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German government seems resigned to the likelihood of a permanent loss of the Krim to the Ukraine;
  • more sanctions are becoming likely but real sactions would be costly - for both sides;

14.03.2014

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The road to sanctions

We have deliberately stayed away from the Ukraine/Russia story as it is mostly outside of our remit, but there are potential spillovers with a big effect on the eurozone economy. It remains our view, for now, that the German government is not serious about sanctions and that the ultimate response will be limited to grand-standing gestures rather than action. Frankfurter Allgemeine reports on its front page that Angela Merkel and her government are now resigned to the fact that the Krim will not remain part of the Ukraine and that sanctions would become likely. But what does that mean?

On its business pages the paper goes into some detail. Germany thinks of sanctions in three stages. Stage one is what happened at the last European Council -the suspension of the G8 meeting, the suspection of visa talks - largely symbolic stuff about which Vladimir Putin's cares little.

Stage two would be the freezing of accounts of rich Russians and travel restrictions on Russian tourists. The problem with the first is that all financial centres would have to participate. The latter might be more effective given the Russian taste for Mediterranean holidays.

Stage three would be genuine economic sanctions: a stop of Russian gas and oil imports. That revenue loss to Russia would be $100m per day, and would have a massive fiscal effect, since energy receipts constitute about half of the Russian state revenues. Germany imports 35% of its gas from Russia but has enough storage for sanctions not to cause energy shortages in the short-run. But such a scenario would lead to an immediate peak in energy costs for the economy and for households.

At that point, Russia would retailiate. The biggest concern for European investors in Russia would be a forced nationalisation. The Duma is already preparing legislation.

Germany could not sustain such a strategy through the winter. The gas supplies last about one winter month. That is why a sanctions strategy is very unlikely to happen, and if it were to happen, it would not be sustained. This is the price you pay for making yourself dependent on Putin's oil. The stretegy for now is the equivalent of what central bankers euphemistically call :"verbal intervention" - which seems to have become the policy tool of choice in all our battles: against Putin and against deflation and currency appreciation.
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