You are on page 1of 3

This report is produced by Skandinaviska Enskilda Banken AB (publ) for institutional investors only.

Information and opinions contained within this document 1

are given in good faith and are based on sources believed to be reliable, we do not represent that they are accurate or complete. No liability is accepted for
any direct or consequential loss resulting from reliance on this document Changes may be made to opinions or information contained herein without notice.
Any US person wishing to obtain further information about this report should contact the New York branch of the Bank which has distributed this report in the
US. Skandinaviska Enskilda Banken AB (publ) is a member of London Stock Exchange. It is regulated by the Securities and Futures Authority for the conduct of
investment business in the UK.
Sanctions war will have little direct impact on growth
August 12, 2014
The European Union has entered what it
views as the toughest phase of its sanctions
against Russia, but is reluctant to go too far,
due to the self- interests of major EU
countries. The sanctions imposed so far
against Russia by the EU, the United States
and other Western powers and Russias
counter-sanctions will have rather little
direct impact on their respective economies.
Russias economy is moving towards
stagnation, but this is only partly because of
the sanctions. The economic recovery in the
central and southern parts of Eastern Europe
can continue, though at a somewhat slower
pace due to Russias weaker outlook.

The downing of a Malaysian Airlines passenger plane in
Ukraine on July 17 dramatically rekindled the Ukraine
crisis, following a two-month trend towards easing of
military and diplomatic tensions between Russia and
Ukraine, as well as between Russia and Western powers.
This event underscores our forecast in the May issue of
Nordic Outlook that the geopolitical conflict in eastern
Ukraine, including domestic discord, will last a long time.
The US and the EU have responded by toughening their
sanctions, which had previously encompassed only key
individuals in the business community and politics in
Russia and Ukraine. Today the EU sanctions list totals
more than 100 individuals and companies and includes
travel bans and freezing of bank assets. Their purpose is to
put pressure mainly on Russia to work actively towards a
demilitarisation of the conflict region.
US ahead of EU
The United States quickly seized the initiative, banning a
number of major Russian companies and banks from
taking out long-term dollar-denominated loans. One
reason why the US was a step ahead of the EU is that in
relative terms, the countrys trade with Russia is far smaller
than that of the EU countries. Although only the three
Baltic countries, Finland and Bulgaria have a high
exposure, 30 per cent of Western Europes natural gas
needs are covered by Russia. In addition, there have
obviously been political divisions among the major EU
countries for partly selfish national reasons. For example
Germany imports large quantities of Russian natural gas
and France is in the process of selling two warships to
Russia. Italy is the only large EU country with more
marginal direct links to Russia in its overall foreign trade.
It took until late July before the EU reached agreement on
an expanded three-part sanctions package: Russian state-
owned banks and some large non-financial companies will
be blocked from access to long-term financing in EU
capital markets; there will be a partial embargo on arms
trade with Russia (applicable to new contracts out of
deference to France?); and exports of certain energy
sector technology to Russia will be banned. The US
immediately imposed a similar embargo on defence- and
energy-related trade. Japan and Switzerland also followed
up with financial sanctions against individuals and
companies of both Russian and Ukrainian nationality
connected to the Ukraine crisis. In Japans case this was an
expansion of last springs list. It was aimed at blocking
possible evasion of US and EU sanctions.
Little direct impact
With its expansion of sanctions after the Malaysian plane
was shot down, the EU entered the toughest phase
known as Phase 3 of the action plan it launched early last
spring following Russias annexation of Crimea. This is
aimed at hurting such sectors of the Russian economy as
finance, energy and defence.
However, the sanctions imposed so far have had a fairly
small effect, at least viewed in the short term. Russian
banks have a modest need for refinancing their foreign
loans over the coming nine months, the central bank has a
strong foreign currency reserve and the federal
government is in a strong financial position if funding
needs to be provided. Arms exports from Russia are small
in relation to the countrys total arms production. The
freeze on Western technology input in the energy sector
will affect performance and production only in the long
term. The escalated sanctions from the EU and other
major Western powers are nevertheless expected, in
themselves, to cause greater uncertainty about general
developments in Russia as well as speculation that the
Ecnomic Insights

sanctions will be further tightened or broadened. As a
result, foreign companies will be more restrictive about
investing in Russia, hampering growth short term growth
as well.
In August, Russia responded to Western sanctions by
imposed various trade barriers in the aviation, agriculture
and food sectors. About 10 per cent of Russias food
imports are being suspended for one year. The effect of
this ban is mostly symbolic. It will have very little economic
impact on any of the affected countries, except Lithuania,
which has relatively large food exports to Russia. Instead it
threatens to push up Russian inflation. Further targeted
sanction measures by the Russians are rather likely. But in
that case they will be relatively cautious. Note the words of
President Vladimir Putin in his decree to Russian
authorities concerning agricultural and food products:
with the goal of guaranteeing the security of the Russian
We are sticking to the fundamental economic assumptions
we have maintained since the Russia-Ukraine conflict
broke out in February-March: There will be no large-scale
trade sanctions and no serious disruptions in Russian
energy deliveries to Europe. Both Western powers and
Russia are highly reluctant to start a full-scale trade war,
since the early recovery of the euro zone is fragile and
Russias economy is both cyclically and structurally weak.
There is also sizeable mutual dependence on Russian
natural gas.
The repercussions of the geopolitical conflict especially
via accentuated weakness in the data and outlook for
Russian and Ukrainian growth resulted in modest
downward adjustments in our general growth forecasts for
Eastern (including Central) Europe last spring, but
relatively large such adjustments for Estonia and Latvia.
Yet our latest downward adjustment of the 2015 growth
outlook for Russia (see below), as well as any new
sanctions, only justify a marginal new lowering of GDP
forecasts for the region.
Continued recovery in Central Europe
Given the limited impact of sanctions, we are sticking to
our forecast that the gradual recovery which began in the
second half of 2013, mainly in the central portion of
Eastern Europe but also further south in the region, will
continue over the next couple of years. The recovery will
be modest. Growing private consumption and cyclical
upturns in Germany/Western Europe will offset lost
exports to Russia and at least short-term investment
downturns, especially in countries near the conflict area. It
is worth noting that the larger countries of Central Europe
send a relatively small share of their exports to Russia.
During the second quarter, fairly strong GDP growth in a
number of central and southern countries in the region
probably gained further strength. Retail sales remained
good. Although manufacturing indicators have lost some
ground almost everywhere in the region, a similar pattern
is also apparent in Western Europe. We believe this is a
temporary correction. Both in Eastern and Western
Europe, in part this probably was due to uncertainty
created by the Ukraine crisis, especially in its initial stage.
Private consumption will remain a key driver of economic
growth in many Eastern European countries. Households
are benefiting from good real income increases due to
labour market stabilisation, but especially via low inflation.
Purchasing power has further strengthened just in the past
few months, since weak price pressures in such countries
as Hungary and Slovakia have morphed into deflation. In
Poland, inflation is now only a few tenths of a per cent
above zero. We expect continued strong downward
pressure on inflation in Central Europe and further south
during the coming year, since there are sizeable idle
resources in these economies. In the near future, inflation
will remain low in the wake of declining global food prices
late in the spring; food is a major component of the
Consumer Price Index in many countries of Eastern
Europe. In Poland, for example, this may open the way for
further cuts in key interest rates, which are already very
low, boosting household demand for loans and
contributing to higher consumption.
Russian stagnation, but no collapse
Russia is not on its way towards economic collapse over
the next couple of years far from it. The economy will be
sustained by continued stable energy prices, a strong
labour market and underlying government financial
strength in the form of low sovereign debt (11 per cent of
GDP), a balanced budget and a strong currency reserve.
Note that extra expenditures for Crimea/Sevastopol this
year are being paid for out of funds, not the federal
government budget. In addition, the governments
forecast that its 2014 budget surplus will total 0.5 per cent
of GDP (compared to a final 2013 figure of -0.5 per cent) is
based on a realistic +0.5 per cent growth assumption.
But there are many years of anaemic growth ahead, in
addition to the difficult short-term challenge of ending
high inflation. This is not, however, only a consequence of
the Russia-Ukraine conflict but largely a result of structural
Russias GDP will increase by 0.5 per cent this year.
The economy will stagnate in 2015 and then expand
by 1.5 per cent in 2016. This is well below its potential
growth rate of 2-3 per cent.
We have adjusted our 2014 forecast upward from zero in
the May issue of Nordic Outlook, following unexpectedly
good growth in the second quarter (according to official
figures 1.2 per cent year-on-year, after +0.9 per cent in the
first quarter). This was after industrial production provided
something of a surprise and short-term manufacturing
sector indicators showed a weak but consistent
improvement. The purchasing managers index gradually
rose from around 48 in March to 51 in July, in other words
above the expansion threshold of 50. Assuming largely
unchanged oil prices of USD 105-110/barrel for the rest of
2014 and decent net exports, Russia can avoid recession
despite a rapid decline in domestic demand.
Ecnomic Insights

We have lowered our 2015 GDP growth forecast from 1.2
per cent to zero due to lower household purchasing power
(via higher-than-expected inflation), recently approved
extra sales taxes of up to 3 per cent in various regions (to
maintain a balanced budget when large sums are being
allocated for developing Crimea), even weaker capital
spending in the wake of the conflict with Ukraine and the
impact of new sanctions. A sharp upturn in long-term
bond yields will contribute to lower capital spending, but
this summer the government has provided some support
for infrastructure investments. There will probably also be
increases in Russian wages and pensions next year to
combat economic weakness.
Supply-side restrictions
The Russian economy is being squeezed on several fronts.
There are supply-side restrictions in the labour market,
despite clearly slower economic growth in recent years.
Unemployment has fallen further, from 5.5 per cent early
in 2014 to just below 5 per cent (the lowest level since the
mid-1990s) and has been somewhat below its equilibrium
level of 6-7 per cent since mid-2011. Because of negative
demographics, it will take time to strengthen labour
supply. Furthermore, capital spending has lagged for many
years; Russias investment ratio is low compared to other
emerging market economies.

Inflation above target
Inflation has surged from 6 per cent at the beginning of
2014 to 7.5 per cent, well above the central banks target
of 6.0-6.5 per cent by the end of the year (raised since last
spring) and its medium-term target of 4 per cent. The
upturn is being driven by waves of decline in the rouble
exchange rate connected to last springs Crimea conflict
and a powerful new downswing after the exchange rate
had almost completely recovered in May-June. But
inflation is also fundamentally high due to the tight labour
market. The central bank unexpectedly raised its key
interest rate in late July to slow inflation and try to halt new
capital outflows (a weak effect is expected there). We
expect new interest rate hikes, but inflation will lose its
momentum only slowly during the coming year despite
weaker demand. This is partly because we foresee a
further weakening of the rouble (to 38.5 per USD,
compared to 36 today), driven by geopolitical turmoil and
economic weakness. The ban on certain food imports will
also lead to some price increases, despite a government
directive ordering a price freeze. The broad extra sales tax
will also have an impact, leading to somewhat higher
consumer prices next year. We expect inflation to average
6.5 per cent in 2015.

Mikael Johansson, Head of CEE Research,
SEB Economic Research
+ 46 8 763 80 93