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What to Expect from the New Economic Warfare Against Russia

MRP’s recent DIBs report on Russia gave an overview of the latest sanctions imposed by the U.S., and what that meant for Russia’s economy in general. Today’s report dives a little deeper into the rationale of the sanctions and highlights sectors that are getting impacted.

As noted last week, Russia’s economic star has been on the rise and the country is finally enjoying a period of macroeconomic stability and growth, after emerging from a painful recession. If the intent had been to put pressure on the Russian economy, officials in Washington would have directly imposed sanctions on institutions such as Gazprom, Lukoil and Rosneft in the all-important oil & gas sector, or Sberbank, the nation’s largest bank.

But, the U.S. chose not to exercise the “nuclear option” -– at least for now –- preferring instead to go after oligarchs in Putin’s inner circle and their business empires as well. In doing so, the U.S. treasury highlighted the extent to which Russian banks, companies, oligarchs and officials are exposed to the dollar and the might of U.S. economic warfare.

Despite the rise of other currencies such as the Euro and Renminbi, the U.S. dollar remains the dominant currency around the world, with 50% of global trade still conducted in dollars and nearly two-thirds of global currency reserves being held in dollars. This dominance has made it possible for the United States to weaponize its currency against those that act counter to its wishes.

Since emerging from its debt crisis in 1998, Russia has become integrated into global supply chains and finance. Russian entities have tapped into European and U.S. capital markets for funding, with many of them listing shares on international stock exchanges; Russian companies engaged in resource extraction have benefited from growing global demand for commodities. That integration into the global markets is what makes Russian conglomerates, and ultimately the Russian economy, vulnerable to this new breed of U.S. sanctions.

The sanctions were announced on Friday, and by Monday the impact was striking. The share prices of Rusal and its parent company EN+ Group, both sanctioned for their material connection to Oleg Deripaska, fell roughly 50%. Clearstream, a key component of investment market infrastructure, announced it would stop processing transactions in those securities, and the London Metal Exchange suspended trading of Rusal’s aluminum.

Meanwhile, commodity traders, clients and other entities transacting with the sanctioned companies found related payments blocked as banks too sought to steer away. Apparently, very few banks want to risk handling funds that could bring unwelcome attention from American authorities, especially since the U.S. Treasury stipulated that foreign persons and entities would face “consequences” if they “knowingly facilitate significant transactions, including deceptive or structured transactions, for or on behalf of any person subject to US sanctions with respect to the Russian Federation, or their child, spouse, parent, or sibling”.

One can think of Oleg Deripaska as the poster boy for this round of sanctions. His name and nearly all of his companies were on the sanctions list, including Rusal.

The swift crippling of Rusal’s aluminum business and stock price demonstrated to Oleg Deripaska and other Putin cronies how punitive this form of sanctions can be if the U.S. decides to go after their personal fortunes. One reason Putin has been able to stay in power is his ability to make his friends rich. But if their association with the Kremlin confines them to only doing business in Russia, Putin’s patronage could become a problem they want to get away from, which would weaken Putin. Most of the oligarchs have assets and business interests outside of Russia, which means they are exposed.

One sector that stands to benefit is aluminum. After top exchanges said they would stop accepting metal from Rusal, buyers scrambled to find new supplies sending aluminum prices soaring over 15% to a six-year high of USD $2,326 a ton on April 13th. Rusal, which gets 80% of its business from international sales, reported nearly $10 billion of sales in 2017, with about 15% coming from the United States — its second largest market after Russia. The removal of the Rusal supplies and the new 10% tariff imposed by the U.S. on some aluminum imports may continue to put upward pressure on prices, mostly to the benefit of U.S. aluminum producers.

In contrast, banks with loans to the companies on the sanctions list are exposed. For example, the share price of Sberbank (SBER) dropped more than 20% on the first trading day after the sanctions were announced. With half of Russia’s retail deposits, Sberbank tends to be more sensitive to the Russian economy than to external markets. However, as Russia’s biggest lender, it is vulnerable to sanctions against other Russian companies to which it lends. If a hard-hit company like Rusal has a loan from Sberbank, that loan could become non-performing, hurting the bank’s balance sheet. Rusal has already warned that it will likely experience a technical default on some of its debt.

Outraged by the sanctions, Russia’s parliament has drafted legislation to restrict U.S.-made imports, which amounted to about $12 billion in 2017. The draft law proposes banning some agricultural, industrial, and pharmaceutical products which Russia can obtain elsewhere; barring cooperation on atomic energy and aerospace; and stopping U.S. firms from taking part in Russian privatization deals. These measures will be discussed in Russia’s lower house later this month.

In the meantime, markets, banks and investors are bracing themselves for more possible action from the administration. Indeed, Putin’s unflinching support of Syrian leader Bashar-Al-Assad, even in the wake of Friday night’s military strikes – conducted by the U.S., France and the UK in response to the Syrian leader’s reported use of chemical weapons on civilians – has the U.S. already considering additional sanctions on Russia.

In January, the U.S. Treasury published a list of 206 senior Russian political figures, oligarchs and other persons of interest. Last week’s sanctions targeted 24 individuals on that list. This succinct chart details who they are, how they’re connected, and the US Treasury’s allegations against them. There are potentially a further 182 names to go, if the U.S. chooses to follow the same strategy, the most vulnerable being those with businesses that derive most of their revenues and funding outside Russia. Here’s the full list of 206 names.

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