Thoughts From Across the Atlantic

Does the West Have Economic Levers to Influence Russian Foreign Policy?

The financial markets have reacted frantically to Russia’s invasion of Crimea – the rouble has weakened despite the Central Bank of Russia intervening massively to prop it up, share prices on the Moscow stock exchange have collapsed and there are reports of significant capital flight from Russia. The West has decided on a travel ban and asset freeze for a number of individuals from Russia and is considering further economic and financial sanctions against Russia, although their exact form is not yet clear. This, along with already weak economic data from Russia recently has led some analysts to opine that deep economic trouble, if not outright economic collapse is imminent in Russia.

Economic growth in Russia has indeed slowed down considerably during previous years and its real GDP increased just by 1.3% in 2013. Its longer term economic growth prospects indeed look bleak as the oil price increase of last decade is unlikely to be repeated, the economy is at or near full capacity, demographics are negative and its business climate is weak (IMF). The Economist named Russia as one of the extreme cases of „crony capitalism”, that is inimical to growth. Russia has undoubtedly been plagued by a „resource curse” that has kept it from developing alternative engines of growth once the revenues from oil and gas start stagnating or falling.

At the same time Russia is relatively well equipped to overcome short term economic adversity. As a result of many years of current account surpluses, the Net International Investment Position of Russia is positive, i.e., its residents hold more assets abroad than they owe to foreigners in form of various liabilities. The Central Bank of Russia has accumulated reserves of almost USD 500 bn, roughly equal to about one fourth of its annual GDP (USD 2 trillion). The value of the assets held by Russia’s two sovereign wealth funds – the Reserve fund and the National Wealth Fund as at the beginning of March had reached USD 175 billion or about 8.6% of GDP. Russia’s gross government debt is at a very low level of about 14% of GDP.

In addition, depreciation of the rouble and share price collapse don’t hurt Russia as much as one might think, at least not in the short run. Foreign-currency denominated revenue related to oil exports accounts for more than a fourth of the total budget revenue while expenses are predominantly rouble-denominated. Thus, in the short run a depreciation of the rouble is likely to improve Russia’s budget situation as long as the oil price in dollars doesn’t go down more.

Foreigners hold a large part of blue-chip shares traded on the Moscow stock exchange, thus, while the statement that the market capitalization of the Russian rouble-denominated MICEX stock index fell some USD 60 billion on 3 March, which is more than USD 51 billion Russia spent on the Winter Olympics in Sochi (Reuters), is technically true, it has to be taken into account that a substantial part of this loss accrued to foreign investors. In addition, Russia does not have a culture of stock ownership like the US, thus, there is no significant wealth effect from the share price collapse that could negatively affect consumption.

There is, however, an Achiles heel in the Russian economy, and that is its heavy dependence on exports of raw materials. Oil alone accounts for more than 50% of Russia’s exports while oil, natural gas and metals together make up more than 70%. The non-oil deficit of the federal budget of Russia is in excess of 10% of GDP, even though with the oil revenues the budget is roughly in balance. Thus, a sharp downward correction in oil prices would have a significant negative effect on the financial situation of the government and the economy in general. However, even then a fall in prices would have to be protracted – like the 1980s „Oil Glut”.After reaching its peak in 1980 at USD 106 per barrel, the real price of crude oil (in 2013 dollars) experience a large and sustained drop to USD 34 per barrel in 1991. This dramatic decline in the price of Russia’s main export has been considered as a factor that contributed to the disintegration of the Soviet Union. However, since 2011, the real oil price has been consistently above USD 90 per barrel, and it has boosted Russia’s real GDP and the power of the Putin regime.

The inital reaction to Russian intervention in Crimea by the U.S. and EU has been to restrict travel and freeze assets of certain Russian and Ukrainian individuals,without restricting trade. According to extensive empirical studies (Hufbauer et al.), economic sanctions have rarely been an effective way to restrain the actions of target governments or impair their military potential, in particular, when dealing with large target countries. A key problem in such cases is that the countries imposing sanctions suffer a sizeable economic loss in addition to the loss suffered by the target country. For example, an embargo on oil exports from Russia would result in a huge increase in oil prices, at least temporarily. In addition, several EU countries are heavily dependent on Russia for natural gas. Beyond energy, German and many other European Union businesses trade extensively with Russia, and they would be harmed by sanctions. In addition to trade, there are also extensive investments between EU and Russian firms that would be adversely affected. For example, German firms have energy investments in Russia while Mikhail Fridman, a Russian billionaire, just announced the purchase of the Dea oil and gas unit from RWE, Germany’s second largest utility (Bloomberg).

In the longer term, European countries currently heavily dependent on Russian energy would benefit from further integrating their energy markets as well as being part of a more thoroughly integrated world energy market. A more integrated market would allow lower cost responses to natural disasters and political or military threats. Tighter integration would include countries such as Ukraine ending energy consumption subsidies that discourage consumers from responding to price incentives (see Dolan for a comparison of the energy efficiency of Ukraine with that of other countries). Impressive increases in production of oil and natural gas in Canada and the United States open up additional sources of exports of oil and liquified natural gas. Greater trade would require the U.S. government to remove export restrictions on oil, natural gas, and refined products that have been in place for decades. In the meantime, short of another „Oil Glut”, it is difficult to think of an economic factor that could effectively weaken Putin’s rule and his aggressive foreign policy.


Bloomberg, 2014. „Billionaire Fridman’s L1 Buys RWE Oil Unit for $7.1 Billion”, March 17

Dolan, Ed. 2014. „Ukraine’s Crisis Threatens to Drag Russia’s Economy Down, Too”, February 24

Economist. 2014. „Planet Plutocrat”, March 15.

Hufbauer, Gary Clyde, Jeffrey J. Schott, Kimberly Ann Elliott, „Economic Sanctions Reconsidered: History and Current Policy, 2nd edition”, Institute for International Economics, 1990

IMF, 2013 „Russian Federation: Staff Report for the 2013 Article IV Consultation”, October

Reuters.2014. „Russian Markets Take Fright on Putin Threat to Ukraine”, March 3.

Wall Street Journal. 2014. „German Firms Fear Fallout if Russia is Hit with Sanctions.” March 17.



12 Responses to “Does the West Have Economic Levers to Influence Russian Foreign Policy?”

ThomasGrennesMarch 19th, 2014 at 9:57 am

There are no sanctions that would impose large costs on Russia without also imposing large damage on the West. Initial sanctions by the US and EU on individuals have induced laughter in the Russian parliament. More severe sanctions on trade and investment would be more costly to Russians, but they would also be more damaging to Western nations and to the fragile world economy. The West could reduce Russian leverage by giving European customers more and better sources of oil and natural gas. Providing greater access to energy cannot be completed in days or weeks but it could begin now by eliminating all restrictions on US exports of crude oil, natural gas, and refined products.

ThomasGrennesMarch 20th, 2014 at 11:37 am

I agree with Simon Johnson and Peter Boone that there are limits to the influence the West can have on both Russia and Ukraine. The relative economic decline of Ukraine was due partly to poor economic governance even before the Yanukovych regime. Refusal by the government to end energy consumption subsidies led to the cut-off of two loans from the IMF. Credible reform must begin inside Ukraine, and the new government could take this crisis to commit to radical reform that could not have occurred in normal times. The United States could contribute to global energy reform by immediately abolishing all restrictions on energy exports.

ThomasGrennesMarch 20th, 2014 at 4:31 pm

Currently imposed weak sanctions will have no effect on Russian policy in Crimea. Stronger sanctions on trade and banking would be harmful to both the West and Russia. Also the adverse effects on EU members would be very uneven. Some countries, such as the Baltics and Poland rely heavily on Russia for energy. However, the United Kingdom is an exporter of energy, but London financial firms have many important Russian customers. Hence, it will be difficult to get agreement on strong economic sanctions. However, the U.S. could reduce the leverage of Russia in future crises by immediately abolishing export restrictions on energy. The new government of Ukraine could also make themselves less vulnerable to future crises by ending subsidies to energy use.

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