Five months have passed since Europe and the United States imposed and financed Russia, a G20 country that was the 11th largest economy in the world on the eve of its invasion of Ukraine. Although the sanctions have been gradually tightened in the intervening months, the debate about their effectiveness, the broader implications of the war for markets and the world economy, and what the West should do next is intense.
Regarding the first question, although the sanctions have been less effective than Europe and the United States expected, also The Russian Central Bank expects GDP to contract by 8-10% this year, while other forecasts foresee a larger drop, along with more lasting damage to growth potential. Imports and exports have been severely disrupted, and foreign investment inflows have virtually stopped. Scarcity multiplies, pushing inflation up. At this time, the country no longer has a properly functioning foreign exchange market.
The sanctions would have been much tougher if the West had not opted for a partition of the Russian energy sector, and if many more countries had joined the United States and Europe in the effort. Because that didn’t happen, Russia hasn’t felt as much pressure as it would have. In addition, it has been able to continue trading through various side and back doors that are likely to become increasingly important as the sanctions regime continues, as
However, it is only a matter of time before the Russian economy takes a bigger hit. Inventories of imported goods – including many critical technological and industrial inputs – are rapidly declining, and many sectors are becoming less resilient. The accumulated damage to the Russian economy will be significant and long-lasting, a fact that has not yet been fully captured by consensus forecasts in the medium term.
The second issue concerns the global effects of the war and the sanctions regime. Most observers agree that the Russian invasion has increased not only energy insecurity, but also food insecurity, highlighting the consequences of the disruption of Ukrainian agricultural exports. However, there is still a lot of debate about the West’s use of the nuclear economic sanctions option: the restrictions placed on the Russian central bank and Russia’s use of the
These curbs are far more intrusive than the usual mix of government and private sector sanctioned restrictions on trade and financial transactions by individuals. However, as they are not subject to internationally agreed standards, guidelines or controls, they fall outside the purview of relevant global governance bodies such as the Bank for International Settlements, the International Monetary Fund and the World Trade Organization.
In times of war, this kind of supervision might seem like a detail. But some worry that the sanctions could significantly reduce the dollar’s role as the world’s reserve currency and the role of the US financial system as the main global intermediary for other countries’ savings and investments. After all, there is no doubt that a growing number of countries now feel more vulnerable to the reach of US sanctions.
But it is impossible to replace something with nothing, which means that there will be no significant loss of the dollar or of America’s financial primacy in the immediate future. Rather, the sanctions will give further impetus to the gradual process of globalization, which was also fueled a few years ago by the tariffs imposed by the Trump administration. More countries now have even more reason to seek greater financial resiliency and inherently inefficient forms of self-insurance.
This brings us to the third debate. With the end of the war in sight, what should the West do next? Fearing the implications for energy prices and gas supplies to Europe, many in the West are tempted to call for a moratorium on any new sanctions, or even to make more exceptions. Others, however, are in favor of additional measures to hold Russia responsible for its indiscriminate attacks against the Ukrainian civilian population.
In any case, the maintenance of the current sanctions regime is not without problems, due to the double objective of putting pressure on Russia and limiting economic disruption in Europe. Furthermore, as the President of the European Commission, Ursula von der Leyen, recently said, it seems that Russia is “blackmailing” Europe by threatening to cut off gas supplies at any moment. It is not surprising that the Commission urges member countries to reduce consumption by 15%.
With the current sanctions regime, the West risks falling between two horses. While the easing of sanctions could help alleviate concerns about Europe’s economic prospects, this option is not feasible, given the atrocities that Russian forces are committing in Ukraine. But if the West is serious about putting pressure on Russia through truly crippling economic and financial sanctions, it needs to turn the tide and scrap energy cuts.
Doing so would undoubtedly have a serious short-term economic impact on European economies and the rest of the world, amplifying the “small fires everywhere” syndrome I warned about in May. Therefore, it is essential that governments use the fiscal space they have to provide targeted support to vulnerable segments of the population, as well as to fragile countries; and multilateral agencies must support developing countries through aid and a more operational framework for debt relief. If done well, this option would give better results in the medium and long term than the current strategy.
If you go ahead, you risk the worst of all possible worlds. It is not enough to deter Russia from continuing its illegal war; it is fueling further fragmentation of the international monetary system; and it’s not even protecting Europe from a winter gas outage.
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