Great Graphic: More Sanctions on Russia

This Great Graphic from the Bank for International Settlements was tweeted Charlie Robertson.  It shows the offshore borrowing by different sectors of the Russia economy.  He links Russia's subdued Eurobond issuance to the completion of the Rosneft TNK/BP purchases.

However, as the charts shows, the quarterly offshore borrowing still held up better than the long term average until Q1 of this year.   This could be the impact of the conflict with Ukraine, the resulting less favorable market conditions and the beginning of sanctions. 

The latest US sanctions do not prevent US companies from doing business with some of Russia's largest companies, but it blocks those Russian companies issuing new equity or initiate new borrowings for more than 90 days.  The sanctions were shaped to minimize the impact on US businesses while raising the cost of doing business for these companies.

Europe's sanctions were aimed at curtailing new investment in Russia by the European Investment Bank and the European Bank of Reconstruction and Development.    The US apparently is pressing Europe to isolate Russia by barring it from taping European capital markets.  Europe is not prepared for such sanctions yet, but given Putin's posture and the limited policy options, more sanctions will likely be forthcoming, perhaps as soon as next month.   

European leadership is in the middle of a transition.  While Juncker has been named as the President of the EC,  members failed yesterday to appoint a new foreign affairs commissioner.  Italy's candidate was rejected for being too soft on Russia, while the Polish contender was rejected by other countries for being too confrontational. 

The US sanctions target two major Russian energy firms, Novatek and Rosneft, and a pair of leading Russian financial institutions, Gazprombank and VEB.   While the sanctions may be an inconvenience for the energy companies, the financial institutions may feel the effects stronger.  Reports suggest that both Gazprombank and VEB rely on wholesale markets (including US money markets) for funding.  Eight Russian arms firms responsible for the production of small arms, mortar shells and tanks were also hit with sanctions.

Some US observers, like Ian Bremmer, the head of the Eurasia Group, are critical of what they perceive to be the ineffectiveness of the sanction regime, but at the same time, complain of the lack more participation by Europe.  Many of those critical of the sanction regime have largely failed to propose an alternative.  To the extent that alternatives are proposed, they largely amount to arming the Ukrainians in some fashion.  Russia's response seems similarly conflicted.  Putin dismisses the sanction as primitive and counter-productive  and at the same time threatens unspecified sanctions.   

Meanwhile, the measures announced represent a modest but clear escalation of the sanction regime.  Up until now, the US and EU actions have been largely limited to travel ban and asset freezes, which  are part of the stage 2 sanctions.  Stage 3 sanctions allow for measures against whole sectors of the Russian economy.    

In reading others' analysis, we think two errors are common.  The first is to think that the sanction will get Russia to return Crimea to Ukraine or to get it to cease and desist its disruptive operation in east Ukraine.  The second misconception is that the sanctions will produce immediate results.  

Yet this does not appear to be the thinking of US (and European officials).  There is not the political will to attempt to dislodge Russia using military means.  This is not new.  The Soviet Union invaded Hungary, Czechoslovakia in the 1950s and 1960s.  It fought with Georgia in 2008 and still occupies parts.  In none of these cases did the US or Europe respond by confronting Russia militarily.  The goal of the sanctions is to raise the cost to Russia for its behavior.   The virtue of the sanction regime, as we have seen, is that it is scalable and targeted.   

The sanction regime works over the medium and longer time frames.  The cost is not felt in a day or a week or a month.  There are ways to mitigate the impact.  For example, some Russian energy companies have already signal their interest in taping the Dim Sum market.    Russian banks and businesses may come to rely more on Chinese banks.  

The latest TIC data showed Russia reduced its Treasury holdings $5 bln in May to $111.4 bln.  Russia Treasury holdings stood at $143.4 bln in May 2013.  In contrast, China's holdings of Treasuries rose $7.7 bln to $1.271 trillion.  This is relatively flat since the end of last year, despite a nearly $170 bln increase in reserves in the first six months of the year.  However, it conceals a shift in duration.  Excluding bills, (which may have matured rather than have been sold), China held $1.263 trillion in notes and bonds in May compared with $1.156 trillion at the end of 2013. The $107 bln increase in US notes and bonds compares with a $71 bln increase in the same year ago period. 

Reports suggest that during the heart of the Great Financial Crisis, Putin tried in vain to convince China to dump its Treasuries in order to do maximum damage.  China refused.   China has a greater stake in global economy than Russia.  It plays a longer game.