U.S. USES CAPITAL MARKETS SANCTIONS TO CUT DEEP INTO RUSSIAN ECONOMY / THE FINANCIAL TIMES

July 17, 2014 6:34 pm

US uses capital markets sanctions to cut deep into Russian economy

By Kathrin Hille and Courtney Weaver in Moscow and Geoff Dyer in Washington

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For weeks, the Obama administration has been searching for “scalpel” sanctions that will cut deep into Russia’s companies and economy as punishment for its actions in Ukraine but avoid significant blowback against American businesses.

The latest package of sanctions on Russia, which were unveiled on Wednesday, make use of a new weapon in the US armoury: blocking some of Russia’s most important companies from raising long-term finance in the US.

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Judging by the swift and angry reaction from Russia to the new round of US sanctions over Ukraine, the administration has succeeded in its first goal of inflicting economic penalties on Russia. But it might not have insulated the US from retaliation.

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While many Russian government officials and tycoons derided a first wave of sanctions announced in March as meaningless, they voiced concern that the new measures will hurt the Russian economy.

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“The sanctions that have been applied today in fact mean a blow to major Russian companies that are leaders in their sectors, be it the energy or the banking sector,” said Andrei Kostin, chairman of state-owned VTB, Russia’s second-largest lender. “Quite a significant negative effect will be caused to the global financial banking system as a whole and our economic co-operation.”

In private, Russian business leaders are even more outspoken. A senior official at a large Russian state bank said sectoral sanctions were equivalent to an act of war. “You cannot just look at the purely economic and financial impact. It will develop into some illogical and completely blown-out-of-proportion fight,” he said.

He added that Russia was likely to respond harshly to full sectoral sanctions with measures such as nationalising assets of US oil companies and banks in the country. “Citibank will just disappear here overnight,” he said.

One reason for the panic is the sense that Washington is using an asymmetrical weapon by exploiting its dominant position in the global financial system. The first wave of sanctions introduced in March already gave Russia a flavour of how powerful an instrument this can be. The earlier measures were limited – they froze the assets of some Russian government officials and business leaders and barred US persons from carrying out transactions with them.

But the fear of harsher steps to come effectively froze Russian banks and corporates out of the international capital markets overnight. International bond issuance out of Russia almost dried up, and foreign banks became reluctant to extend new credit lines.

With western governments slow to proceed to the next stage, the situation had relaxed in recent weeks, allowing state lenders Sberbank, VTB, Gazprombank and Promsvyazbank to raise fresh funds. “The appetite on the international capital markets is smaller but there is still appetite,” the senior state banker said earlier this week.

That could now change for Russian corporates, which have to repay $95.4bn in foreign debt before the end of the year. “For the four directly affected companies, access to the global market is much more limited, and investors are also likely to start placing a political risk premium again on all Russian companies, so the cost of borrowing will go up,” said Vladimir Tikhomirov, chief economist at BCS Prime, a Moscow brokerage.

A senior US official said that one purpose of the new sanctions was to make investors and companies more cautious about dealing with Russia.

“I think we are anticipating both direct costs with respect to those entities and for the market to recognise the seriousness with which we’re taking the situation,” he said.

At the same time, the new sanctions have been tailored to address some of the concerns of the US business community. For example, the measures do not prohibit equity deals with Rosneft and Novatek, the two Russian energy companies targeted on Wednesday. That could help US energy groups as well as Morgan Stanley’s planned sale of its oil merchant trading business to Rosneft.

Gazprombank, one of the sanctioned banks, has $2bn in foreign debt due before the end of the year. It had planned to refinance a $1bn syndicated loan due in 2014 but there are concerns that it may need to abandon this. A $1bn Eurobond is due in December.

VEB, also a target of sanctions, has $1.3bn in foreign debt due in 2015 and $1.1bn in foreign debt due in 2016. It has $15.4bn in debt maturing in 2032.

“VEB’s strategy has been to rely heavily on US dollar wholesale funding,” suggesting that the government may now have to lend VEB money from its reserves, as it did during the 2008-2009 financial crisis, says Ivan Tchakarov, chief economist at Citibank in Moscow.

Mr Tchakarov predicts the central bank could potentially go ahead and raise rates now “which means it’s going to be even more difficult for companies and consumers to borrow”.

Copyright The Financial Times Limited 2014.