US sanctions over Russian attack on Ukraine could disrupt financial markets
The standoff prepared investors for further volatility this week, with stocks already struggling amid inflation concerns and signals from the Federal Reserve of an interest rate hike next month.
A White House statement on Friday that the Russian military could rush to Kiev at any moment slashed the Dow Jones industrial average and pushed up prices for Treasuries and gold.
During a conversation lasting more than an hour, Biden on Saturday warned the Russian leader of “swift and significant costs” if he attacked Ukraine. Administration officials insist that any allied response this time around will be much harsher than the sanctions imposed following Russia’s 2014 takeover of Crimea.
“It was supposed to cost them money. This time it’s supposed to blow them up,” said Brian O’Toole, a former Obama administration treasury sanctions official who is now with the Atlantic Council.
The prospect of severe financial sanctions, likely targeted at Russia’s state-owned banks, is meant to deter a Russian invasion by highlighting the danger of capital outflows, a falling currency and bank runs. Russian investors have already paid for Putin’s belligerence: the benchmark RTS stock index is down about 25% from its late-October high.
But the sanctions could also boomerang the US and European economies, especially if Putin retaliates.
Although its role in the global economy is not comparable to that of China, Russia is a key supplier of critical materials, such as titanium for Boeing planes and palladium for automotive catalytic converters. More than 400 US companies have a major supplier based in Ukraine and 1,100 have a “Tier 1” supplier in Russia, according to Interos, a supply chain risk management firm in Arlington, Virginia. US agribusiness giants such as Cargill and ADM have operations in Ukraine.
Putin could also respond to the sanctions by unleashing crippling cyberattacks on power grids, banks or corporate networks in the United States or Europe, further rattling investors.
“A ground war in Europe is something that would probably shock the complacency of financial markets more broadly than people appreciate,” said Douglas Rediker, partner at International Capital Strategies. “I don’t know how many analysts or investors are remotely prepared to understand the ramifications of this.”
The three major U.S. stock indexes have already lost ground so far this year as the highest inflation in 40 years caused the Fed to raise borrowing costs for the first time since 2018. The hardest hit was the tech-heavy Nasdaq, which is down. nearly 12% since January 1.
The financial fallout from Russian action against Ukraine would depend on the scale of the attack and the extent of US and allied sanctions subsequently imposed. A full-scale air, artillery and ground offensive to seize the country would likely elicit a more punitive US response than a limited move into the separatist Donbass region in eastern Ukraine.
On Sunday, Sen. Lindsey O. Graham (RS.C.) told ABC’s “This Week” that Congress should quickly approve legislation authorizing sanctions “that would destroy the ruble and cripple the Russian economy.”
The ruble fell more than 3% against the dollar on Thursday and Friday and is now worth less than half its value at the start of 2014. Further weakening of the Russian currency would make imported goods more expensive for Russian consumers, exacerbating the inflation which is already running at an annual rate of almost 9%.
Russian banks are likely to be the main target of US sanctions. The five largest – Sberbank, VTB Bank, Gazprombank, Rosselkhozbank and Otkritie – account for more than 60% of banking system assets, according to the Institute of International Finance (IIF).
More than half of Russian salaries and pensions are paid through Sberbank alone. Tough sanctions targeting the institution, majority-owned by Russia’s central bank, could trigger a run on depositors, analysts said.
Barring US banks and businesses from doing business with one or more of these institutions could seriously hamper the ability of Russian banks and businesses to send money across borders. This would jeopardize Russia’s more than $700 billion in bilateral trade flows, especially with European companies.
As part of what one analyst calls a “Fortress Russia” strategy, Putin has in recent years developed a national payment system known as SPFS. Although it can process all financial transactions in Russia, its international links are limited.
“We’re talking about the plumbing of the financial sector here,” said Elina Ribakova, IIF’s deputy chief economist. “If Russia were disconnected, it would have a devastating effect.”
In other respects, however, the Russian economy is less exposed to external pressures than when Putin took control of Crimea. Since mid-2014, Russia has reduced its total external debt to $478 billion from $733 billion.
Russian borrowers owed global banks $121.5 billion at the end of September, according to the Bank for International Settlements in Basel, Switzerland. That’s about half the amount they owed at the start of 2014.
French and Italian banks have the largest positions, at around $25 billion each. But US banks owe $14.7 billion.
The reduced need for foreign financing is the result of Russian government policy and past sanctions, which effectively forced Russian borrowers to repay their debts as they came due rather than refinance them, Ribakova said.
Thanks to high oil prices, Putin was also able to build up a war chest of foreign exchange reserves, which could be deployed to defend the ruble against attacks or to bail out injured state banks. The Russian central bank now has $630 billion, up from $356 billion in spring 2015.
Although Russia has tightened its ties with the US-dominated global financial system, industries and individual companies retain vital bilateral ties. The country is a major supplier of many industrial metals and fertilizers, as well as oil and gas.
Global companies with Ukrainian or Russian suppliers could also face supply disruptions in the event of a major dispute, with or without the added complication of sanctions. Many companies could turn to other sources of goods or materials.
“But it would take time to find those alternatives and get contracts in place,” said Jennifer Bisceglie, chief executive of Interos.
Dan Ujczo, a commercial lawyer with Thompson Hine in Columbus, Ohio, said clients have sought advice on the possible effects of sanctions on multinational companies with operations in the United States, Ukraine or Russia.
“The Black Sea region is quite important for our customers,” he said. “There have been a lot of concerns.”
Russia’s prominence in commodity markets is also attracting attention amid geopolitical confrontation.
The price of palladium, used in catalytic converters, has risen more than 30% since mid-December. And the US aircraft industry depends on Russia for the titanium used in jet engines. Just three months ago, Boeing signed a “memorandum of understanding” with VSMPO-AVISMA, a titanium producer, confirming that it would remain the largest supplier of Boeing aircraft.
The Russian company’s titanium parts are used on the 737, 767, 787, 777 and 777X models, as well as products manufactured by Airbus, Rolls-Royce, General Electric and Pratt & Whitney.
If titanium supplies were interrupted, “we’re protected for a while, but not forever,” Boeing CEO David Calhoun told investors last month.
On Friday, national security adviser Jake Sullivan promised that the United States – along with the United Kingdom, the European Union and Canada – would impose “tough economic sanctions” on Russia after any attack.
“It will face massive pressure on its economy and export controls that will erode its defense industrial base,” he told reporters.
Any new constraints would come on top of existing measures imposed following the invasion of Crimea, which restrict the access of Russia’s financial and energy sectors to capital markets. The United States also prohibits Russian oil giants from obtaining the most advanced exploration technologies for use in the Arctic offshore or shale formations.
Further restricting Russia’s economic development without inadvertently harming US or allied economic interests will be a delicate task.
Indeed, the US was forced to backtrack in 2018 on sanctions it imposed on Rusal, an industrial metals producer controlled by Russian oligarch Oleg Deripaska. After the Treasury Department announced the measures, aluminum prices soared 30%, prompting complaints from US manufacturers who used aluminum to make products such as cars and drink cans.
The measures were eased 17 days later and eventually repealed after Rusal and a second company controlled by Deripaska agreed to restructure to reduce its stake.
“There is no way to avoid collateral damage. That’s what happens with any sanctions program,” said Doug Jacobson, sanctions specialist at Jacobson Burton Kelley in Washington. “There’s going to be collateral damage for American businesses.”