Streetwise Professor

July 29, 2014

‘Tis But a Scratch

Filed under: Economics,History,Politics,Russia — The Professor @ 9:10 pm

I owe the Euros an apology. It turns out that they did implement most of the sanctions recommended in the “non-paper.” So it proved to be more than an orphan straw man.

That said, upon further consideration, there is less here than could have been hoped for. Indeed, these sanctions will impose little real damage on Russia.

There are three major pieces of the new European sanctions. First, Europeans (including foreign subsidiaries and branches of non-EU banks) are prohibited from buying new equity or debt with maturity of greater than 90 days from Russian banks with more than 50 percent state ownership. Second, there is a ban on the sale of oil technology and equipment. Third, there is an arms sales ban.

The US has implemented similar measures, with one peculiar exception: Sberbank is not included in the US sanctions, though it is in the European sanctions.

The bank sanctions are getting the most attention, but they are hardly devastating. I only had enough time today to look at the international borrowings of Sberbank, VTB, and VEB. Sberbank’s foreign debt borrowings total only about 4 percent of its total liabilities, and only a small fraction of those mature in the next year. Therefore, the sanctions put no immediate pressure on Sberbank, especially since it still can borrow from US persons. VTB’s foreign debt with maturities in 2014 and 2015 is no more than 6 percent of its total liabilities: I can’t be more precise because its financial statements only report broad maturity categories. VEB’s total Eurobond issues are about 8 percent of its liabilities: again, only a fraction of these are due in the next year or so.

Loss of this funding would be something of a strain, but the sums involved could readily be replaced by drawing on Russian foreign reserves and borrowing from non-EU and non-US banks.

What’s more, a little financial engineering permits these institutions to circumvent the effect of the sanctions. It seems that they can still enter into derivatives trades: derivatives are explicitly excluded from US sanctions. Since under the sanctions the banks can still borrow with 90 day maturities, they can create a synthetic long term loan with a fixed interest rate by borrowing for 90 days on a rolling basis, and enter into receive floating-pay fix swaps. Yes, there still is some risk here: if sanctions are extended to prevent even short term borrowings, the banks following this strategy would have a short swap position and no offsetting floating rate borrowings.

In brief, the sanctioned banks aren’t heavily dependent on European or US debt markets for their funding; the Russian government has the resources to cover this funding gap; and there is a somewhat riskier alternative (borrow short-term and hedge via swaps). Thus, although it would be unfair to say that the financial sanctions merely damage a few capillaries, it is definitely the case that they don’t come anywhere close to striking at Russia’s financial jugular. They are annoyance, and no more.

It is also important to note that the European sanctions do not target Rosneft. So the Russian oil company still has access to European (and Asian) debt and equity markets. As I noted before, this significantly cushions the blow on the Russian firm.

Insofar as the weapons ban is considered, it is largely symbolic because Russia builds most of its own weaponry. Predictably, existing deals are exempted. Meaning that France can continue with its sales of Mistral assault ships.

A bigger threat to the second Mistral sale is yesterday’s arbitration verdict in the Yukos litigation. If Russia doesn’t pay the $50 billion by January-a metaphysical certainty-the winning claimants can move to seize non-diplomatic Russian government assets in countries that are signatories to the New York Arbitration Convention. Conceivably the claimants could attempt to seize the second Mistral-the Vladivostok, ominously slated for service in the Med and Black Seas-while it is still in France. But no doubt the Russians and French could circumvent this by transferring ownership only after the ship had sailed to Russia. (As an aside, the main effect of the arbitration verdict will be to ensure employment of large number of lawyers for years, because the Russians will fight every attempt to enforce the award by seizing government assets abroad tooth and nail. It is a welcome verdict, but its immediate financial impact on Russia will be pretty much nil.)

The sanctions on oil equipment will have little impact in the near term, and since the European sanctions are time limited, their effect will be diminished even further.

In sum, the new sanctions are far beyond what had been imposed before, but they are still not that damaging to Russia. Putin can legitimately say “’tis but a scratch,” and not in the Black Knight, Monty Python, I’m not going to admit I’m wounded sense.

The United States in particular still has the power to leave Putin financially limbless and bleeding, pitifully claiming his invincibility. But that would require hacking away with a real banking broadsword: cutting off Russian access to dollar markets altogether. But there is no appetite to do this in the west: the Europeans had to screw up their courage to the sticking place to implement even these limited sanctions. And Obama has little appetite for this either: his sanction announcement today was delivered in a listless, phone-it-in fashion, before he ran off to fly to Kansas City for some silly event involving meeting people who had written him letters. He is obviously not engaged in this at all.

The Europeans and Obama believe that they are engaged in a nuanced strategy of graduated escalation that will convince Putin that continued attempts to subvert Ukraine through force will eventually result in Russia incurring unbearable financial costs, and that this will deter him from going further.

Ask the shades of LBJ and McNamara about how hardened dictators interpret graduated escalation. They interpret it as a signal of weakness, not resolve. If anything, it urges them to go further. I would anticipate that this will be true today, with Putin.


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  1. There is nothing to worry about. European politics suck in a very bureaucratic way.
    If it were not the 298 dead from the MH17 that was shoot down by Putler, European politicians would implement not a single meaningful sanction at all.
    I myself am not a fan of Obama administration either, but in one he has right: shooting down of Malaysia Airlines civil flight 17 was a game changer and eye opener for most Europeans.
    P.S. I am from Bulgaria – till now one of the most pro-Russian countries in all Europe and even here the Putinophobes are increasing on a daily basis by hundreds if not thousands.
    P.S.2 Sorry for my broken English!

    Comment by Europeo — July 29, 2014 @ 10:01 pm

  2. @Europeo-Welcome to SWP. Thanks for commenting. I agree with everything you said re the Europeans. My basic take on the EU is that it exercises excessive power and control where it is not needed (through excessive regulation of private transactions, and its mania with standardizing practices across diverse countries) while it is utterly powerless and feckless in things that really matter (foreign & energy policies vis-a-vis Russia being the prime example).

    No need to apologize for your English. It wasn’t broken at all.

    The ProfessorComment by The Professor — July 30, 2014 @ 8:58 am

  3. In the meantime, Lavrov asking not to be thrown into the briar bush…

    Comment by Bypass — July 30, 2014 @ 9:48 am

  4. Sberbank isnt sanctioned by EU

    Comment by erik — July 30, 2014 @ 10:13 am

  5. @The Professor, I totally agree with you. It is annoying to see that the EU hesitated to fight for principles and now it will need to fight for power. If these sanctions were placed in action a few months ago, right before the illegal anexation of Crimea by Putler’s green anonymous army maybe Ukraine would not have lost control over Luhansk and Donetsk.
    How about the energy policy – EU has no energy policy, thus putting enormous strength on small and dependent on Russia’s gas countries, just like the one I live in. This could only help Kremlin to put in place marionette governments in countries where it has strategic interests, which was the case with Bulgarian so called “Oresharski Government” (Oresharski himself being Kremlin’s puppet operated by Russian mafia). Time is running out for Europe to cut all its ties with Russia in energy sector and to rebuild its energy relations with the USA. Tomorrow will be too late.

    Comment by Europeo — July 30, 2014 @ 11:24 am

  6. @Europeo – your english is fine – all the more so because it is heartfelt and to the point. I am not bulgarian but have lots of Putinophiles in the Balkan “Orthodox” community and even these fools are beginning to realize that Putin and his enablers in the Church, The Society of Demented Slavophiles and wannabe Stukatchi / toadies are either/ and / or :deluded, corrupt, intellectually bankrupt and most closely resemble an illustration from the Classics Comics’ version of Freud’s “Society and Its Discontents”.

    Comment by sotosy1 — July 30, 2014 @ 11:44 am

  7. @erik-The official list will not be published by the EU until tomorrow (Thursday). All of the reporting states that the sanctions will be imposed on banks that are more than 50 percent government owned, and Sberbank (which is 50+ pct owned by the Russian Central Bank) would qualify.

    Of course, all the reporting could be wrong. In which case the sanctions would be even more lame than I thought.

    The ProfessorComment by The Professor — July 30, 2014 @ 1:32 pm

  8. @perfesser: the point about evaluating the sanctions is not just how they affect the party being sanctioned, but the willingness of the “sanctioning” party to inflict pain on itself. Of course the ideal sanction is one where only the party being punished is hurt, and it certainly makes sense to use those sanctions that hurt the foe most, while costing the least. Given the above, is Sberbank is excluded, it would be interesting to see who has been dealing with them recently in the EU.

    Be that as it may, until the Eurotards, particularly the Krauts, are willing to put up with some mild discomfort- say little gas till winter- the message will be clear that when push comes to shove, Putin will pay little and the sanctions will be, to coin a phrase, “sound and fury signifying not a hell of a lot”.

    Comment by sotosy1 — July 30, 2014 @ 2:03 pm

  9. @Europeo-As Churchill said: “You had a choice between war and dishonor. You chose dishonor, and now you will have war.” Or should that be: “EU had a choice between war and dishonor. EU chose dishonor, and now EU will have war”?

    Russia plays divide and conquer on energy like Pablo Cassals played a cello. It focuses on weaker and more corrupt countries,and those that are most dependent on Russian gas (as you note). I have some sympathy with Bulgaria. I have nothing but disdain for Austria and Italy.

    The ProfessorComment by The Professor — July 30, 2014 @ 6:04 pm

  10. @sotosy1, I believe every word that you say. I feel happy to not maintain any contacts with such an “orthodox” movement in my country. In fact bulgarians are not slavic. We have more in common with greeks than with slavs. Aside, most bulgarians are not as white skinned and blue eyed as poles, czech, lithuanians are. It might be correct to also mention that most bulgarians are atheists (an ancestry from the communist dictate) and this makes it even difficult for Russia to invoke the orthodox card 😉 Well, not-slavic and atheists makes one just wonder why are Bulgarian governments so pro-Kremlin… and here comes the answer – corruption.

    Comment by Europeo — July 30, 2014 @ 6:20 pm


    All right, anyone is willing to comment on this?

    Comment by LL — July 30, 2014 @ 7:30 pm

  12. @LL-Very funny. Just wrote a post on that very article. Read it, and fire away.

    The ProfessorComment by The Professor — July 30, 2014 @ 7:37 pm

  13. @erik-The EU sanctions list was released today. Sberbank tops the list (see p. 11).

    The ProfessorComment by The Professor — July 31, 2014 @ 10:15 am

  14. Europeo:

    Your English is better than Vlad’s (or SWP’s, for that matter) Bulgarian. No need to apologize.

    Vlad looks forward to your future comments.

    Vlad would tell all to follow him on Twitter, but @VJ44 permanently blocked him. Oh well.

    btw, Yesterday was Milton Friedman’s birthday. You should have noted it, SWP!


    Comment by Vlad — August 1, 2014 @ 7:57 pm

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