This week, the US hopes to get the EU to agree to impose so-called tier three sanctions on Russia to punish them for their alleged role in the downing of MH17 and for supporting the rebels in Ukraine. That would include prohibiting investment in Russian equity and debt of Russian banks more than 90 days maturity by European citizens as well as barring EU banks from sourcing funding for them on a regulated market.
One of my colleagues who was in Europe the week before last thought tier three sanctions were unlikely to be implemented. But that was then. The English language press gives the impression that all systems are go, but that depiction could be a PR push to give the sense of inevitability, or it could actually be accurate. Input from readers in Europe very much appreciated.
What is striking is a spate of articles from not exactly expected sources on the potential costs to Europe of putting the screws on Russia. The Financial Times has displayed quite a lot of blood lust on the topic of Russia, so it was instructive to see Wolfgang Munchau, who is based in Germany, sound a cautionary note in one of his comments.
Munchau points out that he’s surprised by the IMF’s latest forecasts, which simultaneously show Russian GDP for 2014 1.1% lower than previously estimated as a result of the sanctions implemented so far, while increasing Germany’s by 0.2%. Munchau thinks the two in combination are not credible:
The Committee on eastern European Economic Relations, a German business lobby with political power similar to that of the National Rifle Association in the US, says existing sanctions threaten 25,000 German jobs. An estimated 350,000 German jobs directly depend on German-Russian trade; many would be at risk if sanctions were stepped up. Total German trade with Russia was close to €80bn in 2013….
In terms of how the sanctions will affect the west more broadly, Francesco Papadia, formerly at the European Central Bank, has estimated in a recent article that the impact on the EU will be about two-thirds higher than on the US. The effect on Russia is going to be much stronger, although possibly not right away. According to the Central Bank of Russia, the country’s foreign exchange reserves had a market value of $478bn at the end of June, a large but finite buffer.
Most of that is presumably held in dollars and euros – and, since they are not held in cash but in bonds or other securities, they would have to be channelled through payment systems in the US and the EU to be usable.
Depending on how the sanctions are drawn up, those reserves may prove hard to mobilise if the EU and the US were to engage in all-out financial warfare.
We are a long way away from that. But even the current list of sanctions could be macroeconomically significant in a way not captured by forecasts or sentiment surveys. My guess is that the cumulative global effect of the sanctions will be much stronger than estimated but that it might be a while before they kick in fully.
OilPrice also reminds its readers that Ukraine is likely to start syphoning off Russian gas destined for Europe. The OilPrice article basically urges Ukraine to man up and accept the harsh terms of IMF assistance, but given that the country was already high on global corruption rankings even before the crisis broke out, and an IMF loan will come with stringent terms, it’s not clear that any government that agreed to them would last very long. In other words, stealing looks like the obvious choice for Ukraine, particularly if they can claim it was really “losses” due to separatists targeting pipelines.
The issue of natural gas has divided European opinion on the civil war in Ukraine. Brussels’ plan to force EU members into “energy solidarity” with the disintegrating state of Ukraine and to use illegal reversed gas flows is losing support. “The EU has no intention of repaying Ukraine’s debts for Russian gas,” said Dominique Ristori, the director general of the European Commission’s Directorate-General for Energy, adding that all debt problems should be settled through the International Monetary Fund.
The reference to the IMF is worthy of note. According to the Fund’s official statements, it will offer assistance to Kiev only if President Petro Poroshenko’s “Drang nach Osten” in the Donbass region is successful. Therefore, the end result of the civil war may affect Ukraine’s ability and willingness to pay its debts. The IMF has also given strict guidelines for Ukraine’s international reserves and has set cash-shortage limits for debt-ridden joint-stock gas company Naftogaz Ukraine.
(The IMF demanded an increase of up to 40 percent in residential gas rates by May 2015. The rates will go up 20 percent every year until Naftogaz Ukraine’s gas debt has been paid.)
Historically, countries left on their own in talks with the IMF have often found themselves in danger of sovereign default. The IMF today is anything but a welfare institution — it does not normally assist countries engaged in war.
Ukraine’s government will have to increase domestic gas prices to reach a level on par with the IMF’s standards. This means that in 2015, the Euromaidan babushkas will receive their first 250-euro monthly gas bills. Ukraine’s energy officials often mention their ambitious plans to use fracking or reverse flows from Slovakia and Poland to make up for any gas shortfalls. In reality, the so-called “big gas reverse from Slovakia” would provide for only about 15 percent of Ukraine’s gas needs (after deducting the natural-gas consumption in the Crimea and the Donbass region). In any event, the price of this reversed gas would probably be close to the European contract price.
In regard to fracking, Ukraine’s shale projects are either half-dead or have been officially halted. The European Commission is much more skeptical about shale gas than it was two or three years ago. “Shale gas extraction will bring about no significant reduction in Europe’s dependence on gas imports,” claimed European Energy Commissioner Günther Oettinger in an interview with B.Z. am Sonntag. Oettinger said that in the long-term future, Europe will be able to cover around one-tenth of its overall need for gas by using fracking technology.
Therefore, the government in Kiev may start siphoning European gas out of Ukraine’s transportation system in order to make up for a shortage of natural gas despite all its solemn promises. The media’s fear mongering will be used to portray social unrest as a threat to national security. Meanwhile, Ukraine’s smart prime minister, Arseniy Yatsenyuk, announced his resignation in response to parliament’s failure to pass gas legislation (abandoning the sinking ship of Ukraine’s economy just in time).
Now admittedly, most analysts contend that Europe has enough gas stored to get it through the winter, and Russia will be hard hit by the financial pain of sanctions and reduced exports long before Europe suffers badly on the energy front.
But I’m not sure the financial calculations are necessarily good measures of how this plays out. Russia was used terribly by the West in the period right after the fall of the USSR. Western organizations and Harvard promoted the programs that produced a plutocratic land grab and misery for ordinary citizens. The life expectancy of adult men fell by an unheard of four year during this period. Putin’s domestic support is at record levels and the Russians have a remarkable capacity to take pain. While the conventional calculus may prove to be correct, breaking Russia (or perhaps more narrowly, getting Putin displaced so the West can declare victory and relent) is far from a safe bet.