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A nation must think before it acts.
In early 2015, Western leaders thought they had Russia cornered. A year earlier they imposed on Russia economic sanctions, which ranged from restrictions on access to Western capital markets to bans on the export of oil-production technology, to punish it for its role in dismembering Ukraine. Those sanctions and the Russian boycotts that followed threw Russia’s economy into turmoil. With some justification, President Barack Obama declared that “Russia is isolated with its economy in tatters” in January 2015. But two years later, Russia has stabilized its economy, annexed Crimea, and kept its “little green men” in eastern Ukraine. What went awry?
In financial terms, Russia felt the most damaging impact of the West’s economic sanctions within the first year of their imposition. Suddenly, Russian companies, holding dollar and euro-denominated debt, had to repay their loans without the ability to refinance them. Russian banks targeted by Western sanctions saw their overseas assets frozen. That created a cash crunch. Many companies were forced to suspend operations and slash jobs; some even required government capital injections to survive. But they did survive.
Unfortunately for Russia, the West’s economic sanctions coincided with a steep drop in global oil prices. That, more than anything else, exacerbated Russia’s economic woes, since much of the country’s economy depends on the production of commodities, primarily oil. Oil prices plummeted from over $100 per barrel to under $35 per barrel in late 2015. But then they began to recover the following year. So too did the prices of other major commodities that Russia produces, including iron, aluminum, and copper. No doubt global economic growth, which boosted commodity prices, helped Russia to better ride out Western sanctions.
But the stabilization of commodities prices did not save Russia’s economy. With economic sanctions darkening the country’s outlook, the value of the Russian ruble was cut in half. At first, Russia’s central bank tried to defend it, consuming $200 billion in foreign exchange reserves in the effort. But ultimately, Russia’s central bank took a leaf from the International Monetary Fund’s market-based playbook and allowed the Russian ruble to float. That freed Russia’s central bank from having to defend the ruble and prevented an even greater outflow of hard currency that would have further undermined Russia’s economy.
Moreover, since commodities are generally priced in dollars, the sharply devalued ruble meant that though Russian companies faced falling prices for their goods, the dollars they did receive could be converted into more rubles. That softened the economic blow—enough so that Russian energy companies could continue to reinvest in their businesses. As a result, despite the sanctions on oil-production technology, Russia is able to produce more oil today than it did before the sanctions were imposed.
With shortages of imported goods and more rubles in circulation, inflation became a real threat. Rising prices ate away at the purchasing power of ordinary Russians. But rather than reflexively enact price controls, Russia’s central bank used another market-inspired lever. It raised interest rates, up to 17 percent by December 2014. Credit naturally dried up, further depressing the Russian economy. But fortunately for Russia, inflation was quickly brought under control. That allowed Russia’s central bank to gradually lower interest rates to 10 percent, giving Russian companies much-needed breathing room to recover.
In the depths of its economic recession, Moscow could have increased government spending to boost economic activity. But with falling revenues from Russian oil production, a surge in spending would have pushed Russia’s government budget deep into the red and fueled a potential economic crisis. Instead, Moscow exercised fiscal discipline. It held its spending in check and ran a budget deficit of only 3 percent of Russia’s GDP last year. When more funds were needed, Moscow raised taxes and dug into its two sovereign wealth funds, draining a third of their assets before oil prices stabilized.
Meanwhile, European companies, particularly German ones, gave Moscow hope. They were never keen on the economic sanctions against Russia. From the start, they lobbied German Chancellor Angela Merkel to water them down. After they were imposed in 2014, German direct investment into Russia evaporated. But only a year later, German companies returned, investing $1.8 billion into Russia. Last year, they invested another $2.1 billion, more than they had in the year before economic sanctions were imposed. Such continued investments have encouraged Moscow to question the strength of Western resolve.
The West’s economic sanctions have bent but did not break the Russian economy, despite its structural vulnerabilities. What steadied it was a combination of several factors, the most important of which were the stabilization of global commodity prices and the market-oriented policies implemented by Russian authorities. They made Russia’s economy more resilient and prevented an even deeper recession.
Ultimately, economic sanctions can make countries more vulnerable to global economic forces. But rarely do they deliver a knockout blow themselves. Western economic sanctions against Russia have proven the rule, rather than the exception. Ironically, the West’s success in spreading open-market ideas at Russia’s central bank may have inadvertently weakened the effectiveness of its own economic sanctions. If so, the further spread of such ideas could make economic sanctions even less effective in the future.