Germany recently hosted the Munich Security Conference where key topics on the agenda included the war in Syria, the refugee crisis in Europe and issues of European security. (For more, see: Could Europe's Migrant Crisis Help its Economy?) Although not formally scheduled into the conference, European Union (EU) leaders were expected to informally discuss the possibility of lifting sanctions against Russia, according to the Moscow Times. The U.S. and EU imposed trade and investment sanctions against Russia in 2014 over its annexation of the Crimean peninsula and support for rebel forces in eastern Ukraine.
The official line from the security conference; however, was that sanctions are here to stay. The Washington Post states, “On Ukraine, [US Secretary of State John] Kerry said Russia would continue to be subject to sanctions until it and the rebels it supports in the east come into full compliance with a political agreement reached last year [2015] in Minsk, the capital of Belarus.“
Are sanctions really working to change Russian policy? In September 2015, USA Today reported that fighting in eastern Ukraine had significantly eased as Russia backed off support for separatists. The article says, “Russia appears to be ramping down its support of separatist forces in Ukraine’s breakaway provinces of Donetsk and Luhansk.” John Herbst, a former US ambassador to Ukraine, describes the fighting as “a stalemate that favors Ukraine.”
Bloomberg News reported in November 2015 that, “[Russian President] Putin and his Western counterparts agreed in October [2015] to back a withdrawal of weapons in Ukraine, where a fragile cease-fire between pro-Russian rebels and government troops has held since February [2015].” Nonetheless, USA Today says Russia still has 50,000 troops in Ukraine.
Financial Sanctions
The U.S. and EU put in place two types of sanctions against Russia. The first is intended to cut off international financing for Russian companies operating in strategic sectors of the Russian economy like oil, banking and defense. The second is a ban on importing technologically sensitive equipment such as the kind used to explore and drill for oil. Financial sanctions seem to be effective, with none of the companies on the sanctions list issuing debt since September 2014. Bloomberg reports that investors are shying away from Russian debt in general, with companies selling just USD4 billion of Eurobonds in 2015, down from the 2013 record of USD42 billion of foreign debt sales.
Now the Russian government hopes to access the international debt capital markets, since there are no financial sanctions against the Russian state itself. The Financial Times reports that Russia plans its first bond issuance since sanctions were imposed. The article goes on to say that Nomura, a Japanese bank, believes the bond issuance could pose a challenge to the West’s sanctions regime because if the Russian sovereign is able to borrow long-term money, there is nothing to prevent the Russian state from filtering the funds down to sanctioned companies and banks. This would go a long way to easing the financing position of these Russian entities.
The timing of this bond issuance is also important. 2016 is a relatively easy year for Russian corporate and bank debt maturities; starting in 2017 and 2018 a maturity wall of USD72 billion hits corporate issuers and the government alike. The chart below from Bloomberg shows that external refinancing risks pick up significantly in 2017. If sanctions are still in place, these companies, and banks will not be able to refinance this debt in western capital markets. This could increase the burden on Russia’s sovereign wealth funds to meet redemptions. If the Russian government can borrow on their behalf, however, it will considerably ease the pressure on Russia's external financing position.
Trade Sanctions
In addition to financial sanctions, the U.S. and EU also impose trade sanctions on Russian companies. This type of sanction is longer term in nature and prevents Russian companies from importing technology needed to advance key industries like oil and gas. There have been a couple of notable transactions that have been impacted by these sanctions.
In March 2015, Forbes reported that sanctions against Russian oil company Rosneft stopped ExxonMobil (XOM) from participating in a USD720 million joint venture to drill for oil in Russia’s Kara Sea despite the discovery of oil. This type of sanction will have longer-term ramifications for the Russian oil industry, but isn’t likely to slow production in the short-term.
In August 2015, Reuters reported that the U.S. government placed new sanctions on Royal Dutch Shell and Gazprom’s natural gas development of the Yuzhno-Kirinskoye field on the island of Sakhalin. The sanctions specifically forbid the export, re-export and transfer of technology and equipment to the field. Alfa Bank in Moscow said that the new sanctions are a surgical strike aimed at slowing Gazprom’s LNG projects in Asia, according to Reuters.
Another notable victim of sanctions is General Motors (GM). GM announced in March 2015 that it was closing its only assembly line in Russia after just seven years of operations, laying off roughly 4,000 workers, according to Forbes. GM’s car sales declined rapidly following the implementation of Russian sanctions. The chart below shows GM’s Russian car sales fell 26.7% in 2014 and 64.8% in 2015. 2016 is likely to be another bad year for GM in Russia.
The Bottom Line
Russia is eager for sanctions to be removed, and the West seems open to the idea if the Minsk agreement is met in full. The EU reviews sanctions every six months, whereas U.S. measures remain in place until repealed, according to Bloomberg. It is possible that June 2016 could mark a new turning point when EU sanctions are next reviewed. In the meantime, Russia will try to tap the Eurobond market this year, and has already submitted requests to 25 banks to work on the deal, according to the FT. If Russia can access Western capital markets, it could signal a major crack in the sanctions regime. The Western response could be similar to the one imposed on Gazprom, with new sanctions being implemented to prevent the sovereign from accessing capital markets. So Russia’s bond issuance is an important one to watch to get a sense where the sanctions regime is going next.
