The devastating long-term effects of sanctions against Russia

Close-out sale in the Finnish supermarket "Prisma" after the company decided to leave business in Russia. Photo: Alexander Chizhenok / Shutterstock

The sanctions have also targeted wealthy and powerful Russians who are accomplices to the Putin regime in order to inflict harsh personal cost for supporting the Russian aggression.

The sanctions have been enacted rapidly and in a stunning show of unity by the West, which may have come as a surprise to the Kremlin. Russia has been under sanctions for some time now, ever since its annexation of Crimea and the start of the conflict in Donbas in 2014. The myriad of restrictions then – the hardest being the ban on certain Russian companies from borrowing on international capital markets – has not been truly effective and may have left the Putin regime sceptical of the West’s desire and ability to act united. However, Putin has been proven wrong. The current sanctions have been well coordinated and designed to be relatively comprehensive in decoupling Russia from global flows. They will most certainly have severe, far-reaching and long-term depressing effects on the Russian economy and society.

Banking and finance sector

The most immediate and powerful sanctions have been financial. With great impact, the G7 countries have effectively frozen the assets and accounts of the Central Bank of Russia. This means that out of about 640 billion US dollars that could be used to regulate the floating value of the rouble, only about 127 billion remains free in the form of gold kept in Russia itself and 70 billion of reserves kept in Chinese renminbi. The US and the EU have also disconnected some (but not all) Russian banks from the SWIFT system, a global financial messaging service. This does not preclude the banks from making international payments but makes these longer and more expensive.

A number of Russian banks and companies have been blocked from western capital markets, while US investors have been barred from buying new Russian government bonds. The result is a substantial outflow of foreign investors from Russia, with large western fund managers already removing Russian securities from their indices and writing-down Russian exposures as losses. This ban will severely impact the ability of Russian banks and companies to repay their foreign debts. The Russian foreign debt (both sovereign and corporate) is about 30 per cent of GDP, which is a relatively low fraction when compared to industrialised western countries. However, much of it is short term and about one-quarter is due in the coming 12 months. Default seems to be looming, as Putin suggested on March 5th that creditors in “unfriendly” countries should be paid in roubles rather than the foreign currency the debt is issued in (the legal tender of repayment).

The immediate impact of the financial sanctions has seen the rouble plummet in value, which was down by 40 per cent against the dollar in the first week of the war. The country has also experienced a rapid rise in inflation (up by 20 per cent in the first two weeks of the war) and the collapse in value of Russian companies listed abroad by magnitudes greater than 95 per cent in most cases. Furthermore, the closure of the domestic stock market has made it impossible to trade securities or release cash from equity. In practical terms, this has meant large and instant losses in wealth for those invested in Russian securities (both Russian and foreign investors among them) and huge queues in front of ATMs and banks, where Russian people have tried to get hold of foreign currency and cash. Russia is also now seeing a sharp rise in prices of consumer goods.

Economic and targeted sanctions

Economic sanctions imposed by the West have restricted exports of high technology products, components and equipment to Russia. This is very significant in the long term, as Russia is a large importer of these products and its industry and military depend on such imports for final production. At the same time, global companies are withdrawing from the energy sector in Russia. BP is willing to take a very severe loss by seeking to end its 20 per cent ownership of Russian state-owned energy firm Rosneft. Out of all the large western energy companies only the French TotalEnergies is still operating in Russia at the time of writing. To add to this, almost all consumer brands – from Apple to McDonald’s – have decided to avoid reputational and political risk and are exiting the Russian domestic market. Thus, at a stroke of a pen, Russian companies have lost a very important source of financial liquidity, but also foreign expertise and technology. Russian consumers have lost access to a wide variety of goods and services.

Sanctions that are more symbolic have targeted individuals from the political and economic elite of Russia who are close to Putin (who has been sanctioned himself) and are accomplices to his regime’s criminal actions. The appropriation of estates, yachts and other assets from Russian oligarchs represents serious individual wealth loss. The widespread travel bans enacted on individuals and Russian airlines are contributing to the isolation of the formerly globetrotting and moneyed Russian elite.

To further the isolation, western-led international institutions have begun suspending Russian membership. The Bank for International Settlements suspended Russia from using its services on March 11th. On March 15th, Russia left the Council of Europe in a move to pre-empt its expulsion. The UN’s International Court of Justice has condemned the Russian invasion and made a legally-binding order for the invasion to be halted on March 16th. The certain rejection of this order will rubber-stamp the pariah status of the Putin regime in international legal terms.

The current sanctions are not unique or unprecedented in their severity. Sanctions imposed on Iraq following the occupation of Kuwait in 1990, and those on Iran in 2006 after its refusal to halt the uranium enrichment programme, were much more severe, all encompassing and immediate. However, Russia is the largest and most globally-connected economy to suffer such a sizeable mix of sanctions. The length of the current round of sanctions against Russia is hard to estimate now, with the war in Ukraine in its fourth week and the scale of violence escalating. The length of sanctions regimes in the past has varied. EU sanctions against Serbia, imposed in response to the military operation in Kosovo in 1998, ended after about 18 months. The UN ban on Iraqi export of oil in the 1990s lasted over 70 months. Barring an unexpected and unlikely regime change in Russia, the current sanctions are likely to stay for some years to come even if the military conflict stops.

Dynamic effects

One consolation for Putin is that the longer the sanctions last the more their edge will be dampened, as loopholes are created and Russia finds alternatives (domestic production focusing on import substitution and/or greater trade with China, for example). However, the economic damage to Russia will also compound with time. The financial sanctions will push inflation to great heights. It is likely that higher and more volatile prices will be a feature of the Russian economy for a long time, with the rouble effectively not convertible under sanctions. High prices will certainly lead to social unrest, even in the very oppressive Russian society.

The dynamic effects of sanctions over time, continued flight of capital away from the country and limited future profits available for reinvestment implies that there will be a long-term depression of investment across all sectors of the Russian economy. Being cut off western capital markets will be aggravated by the expected default on parts or the whole of the foreign debt. This will mean very little funding available for investment in existing or new businesses, infrastructure or research and development.

The economic sanctions are likely to completely halt domestic Russian production using technological components such as microchips, for example. Certain industries, with a leading candidate being the airline industry in Russia, will likely entirely crumble due to lack of suitable repair parts. The decoupling of the Russian economy from global supply chains will also lead to failures of service enterprises engaged in import and export, as well as financial insurance and legal services. This will lead to a very important loss of highly productive economic activity, but also of skills.

The war itself started a flow of emigrants out of Russia, the scale of which is hard to assess. The loss of productive industries (and the closure of Russian offices of the large multinationals) will further feed this exodus of talented individuals. This brain drain is likely to be one of the worst effects of the war and sanctions in the long run for Russia. The most highly educated, capable and enterprising Russians will offer their talents to employers abroad. If they stay home, they will be forced to work in lower-value added domestic sectors.

The exodus of foreign firms will also lead to long-term loss in expertise, both managerial and technological. The outflow of foreign investors is certain to lead to a severe loss of corporate governance expertise and give a big boost to the already existing state of crony capitalism in domestic industry. This second issue has been a key reason why Russian enterprises are uncompetitive in global markets and the country itself has a very limited range of exports (namely selling hydrocarbons and raw materials abroad). This is evidenced by the low score Russia has on the economic complexity index, which measures the technological advancement of a country’s basket of export goods. By this measure, Russia is ranked significantly lower than its neighbours Poland, Belarus and Ukraine.

All of these issues will lead to a sharp economic contraction that will last for some time. Medium-term GDP is already estimated to drop by seven to ten per cent, or by as much as one-third. Depending on how long the war and sanctions last, we could be discussing another lost Russian decade of utter economic destruction and shattered living standards, a mirror image of the 1990s.

Russian response

To counteract the immediate effects of the financial sanctions, the Russian government has applied some extreme measures. They have instituted capital controls and blocked transfers of foreign currency to non-residents. Exporters have been obliged to convert 80 per cent of their proceeds to the domestic market. Russia’s central bank has more than doubled interest rates and provided very large liquidity assistance in roubles to the banking sector, which in the first week of the war amounted to 3.4 per cent of GDP. Any moves to overcome the long-term effects of the sanctions are yet to be devised. The dynamic effects of a possible Russian policy response, to judge from those enacted during the COVID-19 pandemic (taking over struggling firms to try to prevent an unemployment spike), imply very negative effects on future efficiency, productivity and growth. Certainly, no import-substitution strategy and increased partnerships with Russia’s few remaining “friends”, namely China, will be able to compensate for the loss of access to western technological and productivity-enhancing acumen. To those Russians old enough to remember, it may seem that the clocks have gone back and the current extreme crisis, reminiscent of the early 1990s, may be leading to the stagnant 1980s.

The most severe impact of the sanctions, both immediate and long-term, will be felt by the people of Russia and not its corrupt warmongering elite. The budding middle class created during the years of rapid economic growth (2002-13) will wither and likely disappear. The poor will get considerably poorer. The poverty headcount in Russia (the proportion of individuals who live on income lower than a basic consumer goods basket) had fallen from 35 per cent in 2000 to around 14 per cent in 2006. It has remained stable since, but it is now likely to jump significantly. Personally, I believe that it may reach again the very high levels of the late 1990s and early 2000s.

Ultimately, Russia may become a poorer, more unstable, more unequal and possibly more confrontational society. This does not bode well for the stability of the region.

Kiril Kossev works at the directorate for financial and enterprise affairs at the Organisation for Economic Co-operation and Development (OECD). The views expressed are the author’s own and do not necessarily reflect the position of the OECD or its member states.

Russia, sanctions, War, West