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EU Tightens the Economic Screws on Putin’s Russia

Spurred by the MH17 flight disaster, the EU’s latest round of economic sanctions against Russia are symbolic. But strongly symbolic.

The European Union reacted with relative lightning speed to the death of hundreds of its citizens in a Malaysian passenger jet shot down over eastern Ukraine July 17. Within two weeks, the fractious 28-member community unanimously agreed on a beefed-up package of what the bloc called “sectoral sanctions” against Russia, which the West holds responsible for supporting the rebel groups that likely shot down MH17.

EU officials announced the new punitive package after a meeting of ambassadors on July 29. Although exact details remain to be disclosed, official hints made clear that Europe’s often clumsy diplomatic process had produced a deftly targeted package. The EU unsheathed two of its potent tactical weapons against Moscow ­— access to capital markets and advanced technology — while avoiding such nuclear options as cutting off Russian banks from short-term transactions and canceling any existing energy sales or investments. Washington announced the same day that it will impose similar measures. “The Western countries are becoming more and more creative in thinking up sanctions that are painful to Russia’s political and economic elite while damaging the interests of Western business as little as possible,” Sergey Smirnov, a researcher at Moscow’s Higher School of Economics, commented in a biweekly written report issued by the institution.

The sternest of the promised new sanctions is a ban on Russian state banks’ borrowing on Western markets for a term longer than 90 days. Sanctions by the U.S. are also ramped up, as the administration published a list including No. 2 bank VTB while excluding Sberbank, which dominates Russian finance, but leaks from EU officials indicate that they will include Sberbank on their blacklist. The EU is also expected to curtail the export of oil and gas technology that Russia needs to develop its next generation of energy resources, many of which are found in challenging offshore fields in the Arctic and northern Pacific oceans, as well as so-called dual-use goods that could have a military use.

After months in which European capitals dragged their feet over retaliatory actions against Moscow, the latest round of sanctions represented hardening Western attitudes toward President Vladimir Putin’s perceived truculence and military escalation, even after the MH17 bloodbath. “What’s clear is the long-term trend of divergence,” says Fredrik Erixon, director of the European Centre for International Political Economy in Brussels. “Russia has shown itself to be a very unpredictable place, which will lead to far less foreign direct investment and accelerate the diversification of European gas imports.”

In response, Russian financiers are pointing out that the country has plenty of resources to offset any Western funding moratorium. The Higher Economic School, part of Moscow’s National Research University, estimates that state banks need to repay some $19 billion to foreign creditors this year and $21 billion in 2015. That compares with national hard currency reserves of $472 billion as of July 1. The Central Bank of Russia immediately announced that it would extend liquidity to institutions affected by sanctions. Moscow’s MICEX share index actually rose slightly after the July 29 EU meeting, paring a 6 percent decline since MH17 was shot down on July 17. “The effect of the sanctions is most significant in the long term,” Vladimir Bragin, head of research at Moscow-based Alfa Capital Partners, told Russian business newspaper Kommersant. “The direct short-term effect is not so meaningful.”

But perception has been as important as reality as Russia’s economy continues to sputter. The situation has deteriorated since late February, when the Ukraine crisis erupted after Kiev street protests led to the ouster of Viktor Yanukovych from the Ukrainian presidency. Russia saw near-record capital flight of $48.8 billion in the first quarter of this year, most of that coming in March as oligarchs and ordinary consumers alike rushed to dump rubles on fears of a return to cold war–style confrontation with the West. That figure roughly halved to $25.8 billion during the second quarter as eastern Ukraine settled into a stalemate and repeated threats of economic reprisals from Europe fizzled. In recent months capital outflows have dwindled to near zero, but the tougher EU line may provoke a new cycle. “At the macro level, the main effects of the new round of sanctions may include the resumption in higher capital outflows, accompanied by pressure on the ruble,” Deutsche Bank’s Moscow office writes in a research note.

New sanctions are not the only sign that Russia is facing a reversal of two decades of post-Soviet integration with the world economy. The day before the EU meeting, an international arbitration court in the Netherlands ruled that the Kremlin owed more than $50 billion to the former owners of Yukos Oil Co. for the company’s illegal confiscation ten years ago. Today, the BBC reports, the European Court of Human Rights ruled that Russia must pay some $2.5 billion to former Yukos shareholders, and gave the country six months to establish a payment plan. On July 23 the European Bank for Reconstruction and Development announced a freeze on investments in Russia, which in 2013 amounted to €1.8 billion ($2.4 billion). “It is clear that the only path back to business as usual is for Putin to retreat from Ukraine,” says Ian Bond, a veteran U.K. diplomat who is now director of foreign policy at the Centre for European Reform, a think tank in London.

Left to his own devices, Putin would probably not rush any decisions on his southern border, maintaining at least somewhat covert support for the rebels and testing the mettle of a new European Commission, which takes office in the fall. But events on the ground may not afford him that luxury. The Ukrainian army has been gaining on the insurgents for weeks and now stands poised for an assault on Donetsk, their main urban stronghold. The Russian president could soon face a stark choice between accepting humiliating defeat for his proxies or an outright Russian invasion of Ukraine.

Meanwhile, Moscow is punishing Kiev economically in asymmetrical retaliation for Western sanctions and general hostility. Russia cut off gas shipments to Ukraine in mid-June. Now it is tightening the screws on Ukrainian food imports, banning meat, dairy and most canned goods on alleged health grounds as the EU hammers out its policy on Russian banks and technology transfer. This will all ultimately raise the cost of saving Ukraine’s economy, which Europe has implicitly promised to do, and make the looming winter a still harsher one for Ukraine itself. But for the moment, Kiev and Brussels are both willing to pay the price.

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