8 March 2022
Financial sanctions against Russia are a welcome and needed measure. Sanctions can exhibit important short-term effects producing financial isolation and subsequent financial and economic distress. Comprehensive sanctions against Russia’s financial system must lead to widespread default of Russia’s external obligations, freeze of Russia’s external assets and standstill of cross-border financial and commercial transactions.
The financial sanctions will need to prevent Russian banks including the Bank of Russia from making or taking delivery of external payments. This can only be achieved from outright sanctions against all Russian financial institutions. The external assets of the financial system including the Bank of Russia are normally held offshore, except for gold, and any recourse will depend on access beyond the immediate control of Russia (not all countries participate in the sanctions). Exclusion from SWIFT is not sufficient as it would render more difficult for Russian banks to operate externally but not prevent them. The sanctions levelled against the central bank of Russia are a necessary condition for financial sanctions to be effective.
The sharp depreciation of the rouble is indicative of the instant sanctions impact. The sanctions against the Bank of Russia must lead to a continued impairment of its capacity to support the rouble exchange rate. The sharp depreciation of the rouble will cause important macroeconomic instability and in combination with the decline in external financing and international trade will likely result in a significant decline in output.
Russia has a GDP of US$1.6 trillion in GDP in 2021, about 1.7 percent of world GDP. It has important external assets and is a relatively open economy. Its external assets are equivalent to its GDP. Exports and imports of goods and services represent more than half of GDP indicating Russia’s dependence on international trade. Russia maintains a large positive international investment position and surplus balance of payments.
Russia’s external liabilities, representing claims on Russia by foreigners that may also include Russians living abroad, of US$1.2 trillion at September 2021 consist mostly of direct investments and are mostly denominated in rouble. Foreign direct investment represents US$600 billion of which US$480 billion are in local currency; the biggest holders are Cyprus, UK, Netherlands, Bermuda, Ireland, Luxembourg and Bahamas with a combined total of US$380 billion. China has US$2.2 billion outstanding and India US$0.6 billion. Portfolio investment are U$300 billion mostly denominated in rouble. US$27 billion of debt securities are denominated in foreign currency comprising Russia’s Eurobonds. Loans are the single most important foreign liability in foreign currency of US$130 billion.
Short-term foreign debt liabilities, due within 1 year, represent US$158 billion of which banks US$45 billion and other sectors US$67 billion. The government had less than US$2 billion.
Russia has US$1.6 trillion in foreign assets of which the central bank reserves represent US$610 billion at September 2021. US$1.5 trillion are denominated in foreign currencies. Using outward foreign direct investment as a proxy for where Russia holds its wealth, 84 percent is held in Western countries (including Japan, New Zealand and South Korea), of which more than 40 percent in Cyprus, up from 72 percent 10 years ago.
Russia’s exports of goods and services are estimated to amount to US$500 billion in 2021. About 46 percent of its exports (2020) are to Western countries. Mineral exports constitute about 40 percent of total goods exports (2020). Imports of goods and services amount to US$360 billion in 2021.
The sanctions will cause Russia to suffer more than the rest of the world amid its large positive international investment position and surplus balance of payments making it vulnerable to adverse external shocks. Russia has also become more suceptible to sanctions amid its increase of assets held in Western countries. For the financial sanctions to be effective all Russian banks, the Bank of Russia and their intermediaries need to be included. Cyprus requires special vigilance amid Russia’s important exposure. Sanctions against exports need to be broad-based as mineral fuels represent less than half of Russia’s exports.
Russia is a relatively small economy. Any significant impairment to Russia’s economic and financial performance, while possibly causing select high cyclical transition costs for some countries, will therefore only have a modest impact structurally on the rest of the world.
The sanctions if permanent and comprehensive will cost Russia in the short-term US$2.1 trillion (130 percent of Russia’s GDP) amid an unrecoverable decline in its external assets and loss in annual export revenues. The rest of the world will incur a cost of US$1.6 trillion (1.7 percent of world GDP excluding Russia) amid a total impairment of its claims on Russia and loss of its annual export revenues. Cumulative losses due to a continued suspension of intrnational trade would add to the costs. Any deviations from the above costs would be due to sanction leakages.
Source: CBR (international investment position and international trade); IMF (direction of trade); Comtrade (composition of trade).