Four things MNC executives need to know about the latest sanctions against Russia

In what has been the harshest Western response to Russia’s involvement in the Ukraine crisis, the EU today imposed broad – so called Level 3 – sanctions against Russia. The US is likely to follow suit shortly.

European Parliament in Brussels (Image: Reuters)
European Parliament in Brussels (Image: Reuters)
Four things MNCs need to know about the implications of these sanctions:

1. Credit costs will increase considerably and lending will become more restricted.

The sanctions will restrict the ability of majority state-owned Russian banks to conduct long-term borrowing on European financial markets. Russia’s biggest banks – Sberbank and VTB – will both be affected, in addition to a host of smaller banks, including ones already targeted by US sanctions. Sberbank alone holds 29.0% of Russian banking sector assets and accounts for 50.0% of retail and 32.0% of commercial lending. Shut out of EU and (likely) US financial markets, these banks will see their funding costs increase considerably. In response, they are likely to reduce new lending to both businesses and consumers and increase interest rates. Importantly, however, these banks will be able to continue processing financial transactions in US dollars and euro.

2. Sanctions will have a considerable impact on investment.

Investment in Russia is already contracting – it decreased by close to 5.0% in Q1 2014. Faced with weaker demand, higher financing costs, and political uncertainty, businesses in Russia will be more likely to postpone investments and put long-term plans on hold until the situation stabilizes.

3. The Russian government may create operational problems for Western MNCs.

Russian government discussions about import substitution and re-orienting trade toward Asia have been going on since the annexation of Crimea earlier this year. The new sanctions give proponents of such ideas a strong argument for more aggressive measures to restrict Western MNCs from the market, particularly companies that sell to the government. MNCs should be prepared for a range of Russian government responses, from slightly more onerous inspections to the outright expropriation of foreign assets, although the latter is not highly likely.

4. Companies should have a plan in place that accounts for a deteriorating operating environment:

Most MNCs’s Russia plans built in 2013 or even early 2014 are likely no longer reflective of the reality on the ground. Companies need to reassess the regulatory, operational, and economic environment in which their business will be operating in the coming months and prepare their business accordingly. FSG clients can read suggested actions on building such a plan here.

Customer Segmentation in Emerging Markets

Who Moved My Cheese?

It’s no secret the emerging market business environment has become more challenging over the last few years.  Currently, MNC growth rates are contracting on average.  An FSG survey of 52 MNC executives revealed that while 1 in 5 had enjoyed emerging markets regional revenue growth above 20% in 2011-2012, by 2014 only 1 in 10 expected such high performance.Only 39% of MNCs surveyed are satisfied with their differentiation vis-a-vis competitors.

While capital flow reversals and other macroeconomic cyclical trends account for part of this change, much of it is due to a more permanent shift: the rise of serious local competitors and more discerning local customers.  Only 39% of MNCs surveyed are satisfied with their differentiation vis-à-vis competitors.  A more competitive landscape means that market power in emerging markets is shifting from the seller to the customer.

Opportunity is still plentiful for global MNCs, but it is not readily available by just showing up with a fancy global brand and finding a good distributor.  In the metaphor of the business classic “Who Moved My Cheese?” someone has moved the cheese in emerging markets.  The best MNCs are trying to figure out where the cheese is now, rather than sitting in their maze staring at the corner where the cheese used to be.

Redrawing the Market Map from the Customer’s Perspective

FSG research suggests that in this fluctuating environment, a management tactic that raises some MNC out-performers above the rest is a dynamic approach to customer segmentation that stays on its toes and really puts the customer’s perspective at the center of the matter.

Many companies would say they do “customer segmentation,” but what they actually do is segment their markets based on their own internal logic – their organizational geography, sales channel model (direct vs. indirect) and product lines.  And those that do engage in customer-oriented segmentation often take too superficial an approach, looking at outside descriptions of their customers, such as customer purchasing power (industry and size of the firm in B2B markets, gender and income bracket in B2C).

It may sound obvious, but the most powerful (both insightful and commercially effective) customer segmentation is customer-centric.  While there are differences in the segmentation techniques most applicable for different industries, overall there is a pattern of common principles among those that are getting this right:

  1. Focus externally, not internally: What does the market look like from the buyer’s perspective?  What do they want, and what can they currently have at what price point?  These questions can only be answered by looking at the buyer’s options, which means incorporating competitive intelligence as a core input into any segments-refresh exercise.  In our survey results, MNCs that applied this principle closed an average of 15x more deals per month than the rest.
  2. Review your segmentation annually: Markets can change significantly in twelve month, and so can customer’s preferences and options.  Make sure to review your segmentation on an annual basis to ensure your segment boundaries are still drawn in the right place.  This does not mean you launch a new segmentation approach every year – that would definitely be overkill.  Instead it is a considerate gut-check that should reveal whether or not adjustments are needed.  This is usually best done right before launching into your strategic planning season.  Companies that apply this principle enjoyed 41% better sales conversation rates.
  3. Do not put a single function in charge of segmentation: Interestingly, while it is common for B2C companies to put Marketing in charge of segmentation, and B2B companies to put Sales in charge, the most effective companies make their segment reviews a truly cross-functional exercise, bringing to the table and empowering both Sales and Marketing but also Finance, Strategy, Product, and Operations.  When everyone understands what is meant by a customer segment, this creates a common language for coordinating commercial intent.  Companies that take this approach are 58% more likely to have an emerging markets regional revenue growth rate above 10% year-over-year.
  4. Consider adjacent and new markets: Don’t just re-segment your old market space, think creatively!  Are there entire groups of potential customers we haven’t previously considered or taken seriously?  What are the barriers to entry?  Can and should we get there ahead of the competition?  Companies that persistently ask these questions enjoyed 153% higher market share growth over the past two years.

Together, these four principles ensure that an MNC regional or country-level organization is tackling the practical question of how best to delineate and name current pockets of greater and lesser opportunity.  The follow-up question is how to engage the high-opportunity pockets and find the cheese.

Going Deeper: Three Kinds of Customer Segmentation

So far we have been discussing “customer segmentation” as if it is a unified exercise, for a unified purpose – but it isn’t.  FSG’s recent study goes deeper into three kinds of segmentation that are key to above-average sales performance.  They are:

  • Market segmentation for building commercial strategy
  • Behavioral segmentation for tailoring marketing and sales pitches
  • Profitability segmentation for prioritizing sales team members’ efforts

Each of these segmentation approaches provides a low-cost, high impact strategy to allocate resources where it matters.  We will cover each of these three in more detail over the next few weeks in subsequent blog posts. You can also listen to the podcast on customer segmentation on our Emerging Markets Insights iTunes page.

For further information on how to implement effective customer segmentation for your business, FSG clients should contact their client services director, and prospective clients may send us an email at info@frontierstrategygroup.com.  To learn more about Frontier Strategy Group please visit our website at www.frontierstrategygroup.com.

Nigeria: Insecurity and its impact on business

Despite ongoing violence in Nigeria, opinions about the country’s security challenges and what they mean for investors differ widely among local entrepreneurs and international business leaders.

Some executives, whether in Lagos or other commercial centers like Abuja or Port Harcourt, say they aren’t concerned. They believe business will continue as usual and that the threat from militant group Boko Haram will subside after the elections in February next year.

Boko Haram is generally believed to be sponsored by a few political forces who are keen on influencing election results. The group’s terrorist activity has increased dramatically since the election of President Goodluck Jonathan, the country’s first Southern and Christian president, and some believe that Boko Haram was able to emerge because traditional power structures were disrupted in many of the northern states when the central power shifted to the South.

Other business leaders are deeply troubled, not only by the rising violence but by its underlying dynamics.

“We don’t understand why Nigerians are blowing themselves up for a cause. It simply isn’t part of the Nigerian psyche,” a senior manager of a consumer goods company told me.

The head of marketing at a Nigerian bank echoed these sentiments, before adding: “The dynamics here are changing. Everything is getting more expensive because most of our food comes from the north, prices have been going up and what the average Nigerian earns is simply not enough anymore. I fear this may impact the balance here in Lagos, particularly as we get more refugees from the north. Our infrastructure can’t cope with it.”

Business Impact

The volatile state of Nigerian security has also lead to varied experiences among business leaders. As the owner of a distribution company explained: “In our annual sales meetings, one of our local representatives stood up and pronounced huge losses due to the instability in the North. In response, another representative exclaimed that his major customer sits in Borno state!”

Consumer goods companies tend to be the businesses that suffer most, selling low value, high volume products in the populous yet poor northern states. State-imposed curfews mean less people are going out to buy things, and many traders in neighboring Niger, Chad and Cameroon have ceased buying their products in bulk from Northern Nigeria.

Still, businesses operating in affected areas are developing creative ways to address the challenges.

We just had to adapt to the environment. When Boko Haram destroyed the mobile phone masts, we couldn’t call our local representatives anymore. So we just invested in VoIP (Voice Over Internet Protocoll) technology, which is a little more expensive, but now we can communicate frequently with our local representatives, and business is flourishing,” the CEO of an FMCG distribution company told me.

A Common Enemy

While the threat resulting from Boko Haram is still geographically contained around the Northern and central states, the country’s commercial capital has been spared. It is believed that those funding Boko Haram have business interests in Lagos they do not want to be undermined.

Many business have refocused their attention to safer and more prosperous parts of the country to capture the abundant commercial opportunities Nigeria has to offer, but there is till concern that what led to the rise of Boko Haram is not just political maneuverings but real socioeconomic grievances which if left unaddressed could incite insecurity in more stable places.

Some business leaders stress the need for the government to take action. But as Nigeria enters what is only its fourth electoral cycle, others are more patient. They believe that more time is needed for democratic processes to mature and for the disrupted traditional structures to be corrected, calming the power struggles that lie at the heart of the Boko Haram threat.

And still a few try to look at the situation with a typically positive Nigerian attitude:

“In history, the unifying factors of nation states have often been the existence of a common enemy. We have that now, and it could help us focus less on what divides us as tribes and regions, but what unites us as a country.”


Anna Rosenberg is Head of Sub-Saharan Africa Research at Frontier Strategy Group, a Washington headquartered information services provider advising multinationals on doing business in emerging markets. Anna is currently on a research trip to Nigeria and Ghana, meeting representatives from local and international businesses, journalists and government officials. Follow Anna on twitter @anna_rosenberg

*This article is Part 1 of an ongoing series, originally published in conjunction with How We Made it in Africa.

Emerging Market View: What Our Analysts Are Reading

EM View

On Thursday, EU diplomats will consider increased Russian sanctions. The sanctions include a proposal to ban all Europeans from purchasing any new debt or stock issued by Russia’s largest banks, according to the Financial Times, and FSG’s Head of Research for EMEA says it’s time for multinationals to make contingency plans.

“If some or all of the proposed measures are approved by the EU, MNCs operating in Russia will be significantly affected. Executives should build a targeted contingency plan for their Russia operations to prepare. Read FSG’s report Protecting Your Russia Business for analysis and suggested actions for building a contingency plan in the case of further sanctions against Russia.” – Martina Bozadzhieva

In Southeast Asia, a rising middle class and strong demand for more expensive foods has led to increased investment by Japanese food companies, mirroring FSG predictions on the rising competition from multi-ASEAN corporations.

“The increasing sophistication of regional firms and growing demand is attracting several global players to partner/acquire ASEAN firms. MNCs should explore all types of partnerships with such regional firms; they understand the market better, tend to have deeper distribution networks, and lower-cost operations.” – Shishir Sinha, FSG’s Senior Analyst for Asia Pacific after reading this WSJ article.

Good news for Argentina this week. Last Friday, the Latin American country struck a deal to borrow $7.5 billion from China for power and rail projects, according to Reuters.

“Argentina has reached a deal with China to borrow US$ 7.5 billion to finance energy and railway projects, and the two countries have also signed a three year, US$ 11 billion currency swap, in which Argentina will receive Chinese yuan that it can then use to finance Chinese imports or exchange to USD to bolster reserves. This news is welcome given Argentina’s balance of payment concerns.” – Christine Herlihy, FSG’s Senior Analyst for Latin America.

FSG clients can keep up to date with the latest emerging markets headlines and exclusive analyst commentary on the client portal.

China’s Rapid Pulse: Thoughts from the Road

I am standing amid the hustle and bustle of the main street of Shanghai, unable to hail a taxi and scrambling to open Google on my phone. I’ve forgotten it’s recently been banned in mainland China and that drivers now prefer passengers who book through WeChat, a mobile app that awards taxis an additional service fee. I’ve lived in this country for most of my life, but I still have trouble keeping up with the pace of China’s evolution.

During the 12 days I spent in Shanghai, I spoke at length with clients, experts, local think tanks, and consulting analysts all focusing on one thing: how businesses can adjust to a developing China. A few of the on-the-ground insights I picked up are highlighted below.

Buildings in Shanghai
Older Shanghai-style “Shikumen” architecture is found adjacent to newer modern facilities.

From the business operations standpoint, local competition is happening at the provincial level rather than the national level. Many strong, regional-based Chinese brands are emerging and ramping up their capabilities in order to become “national” brands. Echoing the findings detailed in my past report on Managing Local Competition in China, the biggest challenge multinationals are facing is how to localize their strategy in an increasingly sophisticated China. Opening up a developed-market “toolbox” is not sufficient enough to solve China-specific issues.

The crux of this problem is that, in a sense, China is not really a single country—it is a series of distinct regions. A standardized strategy cannot work well in China because of the cultural diversities, wide range of local dialects, and large wealth gap. Some clients are beginning to reconsider their city tier-based model, questioning whether it is an effective way to segment customer needs. Even within one tier, the divergence will be daunting. However, you cannot create 200 business models for one country because it will not be profitable. In my upcoming report on Evolving Consumer Base and Urbanization, which will be released in a few weeks, I will provide detailed analysis of FSG’s cluster model and its implications for MNCs’ go-to-market strategies.

The idea to develop city clusters is central to the government’s plans to smartly urbanize people and cities in order to better allocate resources and boost small and mid-sized cities by leveraging the agglomeration effect from big cities. In the future, China will have three world-class super clusters that will radiate around 16 regional clusters. Logistical corridors will be built to strengthen the linkages between the northwest Chinese city of Urumqi and Russia, as well as the southwest city of Chengdu and European countries through the Pan Europe-Asia Bridge.

One pitfall that MNCs run into easily is making overambitious investments in backend facilities before the business strategy has been proven successful and the front end starts to generate revenue. Another pitfall is applying a swing strategy between the premier and middle markets. As the middle class booms, successful MNCs will create high-margin products to serve the massive middle market instead of the super premier market, which has very limited scale. (One client used the metaphor, “We don’t want only to skim a slide of fat from a big soup.”)

The O2O (Online-to-offline) model is poised to be the future of e-commerce in China. An e-commerce solution provider I talked to has already seen its O2O revenue contributions to their overall portfolio increase from 0% to 30% within one year. Target clients include lots of big-name retailer/FMCG/luxury products. Many MNC clients will be looking into this option in the coming years.

From the macroeconomic perspective, the recent shift in manufacturing is a result of the Chinese government’s policies. Although the current manufacturing outflow is an irreversible trend for China, the question here is about its timing. On one hand, this change is happening before the economy is fully ready. That’s why this transition is creating some problems. Some enterprises in the coastal region cannot afford the increasing labor/land cost because the government has implemented a land quota, and they will eventually move to ASEAN. On the other hand, the government is encouraging investment in west/central China by increasing the land supply and subsidiaries. However, the infrastructure-driven model makes inland China more prone to debt issues, the “ghost city” phenomenon, and heavy pollution.

Government always follows the path of creating supply first and then waiting for demand to materialize the supply. When the pace of “city-urbanization” outpaces “people-urbanization,” ghost cities are created. When highly polluting manufacturers move to inland cities, polluted water then flows along the Yangtze River from inland to east regions. Two types of manufacturing shifts are taking place. First, higher labor-intensive manufacturing is moving to ASEAN (as we mentioned in our latest ASEAN manufacturing piece), and possibly to Africa in the next 20 years. Second, lower labor-intensive manufacturing is moving to Shanghai’s satellite cities, such as Hefei or inland/west cities, based on the analysis of overall transportation costs and whether the business nature is more export-driven or more domestic market-driven.

Last but not least, China’s growth model dictates that it MUST grow. If growth is under 5%, all of the problems—shadow banking, local debt, and the real estate bubble—will explode. The internationalization of RMB and the financial market will feel consequences overnight and then will impact global markets too. If the country manages to maintain current levels of growth, all of the issues can be resolved by themselves. China’s current challenge is similar to the European debt crisis—one country, one currency. In addition, people cannot move freely because of the “hukou” restriction (the local registration system in China), and governance administrations are managed separately (different provincial governments work differently and lack integration). However, the future of China’s growth is promising. China is different from Japan. The advantage of having a centrally manipulated economy is also having well-planned fiscal/monetary policy from a government that can achieve highly effective results.

Finally in a taxi on my way to the airport, I noticed something interesting. Old Shanghai-style architecture is being replaced by modern facilities. It’s a result of the rapid pace of China’s urbanization, and the sharp contrast is visible on every corner. Differing styles must coexist as the society transitions, proof that everything moves at an astonishing pace in this market.

Multinationals must build contingency plans for Russia

European foreign minister
European foreign ministers gathered in Brussels on Tuesday. Associated Press

The EU has decided to impose more sanctions on Russia. For now, these fall short of the so-called Level 3 sanctions that could be against whole sectors of Russia’s economy and crucially, its banking sector. However, the international fallout from the downing of flight MH17 and the growing tensions between Russia and the West mean that Level 3 sanctions are increasingly a possibility.

For an MNC executive, this means that it’s time to plan. Level 3 sanctions would dampen Russian growth further, reducing demand across industries; they would cause significant problems for customers and distributors to access finance, affecting operations; and are likely to be met with Russian retaliation that could make it more difficult for MNCs (especially American ones) to do business in Russia. All of this will have an impact on a company’s customers, finance, supply chain, people, and marketing strategy and MNCs should be building step-by-step play books on how to respond to spillover across their Russia operations.

martinachart2This is not to say that MNCs should be pulling out of Russia. In fact, planning is so important because of the significant role that Russia plays in many MNCs’ EMEA and even global portfolios. Companies that have stuck with Russia through crises have historically reaped significant benefits and this could be an opportunity for MNCs to strengthen partner and customer relationships and to make low-cost investments.

Meanwhile, larger strategic questions are looming in the background for EMEA and global leadership teams. With the likely opening of Iran for business, a Russia that is increasingly closing in on itself could lose out in the competition for corporate investments.

For a full report on Russia contingency planning, FSG clients can click here. A full report on preparing for a post-sanctions Iran is also available.

Protecting Profits and Managing Prices in Latin America

Companies are increasingly looking to adapt their pricing strategies and tactics to deal with macroeconomic volatility and shifting corporate mandates in Latin America.

As Latin America’s operating environment has become more volatile and bottom lines begin to receive more scrutiny from the corporate center, regional executives are focusing on how they can shift their pricing strategies to maximize profitability mandates while protecting volumes. FSG’s recent study Protecting Profits and Managing Costs: Pricing Strategies and Tactics for Latin America (clients only) focuses on the best approaches to manage pricing and maximize earnings in Latin America’s evolving operating environment.

LATAM Pricing ManagementIn this study, FSG concludes that multinationals’ approaches to pricing strategy are often dictated by organizational constraints, in particular  the degree to which regional teams have the capabilities to adjust prices in response to macroeconomic shocks. This depends in large part on how centralized both risk management and pricing strategies are within a given company.

Companies seeking to maximize the focus of local teams on executing a pre-determined market strategy often find that a centralized approach to pricing and risk management is optimal. By leaving the management of transaction and operational exposure to the corporate treasury, companies can help to ensure that local teams are not distracted by short-term fluctuations in the market environment.

However, a centralized approach to pricing and risk management often means that companies lose the ability to adapt pricing to local market conditions. This makes it more likely that an organization will leave money on the table or lose market share when adjusting prices.

To succeed, companies should ultimately seek to deploy a mix of hedging and operational strategies, coordinated across centralized and decentralized functions within the company. FSG’s study provides a set of best practices and case studies for companies to learn from and consider as they determine the optimal approach to pricing for their business in the region.

For FSG clients interested in learning more about these best practices, the full report is available here. Not a client? Contact us.

Preparing Your Business for Post-Sanctions Iran [Infographic]

Iran_Infographic_PostSanctions

International negotiations involving Iran’s nuclear program were extended until November 24, which is good news for Western multinationals. Senior executives should use this extra time to lay out plans for entering or expanding in the Iranian market. Today, FSG released a report for our clients that outlines actions to take in order to prepare for major challenges and capitalize on huge opportunities in post-sanctions Iran.

Many companies are preparing to enter or expand in post-sanctions Iran, and 40% of FSG clients surveyed already view it as a priority market. A comprehensive nuclear deal and the subsequent opening of the Iranian market would represent the biggest shake-up to the MENA portfolio since the Arab Spring erupted between late 2010 and early 2011. Iran’s population is the second largest in MENA, and its oil and gas reserves are the 4th and 2nd largest in the world, respectively.

Before committing significant resources to overcome operational challenges in Iran, senior executives must first determine whether their organizations are even willing to take the risk by reassessing market potentialsanctions exposure, and indirect vulnerabilities, such as reputational risk. Iran’s opportunities will not outweigh the risks for every company. However, pharmaceuticals, medical devices, and consumer goods companies are especially likely to prioritize post-sanctions Iran given its attractive demographics and future spending power.

For companies focused on entering or expanding in post-sanctions Iran, it is imperative to prepare for the top three challenges identified by FSG clients in a recent poll: a lack of access to bank services, compliance risk, and difficulties in becoming a first mover ahead of competition. FSG clients can read our report on post-sanctions Iran to learn about actions for overcoming these challenges and many others.


FSG Poll Results

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Emerging Market View: What Our Analysts Are Reading

EM View

India’s newly elected Bharatiya Janata Party (BJP) government announced its first budget last week, and according to the Wall Street Journal, it proved a letdown for those expecting big-bang reform, MNCs included.

“While it is a well-balanced fiscal plan with focus on reviving consumption and investments, markets have not been overly pleased and experts find certain growth targets to be quite unrealistic. The absence of specifics on several big-ticket items and lack of an overarching vision should rightfully disappoint companies,” says Shishir Sinha, FSG’s Senior Analyst for Asia Pacific.

(Readers can view FSG’s original expectations for India’s BJP government here.)

Last week, Portugal’s Banco Espirito Santo SA bonds hit record lows after parent company Espirito Santo International reportedly missed a debt payment, rekindling market fears and reminding investors that the eurozone’s woes are far from over.

“Executives should be wary of headlines for recovery in WEUR, and prepared for the heavy downside that could accompany bank failure. Banco Espirito Santo, a Portuguese bank, delayed payments on some securities, reminding us that just because banks have not been in the news does not imply that they are healthy. FSG’s WEUR Regional Outlook outlines how banks could impact MNCs throughout the region,” says Lauren Goodwin, Senior analyst for Western Europe.

In Latin America, Argentine presidential hopefuls are dealing with the issue of debt negotiations and exploring opportunities for business-friendly reform, according to Reuters.

“As Argentina strives to negotiate with holdouts to avoid default, executives should consider the potential for improvement as elections approach in 2015. The current frontrunners favor negotiating with holdouts and would likely be more pragmatic and business-friendly than President Fernandez,” says Christine Herlihy, FSG’s Senior Analyst for Latin America.

In global news, Forbes recently released an article on local companies competing with foreign investors in emerging markets, citing a new study by Boston Consulting Group and echoing past FSG reports.

“Echoing the same message in FSG’s report Winning the Race For The Market Diamond, local competition gaining market share in emerging markets is an increasing concern for multinationals, particularly for MNCs that focus on the burgeoning emerging market middle class. Read the report to understand the strategies other companies have used to battle the evolution of growing domestic companies,” says Sam Osborn, Associate Practice Leader for FSG’s global analytics.

What the Latest Sanctions Against Russia Mean for MNCs

The latest rounds of EU and US sanctions against Russia fall short of imposing restrictions on entire industries, but they do have a number of hidden spillover effects for Western multinationals operating in the market. Beyond the obvious impact on MNCs selling to the energy and defense companies directly targeted by sanctions, a broader set of MNCs operating in Russia should be concerned about the banks that have been included in the sanctions list.

Impact on MNCs:

MNCs selling business goods and services are most likely to be indirectly affected by the sanctions, because some of their customers may face a higher cost of credit. Beyond businesses that directly work with the sanctioned banks, Russia’s financial market as a whole is likely to see more expensive credit as more international banks try to restrict new lending out of cautiousness. In the long term, higher lending costs contribute to the contraction in domestic investment, which will prolong Russia’s economic stagnation and reduce demand across all industries.

Actions for executives:

Executives whose business may be affected should speak with their local teams and identify key customers who may work with the sanctioned banks. Such customers may face the risk of rising borrowing costs, particularly if their credit lines need to be rolled over in the near future.

Three consequences of the new round of sanctions:

  1. They could reduce demand from small and medium enterprises.

Both the European Bank for Reconstruction and Development (which the EU will ask to halt new lending in Russia) and VEB, a bank sanctioned by the US, lend extensively to small and medium businesses. A cut in their lending will result in reduced investment and demand for B2B goods and services at a time when investment activity is already deeply depressed.

Chart: VEB will be prohibited from borrowing at maturities longer than 90 days on US capital markets

  1. Multiple industries could be see more expensive credit.

VEB and Gazprombank, the two banks the US sanctioned, lend extensively to the corporate sector, including industries such as oil and gas, metallurgy, machine-building, chemicals, and others. 40% of VEB’s lending in 2013 was for infrastructure. Interest rates for corporate customers of both banks are likely to increase, hitting multiple industries at once.

  1. Lending in Belarus could also be hurt.

Subsidiaries of VEB and Gazprombank hold almost 10% of the Belarussian banking market and are largely dependent on parent-bank financing. Their lending activity and cost of credit is likely to be negatively affected by the US sanctions, affecting some MNCs’ corporate customers in Belarus.

Understanding how the new US sanctions work:

The banks sanctioned by the US – VEB and Gazprombank – are among the largest in Russia. They lend primarily to corporate customers across multiple industries and much of their portfolios consist of long-term loans. To finance these loans, they need to borrow at long maturities on international financial markets, which is exactly the kind of borrowing that US sanctions have restricted. Their alternative sources of long-term capital are notably more expensive and would require them to increase lending interest rates, hurting the businesses to which they lend. Because of the size of these banks, increases of their interest rates are likely to have a spillover effect across the Russian banking sector as a whole.

View the video below to see FSG’s Martina Bozadzhieva discuss investing in Ukraine and Russia on CNBC yesterday.