How Russia survived sanctions: and why parallel avenues for diplomatic engagement are vital.

Author:Logendran, Vidhya

The United States and the European Union have renewed, until 2016, wide-ranging sanctions imposed on Russia following its annexation of Crimea in 2014 and subsequent support for separatists in Eastern Ukraine. As a tool of economic statecraft, sanctions seek to coerce states to alter their political and economic behavior. In this case, the objective is to force Russia to abandon support for Ukrainian separatists. To this end, the financial sanctions seek to inflict pain on Russian banks by severely curtailing their access to international financial markets. Yet, as of mid-2015, Russian banks seem to have weathered the sanctions reasonably well despite the free-fall of the ruble at the end of 2014 and plunging oil prices. What are the reasons behind the relatively tepid short-term impact of the sanctions on the Russian banking system? What implication does this have for the effectiveness of sanctions as a tool for evincing a more conciliatory foreign policy from Russian President Vladimir Putin?

Russia had an imposing external debt burden of US$729 billion at the end of 2013, 90 percent of which was due from banks and corporates. As a result of the sanctions, cross-border lending to Russia shrank by 21 percent (US$48 billion) in 2014. International credit dried up through 2014, with syndicated loans and debt capital market issuances falling by 80 percent and 92 percent respectively. Unable to refinance existing debt, Russian firms were forced to repay their debts on schedule, resulting in an 18 percent reduction of external debt to US$599 billion at the end of 2014. Capital flight intensified; private net capital outflows nearly tripled in 2014 to US$154.1 billion, representing 4 percent of GDP. Consequently, state coffers were raided to defend the ruble which plunged 45 percent against the U.S. dollar at its nadir. Plummeting oil prices threatened Russia's export earnings, 54 percent of which were from oil exports. Under such circumstances, an acute liquidity crisis crippling a weak banking system has been widely expected. Why has no such crisis materialized?

First, closer scrutiny reveals that while a substantial amount of debt has been repaid, not all of the steep reduction of US$130 billion is attributable to debt repayment. About a fifth of Russian foreign debt is ruble-denominated, in the form of Eurobonds and loans from offshore related companies. There was a nominal reduction in the foreign currency value of this debt due to the...

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