It’s been quite an eventful past month for Russia, to say the least. On March 18th, Putin sailed to his expected victory in presidential elections, having achieved the Kremlin goal of over 70% voter support and nearly 70% voter turnout. Meanwhile, the fallout from an attempted murder of an ex-spy in the UK, further sanctions by the US, and events in Syria have dampened this post-election mood, deteriorating Western-Russian relations to arguably their worst level since the early 1980s. Businesses are all wondering: what is next? And what does it mean for the economy?
Sentiment took a major and immediate hit by these geopolitical tensions as both the ruble (chart below) and the Moscow Stock Exchange fell by roughly 10% in one day. The oil price likewise shot up – in fact supporting the ruble – well beyond $70/bbl from the upper 60s. This dramatic impact is sentiment-driven and is likely to be short-lived. However, the risks that drive it are here to stay, and will contribute to future periods of volatility.
Ironically, Trump’s greatest weapon is his unpredictability – a taste of Putin’s own medicine.
Market panic began in the immediate aftermath of the US’s announcement of sanctions and Trump’s threat to bomb sites in Syria in light of the latest chemical attack there. On April 6, the US Treasury Department imposed sanctions against 24 Russians and 15 related companies in response to 2016 election meddling. Just days later, following Assad’s chemical attack in Syria, Trump tweeted threats that Russia would have a “big price to pay” and to “get ready” for US missiles in Syria.
The sanctions themselves were designed to intentionally increase this rise in volatility. By sanctioning seven high-level oligarchs (including Oleg Deripaska, one of Russia’s richest men) and officials with such close proximity to Putin (in most cases), the US government sought to introduce unpredictability into its sanctions regime going forward, leaving markets and world leaders wondering what the US would do next. The US sent the clear message that any Russian oligarch is vulnerable to sanctions, unless they actively distance themselves from Putin.
What’s new in these latest sanctions – and in part what worsened sentiment so markedly – was that the new sanctions impact those people on the list as well as their associated business partners if they conduct “significant transactions” in the interests of those sanctioned. Likewise, citizens and corporations of other nations are at risk of being sanctioned if they continue business with people on the new list (or contractors).
With regard for the potential for a military conflict between the US and Russia, this remains very low likelihood. Most likely, Trump will fulfill his threat and order the bombing of various strategic military sites of the Syrian regime – as he did in 2017 after that chemical attack – to punish the Assad regime. A further military escalation beyond these anticipated strikes by the US in Syria is unlikely at this point. In fact, these attacks are, in part, meant to serve as a deterrent to both Assad and Putin over their activity in Syria in order to de-escalate the conflict.
On the sanctions front with Russia, the next immediate concern would be retaliation by Russia, ever eager to make a political statement. It remains unclear how the Russian government would respond. After the US/EU sanctions in 2014, Russia banned Western imports of food and dairy products. An expansion of this list is possible. Alternatively, the government could begin targeting US firms’ operations in the country (veiled threats, increased inspections, delays at customs, registration complications, regulatory compliance issues, etc. – see our HBR piece here on this topic). Either of these steps is a concern for businesses and increases uncertainty in the market, making it harder to argue for additional investment even as the country experiences a modest recovery.
While Russia may retaliate in some way, ultimately, the Kremlin is incentivized to de-escalate the conflict. Russia has far more to lose economically from a deeper deterioration of relations with the West in light of the tightening and expansion of sanctions, with more oligarchs and firms potentially included.
Still, while Russia may not actively up the ante and worsen relations, Russia is unlikely to change its current posture (cyber attacks on the West, meddling in Western political systems, support for Assad’s conduct of the war, etc.), ensuring a gradual deterioration of relations over time, with periodic upticks in the disputes. This will inevitably create volatility and consistently declining sentiment for the Russian economy.
On the US side, there is likewise little reason to see the impetus for an improvement in relations. In fact, in March and April, we may have seen a turning point in Trump’s policy towards Russia. Clearly, long gone are the days of believing a in rapprochement and even cooperation on global issues between Trump and Putin, as some saw upon Trump’s inauguration. Rather, with diplomat expulsions, further sanctions, and (at this point) threats regarding Russia’s implicit support for the latest chemical attack in Syria, marked the first time the Trump administration took a decisive action against Russia, not to mention coordinated with Western allies. Add to this the appointments of notable Russia hawks as Secretary of State and National Security Adviser, and you can anticipate more pressure on Russia is likely coming.
Thus, with relations to likely remain strained or even sour further, we are first likely to see more diplomatic expulsions and visa/travel restrictions as well as an expansion of the sanctions list against more oligarchs and companies in the next period of increased tensions. Down the line, the next sanctions could involve asset freezes on specific oligarchs and officials very close to Putin’s inner circle. Most threatening – and with the most clear and negative impact on the Russian economy – would be bans on the purchases of Russian sovereign debt as well as Russian banks (Sberbank, in particular). Limits to Russia’s energy exports could also be a more distant risk.
What it means for business
Interestingly, from our latest discussions with clients in Moscow, the mood was distinctively split. MNC managers heading the Moscow office feel distinct growth of opportunities in the economy matched by another feeling of deterioration of international relations, hurting headquarters’ investment sentiment. This was prior to this latest confrontation with the West. Fairly or unfairly, this latest deterioration of relations is confirming suspicions towards the market and could undermine or delay investment decisions.
Fortunately to this point, there has not been and should not be a notable impact on the Russian economy as whole, despite assured further future volatility. The question for businesses is how to react to and manage volatility in sentiment, not a drop in economic fundamentals. For businesses, the primary impact of this volatility will be internal: headquarters may seek to reduce risk around Russia. Making the case for investment in Russia’s growing market is critical at this time to help companies take share away from competitors as consolidation accelerates across many sectors. Postponing investment at this time could undermine these strategic objectives. Externally, certain key customers may be more exposed in light of relationships with particular sanctioned individuals or corporations, so understanding that exposure becomes important as sanctions may very well expand. Likewise, firms may need to become less flexible in their payment terms, strictly demanding payment on time or even pre-payment, amid increased fears of a further escalation of tensions between Russia and the West.