The European Union’s economic sanctions against Russia, first imposed in July 2014 in reaction to Moscow’s incursions in Ukraine, are set to expire July 31. EU leaders will decide whether or not to extend the measures, which are reviewed every six months, at their regular summit this month.
Dun & Bradstreet’s baseline scenario is that the EU’s economic sanctions against Russia will be renewed for another six months. While internal pressure from a number of EU member states (including Italy and Hungary) to ease or lift the sanctions is intensifying, this likely will not be sufficient to bring about a change in policy — for two key reasons:
- Relations between Russia and the West have become increasingly strained in recent months, and, as such, the majority of European policy makers are likely to want to maintain a tough stance against Moscow.
- More importantly: Russia has not yet fully met any of its obligations under the Minsk Accord and shows no signs of doing so in the immediate future. The accord was signed in February 2015 to provide a framework for the resolution of the ongoing conflict between Ukrainian forces and Russian-backed separatists in eastern Ukraine.
Given our expectation that the sanctions will be extended, it is important to consider their impact on both the Russian and EU economies.
For Russia, the sanctions are generally assessed to have exacerbated the challenges (most notably the oil price slump) already facing the economy, which remains mired in recession. The Kremlin has admitted that sanctions are responsible for approximately one-third of the contraction.
The sanctions have affected the Russian economy in various ways. The main short-term impact arises from the restrictions on access to Western lending and reduced Western investment in Russia. Before the sanctions were imposed, three-quarters of foreign direct investment and a similar share of foreign loans to Russian firms and households were sourced from EU countries. However, the five largest banks in Russia, which account for almost 60% of the overall banking sector, have been shut out of Western capital markets since mid-2014.
Energy Exports to Suffer
Over the longer term, energy exports are likely to suffer, given that Russia relies on Western technology to develop new oil and gas fields. Meanwhile, although Russian countersanctions are benefiting the domestic agricultural sector, consumers face reduced choices and higher prices.
The Institute of Economic Forecasting of the Russian Academy of Sciences has estimated that the sanctions have cost Russia 8%-10% of GDP. Meanwhile, the IMF has estimated the initial impact to be around 1%-1.5% of GDP but projects that in the medium term the cumulative impact could reach 9% of GDP, owing to, among other factors, slower productivity growth.
Turning to the impact on the EU, most estimates suggest that the overall impact of the sanctions on the region’s economy has been relatively limited, although certain countries and sectors have been more affected than others. The primary transmission mechanism is via trade, i.e., by losses in export revenues via the following channels: directly by Western economic sanctions (prohibited exports of oil-producing equipment and of military and dual-use goods), directly by Russia’s food import ban, and indirectly due to the contribution of the sanctions to Russia’s recession and currency collapse, which have severely curtailed the demand for imports.
Overall, the European Commission has estimated that the mutual sanctions cost the EU economy 0.2% and 0.3% of its GDP in 2014 and 2015, respectively.
In terms of the commercial implications, Western firms operating in sectors covered by the mutual sanctions, including agriculture and energy, will continue to face lower demand for their products from Russia as long as the sanctions remain in place and should thus seek to diversify their geographical export base.
Moreover, as the indirect impacts of the sanctions on Russia’s wider economy exacerbate the economic downturn, domestic demand will continue to be muted. As such, businesses should plan for continued weak import demand in Russia over the rest of this year.
Jaspreet Sehmi is a Senior Economist in Dun & Bradstreet’s Macro Market Insight team. Based in Marlow, United Kingdom, she covers Eastern Europe and Central Asia. She has an MSc in Economics from University College London.