Until mid-July, the diplomatic crisis generated by Russia’s annexation of Crimea in March and Moscow’s ongoing indirect support for a pro-Russia separatist rebellion in eastern Ukraine appeared to have settled into a state of equilibrium. Powerful EU members resisted pressure from the U.S. for an expansion of economic sanctions targeting strategic government agencies and powerful political and business allies of President Vladimir Putin.

However, the downing of a Malaysian Airlines commercial jet that has been blamed on Russian military advisors working with the rebels added to pressure for the EU to act. In the process, this boosted tensions and created a heightened risk of an escalation of the conflict.

Although Putin’s strategy remains opaque, his actions since March suggest that the popular early interpretation of the annexation of Crimea as but a first step in a more ambitious land grab — possibly including territory outside of Ukraine — was off the mark. Indeed, that could be attributable to the sanctions already imposed, which, while limited in their scope, have contributed to significant economic losses for wealthy oligarchs who are one of several groups that Putin needs to keep happy if his hold on power is to remain secure.

The threat of harsher sanctions has contributed to an outflow of capital that is weakening the economy.

Beyond the direct affect of the sanctions, the negative attention on Russia and the threat of harsher sanctions has contributed to an outflow of capital that is weakening the economy and creating the threat of an inflationary plunge of the currency. The difficulties were underscored in late July, when, amid growing pressure for EU sanctions following the downing of the Malaysian airliner, monetary authorities hiked interest rates, despite clear evidence that the economy is at risk of falling into recession.

New sanctions approved by the EU in late July target Russian companies and block infrastructure financing supplied by the EIB and the EBRD. The measures also restrict the access of Russia’s state-owned banks to European capital markets, and impose an embargo on the sale of arms and dual-use technologies.

In The Spotlight

The financial sanctions announced by the United States and the EU will create problems for highly leveraged corporations seeking to roll over large debt burdens, which will require increased central bank financing.

A potential credit event caused by default on foreign-denominated bond issues could trigger reimbursement of credit default swap protection that may not be recoverable via a bond auction given the sanctions imposed. The legal ramifications are endless, especially where third parties and/or different currencies are concerned. But the uncertainty will unsettle the markets, with negative implications for paper asset values in the near term.


The PRS Group
About The Author The PRS Group
The PRS Group is a leading global provider of political and country risk analysis and forecasts, covering 140 countries. Based on proprietary, quantitative risk models, the firm's clientele includes financial institutions, multilateral agencies, and trans-national firms.


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