Sanctions against Russia look like boxing matches

First appeared at Policy Center for the New South

The economic sanctions against Russia announced last week by the United States and Europe following the military invasion of Ukraine are having a profound impact on the Russian economy while having repercussions in the country. As in a boxing match, it is expected that blows to the opponent can knock them out, despite the exposure on the side of the punches.

The United States has applied sectoral and limited economic sanctions against Russia since the annexation of Crimea in 2014 and military clashes in eastern Ukraine. Nothing comparable, however, to what was announced last week, after the entry of Russian troops into Ukraine.

Between February 22 and 27, starting with the sanctions lifted by the United States on the secondary market of Russian sovereign debt securities issued after March 1, as well as the German announcement to suspend the certification of the Nord Stream 2 gas pipeline, we have had announcements of the United States, the 27 members of the European Union and the G7 countries to freeze the assets of large Russian banks, certain Russian individuals, as well as controls on the export of technological products. Culminating with the withdrawal of some Russian banks from the QUICK system and prohibiting transactions with the Central Bank of Russia.

SWIFT is a messaging network connecting banks around the world and considered the backbone of international finance. SWIFT is a consortium managed by employees of member banks, which include the central banks of the United States, Europe, Belgium, England and Japan. Based in Belgium, it is a consortium of more than 11,000 financial institutions in more than 200 countries and territories, functioning as a link that makes international payments possible. To give you an idea, in 2021 the system recorded an average of 42 million messages per day, including payment requests and confirmations, negotiations and currency exchanges. More than 1% of these messages allegedly involved Russian payments.

Would there be alternatives for the Russians to transfer and standardize their operations outside of SWIFT? Russia has an alternative network, the Financial Message Transfer System, but it cannot be a replacement. At the end of 2020, the system had only 400 participants from 23 countries. Moreover, China’s cross-border interbank payment system might not be a perfect replacement, at least soon, as it does not integrate SWIFT members.

Last week’s sanctions are already having a significant impact on the Russian financial system and its economy. The value of the ruble collapsed. The Central Bank of Russia was led to raise interest rates to limit the transmission of currency devaluation to inflation. People-run banking started over the weekend through ATMs. Restrictive capital controls and possibly holidays are ahead.

Despite the strategy of reducing exposure since the beginning of the sanctions in 2014, via the geographical relocation of reserves and the acquisition of gold, and currency changes in commercial transactions – a kind of “de-dollarization” – Russia has not become invulnerable and the impact will be great – Figure 1. The contraction in GDP will not be mild, given the tightening financial conditions accompanying ultra-high interest rates and banks without access to foreign currency.

Figure 1

And outside of Russia? Of course, the receiving side of payments – creditors, asset investors – will also be impacted. The consequences of this will only be extended if the devaluation of the corresponding assets leads to a contagion effect – for example, the withdrawal of funds by investors in mutual funds causing their managers to liquidate other assets in their portfolios to pay the withdrawal of funds.

The sanctions were tentatively designed to minimize their effect on Russian gas imports into Europe. The sanctions announced late Saturday night were more limited in scope than the broader targeting advocated by other countries to win Germany’s support.

It is through the rise in the prices of energy raw materials – in addition to possible restrictions on the transport of Russian products – that the war in Ukraine will affect the economies on the other side of the fight. Also, because there is a statistically proven asymmetry: what happens in the energy raw materials subgroup affects the others, such as food and metals. On top of that, the global wheat supply will be negatively impacted – which is particularly impacting in certain regions, such as North Africa and the Middle East. Russia is also a big supplier of fertilizers, palladium and other products that may be affected by logistical “supply chain restrictions”.

The inflationary shock resulting from rising commodity prices and likely further restrictions on supply chains will accentuate the current dilemma facing central banks on both sides of the Atlantic, i.e. how quickly and intensively to tighten financial conditions in the face of inflation that can no longer be considered merely temporary and reversible, while seeking not to slow the pace of economic activity or trigger financial shocks. The deteriorating macroeconomic outlook has analysts predicting that the Federal Reserve will not decide on a 50 basis point hike at its March meeting, opting instead for 25 basis points.

There are fears that these economies will return to conditions similar to those of the early 1980s, when the second oil shock occurred when inflation was already high. The bet is that Jerome Powell and his colleagues are not like Paul Volcker, chairman of the Federal Reserve at the time, whose option was to lower inflation at any cost.

Back to the penalties: of course, additional rounds, extending the scope of those of last week, can still be adopted in new rounds of the boxing match. the Bruegel Institutea Brussels-based think tank, discusses scenarios of how Europe would suffer from a Russian gas flow stoppage (Figure 2). But it would be possible.

Figure 2

Sanctions against Russia look like a boxing match fig 2

The boxing match via financial and commercial sanctions has just begun. But the will to seek to eliminate Russia through sanctions seems stronger than the fear of its consequences.

Otaviano Canuto, based in Washington, DC, is a Principal Investigator at Policy Center for the New South, lecturer in international affairs at the Elliott School of International Affairs – George Washington Universitynon-resident principal investigator at Brookings Institutionprofessor affiliated with UM6P, and principal at Center for Macroeconomics and Development. He is a former vice president and former executive director of the World Bank, former executive director of the International Monetary Fund and former vice president of the Inter-American Development Bank. He is also a former Deputy Minister of International Affairs at the Brazilian Ministry of Finance and a former Professor of Economics at the University of São Paulo and the University of Campinas, Brazil.

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