An Economic Sanctions Menu Targeting Russia

As Russia fosters heightened instability in the eastern portions of Ukraine [0], we should be considering what methods will impose maximum pain on Russian policymakers. Already, the Russian economy has taken a hit, even while in an already fragile state.[1] [2]

From Robert Kahn at CFR:

Direct bans on business trade and investment can meaningfully reduce Russian wealth and growth, but the most powerful effects on Russia stem from financial sanctions. In part, this reflects the inherent importance of finance for cross-border trade and investment. More specifically, the complexity of Russian entities’ financial dealings with the West creates the potential for forced, rapid deleveraging—an intense “Lehman moment” of the sort witnessed in global markets after the failure of Lehman Brothers in September 2008. Tightening of know-your-customer and anti–money laundering rules can be chilling even without a change in law, discouraging Western financial institutions from taking on Russian clients. Blocking Russian banks from accessing international payments systems will also affect investments, and can make it difficult for Russians to invest and save. (A temporary halt in payments services to Rossiya, the sanctioned Russian bank, had immediate effects on the Russian payments system and led to rushed plans by Moscow to develop an alternative payments system.) Credit limits will be reduced and projects halted. Already there is anecdotal evidence that companies doing business with Russia are becoming more cautious, waiting to see whether there will be new, harsher sanctions.

For some statistical analysis of the efficacy of financial sanctions in pursuit of goals other than regime destabilization, see Dashti-Gibson, Davis and Radcliff, American Journal of Political Science, 1997.

While most forecasters have not marked down Russian growth to the negative range (IMF has just marked down 2014 growth by 0.6 ppts since just the January forecast, but still projects positive 1.3 ppt y/y growth [3]Roubini Global Economics (4/4/2014) forecasts a decline from 0.5 ppt q/q annualized growth in Q1 to -1.4 ppt in Q2, and continued negative growth in the subsequent quarters, even in the absence of a military confrontation. Hence, with heightened uncertainty and a depressed economic conditions, the Russian economy is probably more vulnerable to external pressure — financial sanctions and the threat thereof — than is typically thought. There is also the direct fiscal costs of assimilating and financially supporting newly seized Crimea, approximately $7 billion per year, or 1% of GDP, according to Roubini Global Economics. That’s a diversion of fiscal resources that will not be available for countercyclical measures.

Clearly, there is a possibility of retaliation [4], with potentially measurable impact on European economies, but such measures could impose even greater pain on the Russian economy. So the question is whether retaliation is credible.

This piece is cross-posted from Econbrowser with permission.