The economic war against Russia could have surprising consequences3 Mar 2022 06:58
It wasn’t so long ago that a Russian debt default threatened to trigger a global financial crisis. In 1998, Long-Term Capital Management, a highly leveraged hedge fund, was forced into a fire sale of its assets after being hit by heavy losses on Russian bonds. Contagion spread across asset classes, causing a panic that was only ended when the US Federal Reserve organised a bailout. Yet today, despite the Russian economy being far larger — albeit at just 1.2 per cent a smaller share of global GDP — western policymakers appear to have few qualms about declaring an economic war on the country that may yet push it back into bankruptcy. But this time, the markets have barely blinked. Most major equity markets have risen since the invasion of Ukraine.
This bet that the economic war will prove highly asymmetric looks well founded. Western sanctions will certainly cripple the Russian economy. In particular, the decision to freeze the assets of the Central Bank of Russia has made it far harder for it to defend the rouble, which has already lost around 40 per cent of its value since the crisis began. As its currency tumbles, Russia faces an inflationary spiral, while growth will slump as businesses are shut out of world markets by banking sanctions and export restrictions. Capital controls and interest rates of 20 per cent, along with foreign currency revenues from the sale of oil and gas, may enable the CBR to keep the plates spinning for a while, but the longer the war continues, the greater the risk of a Russian economic collapse.
Yet such a collapse holds fewer terrors for the West than it did in 1998. The main potential source of risk for Europe is the banking sector. Yet direct exposure to the Russian economy and markets is low, notes Kallum Pickering at Berenberg Bank. Indirect exposures are also likely to be limited, judging by the relatively low level of cross-border business, and the number of firms facing significant losses is likely to be small. What’s more, the banking sector is far better capitalised today as a result of reforms introduced since the global financial crisis, and regulators can allow losses to be spread over several years. Indeed, policymakers have demonstrated over a series of crises that they have plenty of tools should any institution face difficulties as a result of sanctions.
For Europe, the impact of sanctions is likely to be felt most in the real economy rather than in the financial system. Though here too, the costs seem manageable. The biggest risk is high oil and gas prices, particularly if European countries try to curtail their purchases of Russian energy to avoid financing President Putin’s war machine, or indeed if Putin decides to retaliate by restricting supplies. That could force firms to cut production or, if governments have to ration energy, shutter facilities, which would lead to lower GDP growth.
https://www.thetimes.co.uk/article/the-economic-war-against-russia-could-have-surprising-consequenc
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