet Union, isn’t an economic island isolated from the rest of the world. It is, in contrast, more-or-less integrated into global commerce and, from the chaos of the early 1990s, has grown into the world’s eight largest economy. On what economists called a PPP basis, in fact, adjusting currencies for purchasing power, Russia is the sixth biggest economy on earth, well ahead of the UK and France.

A few days into this crisis, economic sanctions against Russia hardly seem necessary – as the markets are doing the work of those wanting to pressurize Putin. The main Russian stock market index plunged 12pc yesterday, wiping-out $58.4bn of shareholder value, more than was spent on the Sochi Olympics. State-owned companies such as Gazprom and financial services monolith Sberbank were particularly badly hit.

The ruble has also plunged in recent days, with Russia’s Central Bank being forced to raise interest rates “temporarily” from 5.5pc to 7pc. Among currency dealers, rumours abound that Russia sold over $10bn of its dollar reserves yesterday, in a bid to prop up the ruble.

Satisfying as that may be to Western diplomats, economic sanctions will be extremely difficult to impose on Russia and are, for all their symbolism, likely to be counterproductive. For one thing, as is clear to anyone who knows Russia’s commercial landscape, many large and powerful Western companies have invested heavily in this vast, resource rich country and won’t want their interests harmed.

Contrary to the stereotypes, post-Soviet Russia has attracted huge foreign direct investment, going way beyond oil and gas. Western carmakers, retailers and household product companies have piled-in, keen to tap into Europe’s second most valuable retail market and Russia’s highly-educated and relatively cheap workforce.

The likes of VW, Ford, Renault and German engineering giant Liebherr have invested billions in Russian production facilities. Other thoroughbred Western corporates such as Pepsi, Unilever, Proctor & Gamble and Boeing are also heavily committed – all of which will seriously complicate any attempt to impose economic sanctions on Russia.

Western energy security also looms large, of course. Russia is the world’s third-largest oil producer. Any hint the flow of Russian crude might be interrupted would cause havoc on global markets. In recent days, as the sanctions rhetoric has cranked up, oil prices have spiked $2-3 per barrel. This can only harm Western crude importers such as the UK.

Disruption to natural gas could be even more troublesome, given that Russia is the world’s largest exporter, supplying over a third of Western Europe’s gas. So Moscow has its thumb on our economic throat. The situation is complicated by the fact that Ukraine hosts a network of Soviet-era pipelines that supply over half the gas Russia sends to the European Union.

Since 2006, Moscow has twice cut-off supplies to Ukraine due to payment disputes – with the knock-on effect of halting gas to Western Europe. During the most recent episode in 2009, European gas prices spiked a painful 20pc in a fortnight, causing howls of protest from Western firms and households.

Gas prices on wholesale forward markets jumped ominously yesterday, by up to 7pc – even though this year’s relatively mild winter means Europe’s gas inventories are relatively high. Western political analysts meanwhile claim that shale oil and gas in the US and central Europe mean Russia’s energy grip has been loosened. Such production methods are not only extremely expensive and controversial. The day they’ll deliver game-changing output onto global energy markets remains some way in the future.

For now, Russia still holds considerable energy leverage that it could wield in response to any economic sanctions. This reality, combined with protests from powerful Western businesses, mean our politicians will struggle to make the threat of sanctions sound credible.

Another tool in Moscow’s anti-sanction armory is its own fiscal strength. While the Russian economy has lately slowed, with growth currently bumping along at 1.5pc, it has expanded 10-fold in dollar terms since the late 1990s. This has allowed Putin to pay off almost all the countries debts – gross government liabilities are less than 10pc of GDP, by far the lowest of any major economy, and in net terms Russia is one of the world’s few sovereign creditors. In addition, Moscow has reserves totaling $450bn, the world’s fourth-largest haul.

As such, Russia holds most of the cards when it comes to rescuing Ukraine from its current budgetary predicament. Long before the Kiev protests began, the Ukrainian economy was in trouble. World prices for steel, its biggest export, had fallen by half since 2011. Successive governments, trying to placate a restive electorate, spent heavily, resulting in large budget deficits. Ukraine has been borrowing from private creditors at increasingly onerous interest rates and almost a quarter of the $40bn total must be repaid over the next 12-18 months.

Russia will be a big part of the solution to the restoration of financial stability in Kiev, in turn preventing a Ukrainian default from potentially sparking a systemic crisis which could easily impact the West. Before Christmas, Moscow agreed to earmark $15bn to buy newly-issued Ukrainian sovereign debt over the next two years, so allowing Kiev to roll over its obligations. Having bought an initial $3bn slice, the Russians have shelved successive purchases, leaving Ukraine solvency swinging, like a Sword of Damacles over global financial markets.

The EU has talked about “putting a financial package on the table”. Kerry has told the world “a big carrot” is in the works. Yet little actual Western cash has emerged. Remember, also, that this crisis has its immediate origins in the decision of former Ukraine Preisdent Viktor Yanukovich to reject a European trade deal, not least because the EU was seen as unwilling to provide financial support. Even if a catastrophe is averted in Crimea, and Russia and the West pull back from the brink, Kiev needs $15bn-$20bn to avoid financial implosion – and Russia looks like the only realistic source of such funds.

“We’re very concerned about any possibility of a further move by Russia in other parts of Ukraine,” said Hague yesterday. This is a legitimate position. The trouble is, that when it comes to statecraft and diplomacy, money talks. And, unfortunately for the West, the Russians have the cash.

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