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Sanctions and the War in Ukraine are Crippling Russia's Economy

Western sanctions and the deepening flight of foreign capital are hitting Russia’s currency hard — and leaving the country’s citizens high and dry.
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As the conflict in eastern Ukraine drags on, Western sanctions and the deepening flight of foreign capital are hitting Russia's currency hard — and leaving the country's citizens high and dry.

Since January, the ruble has fallen about 20 percent against the dollar — and 14 percent in the last three months alone. This week, in an attempt to buoy the currency, the Russian Central Bank purchased an estimated $1.75 billion worth of rubles, only to see the currency further depreciate. The ruble is hovering at its lowest point since Russia defaulted on roughly $40 billion worth of debt in 1998. Only the Argentine peso and the Ukrainian hryvnia have seen more drastic swings this year.


On Tuesday, the IMF downgraded their forecast for GDP growth in Russia from 3 percent to near zero in 2014.

After Russia invaded and annexed Crimea in March, the US, along with many European countries, levied sanctions on Russian individuals and companies — and ratcheted them up as the fighting in eastern Ukraine showed few signs of abating.

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"In a matter of months, unless the sanctions are removed or eased, they will really start biting Russian consumers," Padma Desai, a professor of comparative economic systems at Columbia University and expert on Russia, told VICE News.

Russian inflation stands at 8 percent — well higher than the 4-5 percent the Kremlin aims for — meaning goods are increasingly expensive for the average consumer. Since last September, food prices have risen 11.4 percent across the board. The price of meat and produce climbed the most — more than 16 percent during the same period. A Russian ban on many agricultural and meat imports from the West has meant pricey foodstuffs are even more limited.

The ruble's descent has left foreign manufacturers, particularly car companies, struggling to turn a profit. Assuming the price in rubles stays the same, firms based abroad but who manufacture and sell vehicles in Russia are seeing 20 percent fewer dollars for cars sold domestically. Because new cars are one of the first things consumers shy away from in an economic downturn, Russia's automotive industry faces the double threat of falling demand and lack of production capacity.


However, a weaker currency should theoretically allow domestically owned firms to produce cheaper items for sale abroad than foreign competitors. A sizeable depreciation of the yen over the past two years has seen profit margins increase among Japanese exporters like Toyota. But domestic companies can only ramp up production with sufficient investment. In Russia, capital flight is expected to total at least $100 billion in 2014.

With fewer investors buying rubles to maintain plants or purchase local stocks, the price the currency fetches falls.

"It's simple, the demand for the ruble only comes if foreigners want to invest in Russia, or if foreigners want to buy Russian goods," Desai said. "But the prospects for the Russian economy have dimmed so much due to the sanctions that foreign investment has practically come to a standstill."

'The prospects for the Russian economy have dimmed so much due to the sanctions that foreign investment has practically come to a standstill.'

Some of those outflows reflect wealthy individuals attempting to convert their money into dollar or euro denominated assets such as real estate and investments abroad. But much of the shift results from domestic companies losing access to credit.

In the past, firms were able to roll over bonds — a continuation of credit that companies around the world rely on — but many foreign lenders that provided a significant share of debt in Russia have simply pulled their money out of the country. Russian banks and private firms face $54.7 billion in debt repayments before the end of 2014 — all due in foreign currency.


To that end, US sanctions against Russia's financial sector have been particularly damaging.

"International institutions understood that they must not provide any money for Russia,'" Anders Aslund, senior fellow at the Peterson Institute and former economic advisor to Russia, told VICE News. "Russia is now starved for financing on all fronts — not even the Chinese are giving the Russians loans."

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Russia is highly exposed, said Aslund, due to its reliance on foreign investors to finance its economy.

The more a company diverts to paying debt, the less it has to invest in its operations and the economy as a whole. The cycle can worsen a nascent downturn. "They are going to enter a recession," Aslund predicts.

At the start of October, Russian foreign currency reserves were already down nearly 15 percent from the same time last year — also the result of attempts to prop up the ruble in the aftermath of the annexation of Crimea.

Compounding matters, the price of oil has also fallen by 20 percent this year, leaving Russia with less foreign currency income. The Kremlin has already predicted 2016 revenues from energy giants Gazprom and Rosneftegaz will likely fall short by $18 billion.

Though state-owned companies (and some members of President Vladimir Putin's inner circle) can rely on the government to fill financing gaps, the same isn't true of small businesses that rely on traditional credit lines, Desai said.


The Russian central bank has maintained it will continue to allow the ruble to "float" on the market. Officials have gone out of their way to promise that despite rumors, there will be no limits on capital outflows. Such fears are believed to have contributed to some of pullout in recent weeks.

However, the bank is expected to further raise interest rates from their current peg of 8 percent. Increasing the country's key lending rate would ensure deposits earn more than what is lost to inflation, and to re-attract foreign capital.

With over $400 billion remaining its foreign reserves, Russia can afford to continue its gambit in eastern Ukraine, and support the ruble for longer — but not indefinitely.

"Putin's goal is to keep Ukraine in a sort of more or less turmoil," Desai said. "I think the Russian public is still in favor of his geopolitical battles."

Follow Samuel Oakford on Twitter: @samueloakford

Photo via Flickr