As the EU extends its economic prohibitions against Moscow, Washington too plans on imposing additional economic sanctions, over and above the ones that have so far been implemented by the Obama and Trump administrations. Specifically, a bill presented by US Senators with bipartisan support earlier this month proposed much more comprehensive and wide-ranging sanctions, primarily on goods, services, technologies and financing that directly and significantly contribute to Russia’s ability to develop crude oil resources.
Such sanctions can cripple the energy sector in Russia, which makes up about a third of the country’s GDP and more than half of its exports. Due to its importance to the Russian economy, any adverse impact on the energy sector could significantly hit economic growth and cause macroeconomic instability. Already, these sanctions have led to an erosion in value of the Russian ruble, through both direct effects and indirect effects (via the channel of decreasing energy exports).
Russia's largest natural gas producer finds itself deprived of important Western partners. The company now aims to develop shale oil on its own
Historically, the value of the ruble has closely followed price cycles of crude oil. When oil crashed from $106 in mid 2014 to about $30 in the start of 2016, the ruble dropped from 38 to 78 against the dollar. However, even though crude oil prices have now recovered to about $70 a barrel, the ruble has remained under significant pressure due to negative market sentiment in light of the economic sanctions against Moscow: since the start of the year, it has been trading at about 65 against the dollar. And now, amid talks of additional sanctions from the US, it has dropped to its lowest value in two years.
While a weak ruble can help Russia increase its exports, the embargoes on oil production related technologies will curtail its ability to fully utilise the drop in its currency. As a result of growing energy-related sanctions, international oil companies have already shelved their development plans, depriving key state-owned companies of Western partners. ExxonMobil has suspended participation in multiple projects envisaged in its 2011 framework agreement with Rosneft, Russia’s biggest oil producer. This means that up to $500bn in planned investment will be foregone – and, more importantly, technology and skills that only international oil companies can currently provide.
Gazprom - Russia’s largest natural gas producer – also finds itself deprived of important Western partners. The company now aims to develop shale oil on its own, but the absence of a Western partner is likely to mean a delay of at least five years according to the company’s chief economist.
Thus, while the West may not be able to completely embargo Russia’s energy exports, its plan to hinder future productive capacity of the sector might just be successful. Earlier this month, the Secretary of the Russian Security Council Nikolai Patrushev told regional heads that Western sanctions had “identified the problem of vulnerability and dependence of the domestic energy sector on foreign capital and technology”. This, he said, would create “serious problems” in the oil and gas sector.
Other than the disastrous impact on the energy sector, the sanctions have so far not done significant damage to Russia’s short-term macroeconomic stability. This is primarily due to stocking up of foreign reserves by the central bank, which currently stand strong at $458 billion. The country’s economic managers have also done well to consolidate the government’s fiscal position, which has left inflation and unemployment at safely low levels for now.
This macroeconomic stability, however, may be short-lived. It may not be long before problems in the energy sector lead to deterioration in Russia’s macroeconomic indicators. According to estimates by the IMF, western sanctions could cut the size of the economy by almost a 10th. A consistently cheap ruble could also increase inflation and consequently unemployment, leading to disastrous economic consequences. Thus, while the country may have secured short-term macroeconomic stability, it may have to compromise on long-term sustainable growth.
Considering how the US and its allies are increasingly frustrated over malign activities by the Kremlin – the war in Ukraine, brutality in Syria, and interference in US elections – these economic sanctions could possibly increase in the coming few months; and there is little doubt as to how severely the Russian economy will be hit by them. The issue, therefore, is to recalibrate whether hurting the Russian economy serves the interests of the US and its allies.
Fact of the matter is that Russia is too important to isolate: at about $4 trillion, it is the world’s sixth largest economy, the largest natural gas exporter, the second largest oil exporter and above all, a nuclear superpower. The strategy should therefore be to deepen Russia’s engagement in the global system, since a greater stake in this system would make the Kremlin more likely to cooperate.
The US should learn from President Reagan’s treatment of USSR in the 1980s, when despite the Soviet war in Afghanistan and shooting down of a Korean Airlines aircraft flying from New York to Seoul, the president did not seek to isolate the USSR. Although he did make the Soviets pay for these actions, he also proposed negotiations to slash long-range nuclear weaponry. These negotiations in turn laid the groundwork for several treaties that further reduced nuclear dangers, leading to much-needed global political (and economic) stability.
The author is an economist at an Islamabad-based think tank