Not waving, but drowning? Russia talks tough on sanctions

The Kremlin has argued that broader Western sanctions would make Russia more self-sufficient. But economists warn that if sanctions persist, the damage could be crippling.

As the threat of intensified US-led sanctions looms over Russia, the message from pro-Kremlin politicians almost sounds like "bring it on."

If the West punishes Russia over its actions in Ukraine, these politicians say it might have the effect of boosting patriotism and persuading Russians to rally around their leaders, renounce the allure of Western consumer goods, and buy into a state-led campaign to restore economic self-reliance.

It's a seductive vision, and one that economists say may even have some merit – in the short run. But in the longer run, the worry is that Russia's already stagnating economy could be thrust into recession; the country's tenuous two-decades-old efforts to integrate with the global economy may unravel; and plans to modernize sagging infrastructure and industry will be starved of needed Western technology and expertise.

"The path Russia now chooses to follow will have huge implications down the road," says Yaroslav Lissovolik, chief economist of Deutsche Bank in Russia. "If the model of development they opt for involves greater seclusion, the [long-term] outcomes will likely be much worse for Russia."

Russian self-sufficiency?

The defiant, optimistic view was on full display in the State Duma Wednesday, when Prime Minister Dmitry Medvedev delivered his annual economic report. He insisted the Russian government is drawing up detailed plans to protect the Russian economy from the impact of "illegitimate sanctions."

"Thanks to Western sanctions, Russia has been given incentive to reduce dependence from outside and instead regional economies are being more self-sufficient," Russian media quoted Medvedev as saying. But if Russia is forced to rely on its own resources to survive, "we will win in the end," he added.

Pro-Kremlin politicians note that Russia is not a small or less-developed country like Iran, Cuba, or Myanmar: It's the core of the old Soviet Union. It possesses vast resources, has an educated population, and the remnants of a Soviet-era industrial base that once produced everything from pianos to laundry detergent to spacecraft. Most Russians alive today grew up in conditions of isolation, and nobody ever won a bet by underestimating the capacity of the Russian people to endure privation.

"No sanctions can threaten a country whose territory holds all the elements of the Periodic Table," says Valery Shnyakin, a senator who was one of the first Russian officials to be sanctioned by the Obama administration, for his outspoken support for the annexation of Crimea.

Moreover, these politicians add, this is no longer the world of 1989, when the Soviet empire cracked, leaving the US and its allies towering over the global economy and setting the rules for the rest. Today, emerging economies enjoy far greater rates of growth, and newly-formed groupings like BRICS [Brazil, Russia, India, China, South Africa] have been decidedly cool to US calls to punish Russia for its annexation of Crimea and its continuing interference in Ukraine.

Economic battlegrounds

The US has little trade with Russia, exporting just $11 billion to Russia last year, compared to about $300 billion in US exports to China and sales by US-invested companies in China. Financial relations between the two are likewise comparatively small.

Still, some sectors of the US economy could be vulnerable: Russia is a leading market for US meat and poultry products, of which it imports almost $1 billion annually. Mr. Medvedev said the government plans to invest heavily in Russian agriculture to end the country's dependence on foreign sources for nearly 40 percent of its food consumption.

Europe does far more trade with Russia, upon which it's dependent for about 30 percent of its energy supplies. Some countries, like Finland and Bulgaria, source almost all their natural gas from Russia. Any attempt to stop those imports would lead to wild price increases and severe disruptions, which may help to explain the relative caution of European leaders towards sanctions on Russia.  

But two-thirds of Russian exports, and about half of state revenue, comes from the export of energy. Russia would suffer profoundly if it lost its European market, and that could not be easily replaced by redirecting exports to China, despite talk in Moscow about a "pivot to the East," says Mikhail Krutikhin, a partner in RusEnergy, a leading Moscow energy consultancy.

"China doesn't need all the gas Russia can produce, and pipelines to deliver it don't exist yet," he says. "Basically, if it came to slashing energy supplies, the damage would be terrible, and mutual."

A very heavy price

In a Kremlin meeting Wednesday, many of Russia's leading economic officials reportedly warned Mr. Putin that financial damage could be worse if sanctions become deep and lasting.

Capital flight could double to as much as $150 billion this year, largely due to the political uncertainties caused by the international spat over Ukraine. The ruble, though recently stabilized, is nudging historic lows.The Russian Central Bank today raised the benchmark interest rate from 7 to 7.5 percent to tamp down inflation fears.

The Economics Ministry optimistically predicts about 1.1 percent growth this year – far down from the 7 percent rates seen in the past decade – and then only if the government pumps substantially more money into the economy. Russia's nearly $750 billion in foreign debt far outweighs its reserves of around half-a-trillion dollars, and many of the outstanding loans to Russian banks and corporations are earmarked for vital infrastructure and industrial modernization projects. And Standard & Poors today cut Russia's credit rating to one notch above "junk," a move that will raise borrowing costs for Russian companies who want to borrow overseas. 

"It's not a good time for Russia to be picking a fight with the West. Economists say sanctions will impact our already weakening economy very badly," says Nikolai Petrov, a professor at Moscow's Higher School of Economics.

"The signs right now are that even Putin would like to avoid this. He's been talking with his economists, and they are warning him that this simple concept that sanctions can help to drive Russian economic growth and self-reliance is not going to be an easy walk. It will come with a very heavy price."