Russia is already feeling economic pain from its Ukrainian land grab—even without tougher sanctions from the West.
A fresh round of violence in Ukraine has prompted calls for Western leaders to ratchet up economic sanctions against the Kremlin.
But with capital flooding out of the country, the local stock market falling and Russia’s currency weakening, the seizure of the Crimea is turning out to be a costly move.
“Even if a diplomatic solution to the crisis can be found, this may not be enough to prevent Russia from sliding into recession over the first half of this year,” according to Neil Shearing, an economist with Capital Economics.
On Sunday, two members of the Senate Foreign Relations Committee said it was time to target industries critical to Russia’s economy.
“I think the time is now to rapidly ratchet up our sanctions, whether it’s on Russian petrochemical companies or on Russian banks,” said Sen. Chris Murphy, D.-Conn. “Yes, there will be economic pain to Europe (under tightened sanctions). But it’s time for them to lead as well.”
So far, the U.S. and European Union have imposed limited sanctions—including travel bans and asset freezes on about 30 close political allies of President Valdimir Putin. The White House is reportedly considering expanding the first round of sanctions by targeting additional individuals and adding specific companies involved in energy production.
Last week, the European Commission briefed member countries on the possible economic and financial impact of tougher sanctions on Russian energy, finance and trade sectors. Those countries have until Tuesday to respond to the proposed measures as the EU formulates its next move. But any European response will be tempered by the Continent’s heavy reliance on imports of Russian oil and gas.
Still, Russia’s reliance on those energy exports may prove to be an Achilles’ heel, say analysts. After a sharp run-up after the global recovery from the Great Recession in 2009, global oil prices have flattened for the last two years. With oil prices stalled, so has Russia’s gross domestic product, which fell from 4.5 percent growth in 2010 to just 1.3 percent last year.
“Unless Russia can reduce its dependence on the production of oil and other commodities and diversify and reform its economy, any recovery will likely remain fragile,” according to a Congressional Research Service report last month.
Those reforms include wider transparency into Russian companies and capital markets. The Russian banking system is still dominated by state-owned banks, and outside investment has been hampered by reports of widespread corruption, according to the Organization for Economic Cooperation and Development.
“Corruption is a serious burden on business in Russia,” the group said in a report last year. “According to business surveys, it is among the main obstacles to market entry and growth.”
Investors have grown even more skittish as the turmoil in Ukraine has sparked massive capital outflows. Some $70 billion has fled the country this year—more than all of 2013—sending the Russian ruble falling some 9 percent. That’s raised the prices that Russian consumers pay for imported goods, adding fuel to an inflation rate that hit nearly 7 percent last month.
To widen the financial pain, Western countries could also target financial transactions involving Russian banks and companies, further pressuring the ruble and putting added stress on Russia’s financial system.
Such a financial embargo would be most effective if coordinated with European banks. But even without Europe’s participation, U.S. financial sanctions could have a powerful impact thanks to the outsize role of U.S. financial institutions, according to Robert Kahn, a senior fellow at the Council on Foreign Relations.
“Because payments are cleared and settled by institutions that have U.S. ownership and participation, those sanctions by themselves can have a significant effect in breaking down transactions,” he told CNBC. “Even if it’s only one leg of the transaction that’s involved, if you can stop that piece of it, you can stop the whole transaction from going forward.”
A broad freeze on Russian financial transactions, though, also raises the risk of a full-blown Russian financial crisis, which would create a new set of problems for the global economy. With central bankers easing up on a five-year spree of money stimulus, and global growth showing signs of slowing, the pain from any harsher sanctions on Russia could be felt beyond its borders.
—By CNBC’s John Schoen. Follow him on Twitter @johnwschoen or email him.