It has been five months since Europe and the United States imposed harsh economic and financial sanctions on Russia, a G20 country that was the world’s 11th largest economy on the eve of its invasion of Ukraine. While the sanctions have been gradually tightened over the ensuing months, debate rages over their effectiveness, the wider implications of the war for markets and the global economy, and what the next steps should be. West.
On the first question, although the sanctions have been less effective than Europe and the United States had hoped, they are also proving to be more onerous than the Kremlin claims. Russia’s central bank expects GDP to contract 8-10% this year, while other forecasters expect a bigger decline, as well as more lasting damage to potential growth. Imports and exports have been severely disrupted and foreign investment inflows have all but stopped. Shortages are multiplying, pushing inflation up. At this point, 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 an exclusion of the Russian energy sector and if many other countries had joined the United States and Europe in this effort. Because that didn’t happen, Russia didn’t feel as much pressure as it would have. Moreover, he was able to continue to trade through various side and back doors that will likely become increasingly important as long as the sanctions regime, as currently designed, continues.
Nevertheless, it is only a matter of time before the Russian economy is hit harder. Stocks of imported goods, including many essential technological and industrial inputs, are rapidly shrinking and many sectors are becoming less resilient. The cumulative damage to the Russian economy over time will be significant and long-lasting, a fact that has yet to be fully captured by consensus medium-term forecasts.
The second question concerns the global fallout from the war and the sanctions regime. Most observers agree that the Russian invasion increased not only energy insecurity but also food insecurity, underscoring the fallout of the war’s disruption on Ukrainian agricultural exports. But there is still much debate about the West’s use of the nuclear economic sanctions option: restrictions on Russia’s central bank and Russia’s use of the international payment system.
These restrictions are far more intrusive than the usual mix of restrictions on government-sanctioned and private-sector trade and personal financial transactions. Yet, because they are not subject to any internationally agreed standards, guidelines or checks and balances, they fall outside the purview of relevant global governance bodies such as the Bank for International Settlements, the International Monetary Fund and the United Nations. ‘World organization of commerce.
In times of war, such an oversight may seem like a subtlety. But some worry that the sanctions will drastically reduce the dollar’s role as the world’s reserve currency and the role of the US financial system as the primary global intermediary for other countries’ savings and investments. After all, a growing number of countries no doubt now feel more vulnerable to the reach of US sanctions.
But it is impossible to replace something with nothing, which means that no significant loss of US dollars or financial primacy will occur in the immediate future. On the contrary, the sanctions will give new impetus to the gradual process of global economic fragmentation, which was also fueled a few years ago by the tariffs imposed by the Trump administration. More and more countries now have even more reason to seek greater financial resilience and inherently inefficient forms of self-insurance.
This brings us to the third debate. With no end in sight for the war, what should the West do next? Fearing the implications for energy prices and gas supplies to Europe, many Westerners are tempted to call for a moratorium on any new sanctions, or even additional bans. Others, however, favor additional measures to hold Russia accountable for its indiscriminate attacks on Ukrainian civilians.
In any case, maintaining the current sanctions regime is not without problems, due to the dual purpose of putting pressure on Russia and limiting economic disruption in Europe. Moreover, as European Commission President Ursula von der Leyen recently said, it feels like Russia is “blackmailing” Europe by threatening to disrupt gas supplies at any time. No wonder the Commission is urging member countries to cut consumption by 15%.
Under the current sanctions regime, the West risks falling between two horses. While easing sanctions could help ease concerns about Europe’s economic prospects, this option is not an option given the atrocities Russian forces are committing in Ukraine. But if the West is serious about pressuring Russia through truly crippling economic and financial sanctions, it must bite the bullet and eliminate the energy exclusions.
This would undoubtedly have a serious short-term economic impact on European economies and the rest of the world, amplifying the “little fires everywhere” syndrome I warned of in May. It is therefore essential that governments use their available fiscal space to provide targeted support to vulnerable segments of the population, as well as to fragile countries; and multilateral agencies should support developing countries through aid and a more operational debt relief framework. If done correctly, this option would yield better medium to long-term results than the current strategy.
Navigating through risks resulting in the worst of all possible worlds. This is insufficient to deter Russia from continuing its illegal war; it fuels a deeper fragmentation of the international monetary system; and it doesn’t even protect Europe from a winter gas break.
The author is a professor at the Wharton School of the University of Pennsylvania
Copyright: Project Syndicate, 2022.