Since early 2014, EU-Russia relations have been severely strained as a result of the ongoing conflict in Ukraine. Politicians, scholars and authors talk of a “new Cold War” that has economics and finance as its main battleground.
The EU, working alongside the US, has imposed an array of economic and diplomatic sanctions on Russian individuals and businesses (15 companies including OAO Gazprom, OAO Rosneft and OAO Transneft), lasting until July 2015, as well as targeting certain key sectors of the Russian economy.
In addition, Brussels has requested the exclusion of Russia from the G8 summit, OECD and International Energy Agency and has suspended the implementation of EU bilateral cooperation programs. Moscow responded with equal measures by introducing a one-year food embargo against the US, EU, Norway, Australia and Canada, blocking an estimated $9 billion worth of agricultural exports.
Not to mention both players have faced turbulent domestic pressures: Europe has been on high alert, boosting security measures in the wake of the recent attacks on Paris, as well as trying to contain anger expressed by the regions far-right movements causing distress in various capitals.
Meanwhile, Russia has struggled to prevent a currency crisis turning into an economic catastrophe. Oil prices have reached an all-time low averaging approximately $50 per barrel resulting in a $45 billion drop in revenues for the oil-exporting giant, claims Finance Minister Anton Siluanov. Add Europe’s economic sanctions to the picture and it is fair to state that Russia’s economy has been hit hard, finding itself more isolated than ever before.
Implications for the Russian economy
The current political state of affairs is not favoring Russian companies and industries. Given the sudden slowdown in the Russian economy, financial analysts expect credit risks to escalate in the short term, especially for businesses dependent on imports.
The declining ruble further catalyzes this effect; as the currency depreciates, imports become more expensive and inflation subsequently rises. Finance Minister, Siluanov, said overall expenditure in 2015 must increase by 5%, not the 11.7% previously budgeted.
Russia has been further destabilized by low oil prices. Russia is one of the world’s largest oil producers, with oil and gas accounting for 70% of export incomes and 50% of tax receipts. According to BBC News, Russia loses about $2bn in revenues for every dollar fall in the oil price. World Bank predicts a Russian economic contraction of 2.9%.
At the moment, infrastructure spending is being sacrificed to protect welfare and defense budgets given Russia’s deep involvement in the Ukraine crisis. Russian bankers are demanding a “radical turn in economic policy” to improve the investment climate.
In late July 2014, the EU issued a series of economic and diplomatic sanctions on Russia, which aggravated the situation significantly. The sanctions were sent as a strong warning signal to Putin and his close inner circle. A main scope of the sanctions targeted major Russian banks and energy companies to restrict access to EU and US capital markets.
Due to the vast economic slowdown, Russian companies are cautious about investing in their domestic economy. A policy brief by the European Leadership Network states that capital investment needs to be at least at 25% of GDP if the economy is to grow, however this figure has shrunk by 42% compared to 2013.
Russians are breathing an atmosphere of tension. Restricted economic ties with its European counterparts have isolated the Russian economy and left domestic investors worried.
Implications for European economy
Europe imposed sanctions on Russia as punishment for the annexation of the Ukrainian region of Crimea. Russia responded by placing a ban on major food imports from European markets.
European leaders, including Hungarian Prime Minister, Viktor Orban, believe that Europe shot itself in the foot as sanctions are backfiring, especially against the nation considered Europe’s “engine of growth”: Germany, given its $88 billion bilateral trade with Russia and 6,000 German companies operating on Russian soil.
Europe is suffering the most from Russia’s food export ban. EU food exports banned by Russia in the summer of 2014, were worth an estimated €5.1 billion (4.2% of the bloc’s agricultural shipments). This resulted in a gradual decrease in agricultural prices and overproduction as Europe struggles either to find new markets or consume more of its own food.
EU foreign policy chief, Federica Mogherini, recently suggested that the EU could re-engage with Russia on global diplomacy, trade and other issues in return for gradual stabilization of the situation in Ukraine.
In a discussion paper distributed to heads of government ahead of a meeting between 28 EU foreign ministers in Brussels, Mogherini suggests complementing the negative spillover of the sanction war with Russia with a more proactive approach closely linked to the full implementation of the ‘Minsk Agreement’- truce accord in September involving Russia, Ukraine and pro-Russian rebels.
Gentle signs of rapprochement are clear. Newly-instated European Commission President Jean-Claude Juncker met with Russian President Vladimir Putin at the Group of 20 leaders in Brisbane, Australia while EU foreign policy chief, Mogherini, is set to visit Moscow in early 2015.
One main idea raised by the paper is the possible regrouping of EU sanctions into those directly tied to the Crimea annexation and others that could be lifted if the situation In East Ukraine is normalized. The former would stay in place as long as Moscow kept control of Crimea.
The other mention was of cooperation in 3 main sectors: foreign policy, trade and sectorial cooperation. In terms of foreign policy, it suggests greater EU-Russia cooperation in the fight against the Islamic state in Syria and Iraq as well as policy coordination in Libya and Iran. Formal trade links would be re-established together with resumption of discussion on updated bilateral trade and political agreement focusing on the rule-of-law cooperation and regulatory convergence.
Unfortunately, unfolding events in Ukraine are part of a larger picture involving the mobilization of U.S./NATO forces (clearly in preparation for potential direct military conflict with Russia). In this case, it makes sense for Russia to respond to the U.S. pre-emptive doctrine with an equally symmetrical doctrine leading to a Cold-War-style arms race.
History teaches us that a weaker Russia is potentially a more dangerous Russia. Europe stands in the middle and its leaders are slowly realizing the necessity of acting as mediators guided by economic pragmatism rather than strategic warfare.