The geopolitical impact of Russia’s unprovoked act of war against Ukraine is hard to overstate and the international response has reflected that. European countries have rushed to re-evaluate their energy and security situation with respect to Russia. And the wider international community has agreed on a sanctions package that is unique in its breadth and ambition to cut off a major economy from the global financial system. 

The sanctions package is comprised of a variety of measures targeting Russian exports, assets of oligarchs and the banking sector. Aside from supporting the Ukrainian military with weaponry, economic and financial sanctions are the West’s main attempt to influence the outcome of the conflict by making it harder for Russia to fund the military expenditure necessary to keep the war going and to inflict so much economic pain among ordinary Russians and potentates that Putin is removed from power.

The scope of financial sanctions announced is unique in modern history with the US’ ‘maximum pressure’ campaign on Iran being the only example coming close to the barrage of measures infliction upon Russia in the past week. US sanctions on Iran were tightened in late 2018 with a further ratcheting up in 2019, which included freezing the country out of the international financial system. As a consequence, Iran’s economy contracted sharply, shrinking by 6.0% in 2018 and a further 6.8% in 2019; inflation shot up from 8% in 2017 to just under 50% in 2020 and still stands around 35% today.

In Russia, the early fall-out from the implementation of financial sanctions could be seen this week with the ruble losing a third of its value against the US dollar and rating agencies downgrading Russian bonds to ‘junk’ status. The ban on some Russian banks using the SWIFT messaging network, the freeze of Russian central bank assets held abroad and further sanctions on the Russian banking system all have the aim of starving the financial system of access to foreign currency. Taken to their extreme the sanctions could bring about the total collapse of the ruble and the Russian banking system. However, the Russian central bank has likely been instructed to prepare for a wide range of potential Western sanctions. By doubling the bank rate to 20%, imposing a 30% commission on foreign currency purchases by individuals and ordering exporting firms (including Russia’s energy giants Gazprom and Rosneft) to sell 80% of their forex revenues on the market to stabilise the currency, the Russian Central Bank has prevented an even more catastrophic devaluation of the ruble thus far.

The latter point is crucial – as long as Russia can still sell its oil and gas to Europe, the US and their allies, it will be impossible to starve Putin’s regime entirely of hard currency. Accordingly, Cebr expects that the West will expand sanctions to include at least some Russian energy exports in the not too distant future, despite the high cost this will entail especially for European countries dependent on Russian gas. It remains to be seen what other measures the West can implement to inflict even further economic pain. However, the example of Iran also shows that despite the concentrated financial might of the Western world, there is no guarantee that sanctions can force the desired change in a country’s leadership or behaviour. We estimate that Iran lost just under 20% of potential output in the two years following the imposition of sanctions, taking into account not only the actual GDP contraction but also the forgone growth in GDP over that period. Given the higher resilience assumed for the Russian economy, our latest estimates show a somewhat smaller extent of damage, coming to 14% of lost output over a two-year period compared to a scenario in which Russia did not invade Ukraine.[1] Inflation will likely be rampant, reaching similar levels as seen in Iran. This would wipe out the savings of the Russian middle-class and lead to serious impoverishment for the less well-off. Should the West get serious about weaning itself off of Russian oil and gas completely through a combination of a faster rollout of renewables, reducing overall demand, and greater use of domestic energy sources, the damages to the Russian economy would increase considerably. While substantial, the damage might still not be enough to make Russia’s current leadership cave in. Again, the Iranian example shows how even a heavily ostracized economy can continue to function, focussing on production for the domestic market and trade with friendly regimes. Only time can tell if Russia can transition into a similar ‘resistance economy’ and how much economic destitution its people can endure.

[1] A similar methodology was used in Cebr’s report on the cumulative cost of Russian aggression in Crimea and Donbas between 2014 and 2020 commissioned by the Ukrainian Ministry of Finance

For more information please contact Kay Neufeld, Head of Forecasting and Thought Leadership Email kneufeld@cebr.com Phone 020 7324 2841