Financial markets in Moscow plunged on Thursday as investors sold Russian stocks and bonds ahead of what are expected to be increasingly severe U.S. and European sanctions in response to Russia’s invasion of Ukraine.
“Markets are basically imploding,” Jonas Goltermann, a senior economist for Capital Economics, said on a client webinar. “Just the threat of sanctions is doing the job.”
Global risks from the European conflict drove U.S. and European markets down as well. In New York, the Dow Jones Industrial Average dropped 2.5 percent or more than 800 points at the open. Germany’s DAX was off almost 5 percent while markets in Paris and London also dropped.
The wild price swings come as President Biden is consulting with leaders of the Group of 7 democracies on plans to punish Russia for attacking its neighbor. The U.S. president is scheduled within a few hours to make public details of additional sanctions on Russia, including expected blows to the nation’s most important financial institutions.
On Tuesday, Biden’s initial response to Russia’s military thrust into eastern Ukraine was to cut off two major Russian banks from U.S. financing and to bar American investors from buying Russian government bonds.
Yet the two banks — VEB and Promsvyazbank — are almost entirely domestically focused and funded. And the Russian government has little immediate need to raise money from foreign investors, whose role in Moscow’s financial system has been ebbing.
“They don’t have a deficit to finance. They’re not desperate for money,” said Elina Ribakova, deputy chief economist for the Institute of International Finance (IIF). “The banking system is very liquid. They have extra cash sloshing around.”
The Biden administration’s opening salvo this week drew swift criticism from some Republicans, who said it fell short of what was needed to deter a further Russian plunge into Ukraine, even after the president added additional measures on Wednesday targeting the company behind a controversial Russian gas pipeline. Yet investors expect Russia’s $1.5 trillion economy — smaller than New York state’s — to incur increasing damage if the crisis persists.
On Wednesday, one market gauge forecast Russia’s benchmark interest rate in 12 months spiking well into the double digits, which could plunge the economy into recession, according to IIF data.
Another measure of market jitters — the cost of insuring against a Russian default — has doubled in one week. An investor now would need to spend $431,000 to insure $10 million in Russian government bonds against a failure by Moscow to repay its debt, the highest price in more than seven years.
Biden’s latest action, reversing a position he adopted last year, also imposed sanctions on Nord Stream 2 AG, the company that is building an $11 billion pipeline to deliver Russian natural gas to Germany. The project is wholly owned by a subsidiary of Russia’s Gazprom, the world’s largest natural gas producer.
The growing financial fallout — including declines in all three major U.S. stock markets on Wednesday — is largely a bet on further Russian military action and American financial retaliation. The market tumult also reflects the Biden administration’s determination to levy tougher penalties in response to Wednesday’s Russian move against Ukraine than the Obama administration did in 2014, when Russian President Vladimir Putin seized control of the Crimean peninsula.
At that time, U.S. officials restricted Russian financial and energy companies’ access to U.S. capital markets and prohibited Russian oil giants from obtaining the most advanced exploration technologies for use in Arctic, offshore or shale formations. But the United States, acting with its European allies, also tried to minimize the impact of financial penalties on existing commercial relationships.
Though the sanctions failed to convince Russia to abandon the Crimea, they did take a toll. Since 2014, the Russian economy has grown at an average annualized rate of less than 1 percent compared with more than 4 percent in the previous decade. Even as the United States imposed additional sanctions over alleged Russian interference in the 2016 U.S. elections and what it called the “state-sponsored poisoning” of opposition leader Aleksey Navalny, Putin moved to reduce his vulnerability to American pressure.
“He learned quite a lot from his experience in 2014,” economist Desmond Lachman of the American Enterprise Institute said.
Russia almost doubled its foreign currency reserves and bulked up on Chinese and Japanese holdings at the expense of its dollar and euro assets. Moscow also has all but eliminated its stockpile of U.S. Treasury securities, selling all but $4 billion of a $97 billion stake it held in 2016.
In what he described as the “first tranche” of U.S. sanctions, Biden this week barred American investors from buying Russia’s sovereign debt. But after years of government budget restraint — and with oil prices well above the level needed to balance government accounts — Moscow has only a limited need to issue the debt that the United States on Tuesday sanctioned.
JP Morgan Chase analysts last month said Russia will need this year to issue just $30 billion in ruble bonds.
Foreign fund managers also hold just 20 percent of Russian government bonds. With American — and European — investors off limits, Russian authorities will probably lean on domestic banks to buy more government debt. The banks have plenty of resources to do that and ultimately are backstopped by the Russian central bank and its $630 billion war chest.
Still, new limits on the resale of Russian bonds in the “secondary” market could further erode global appetite for Moscow’s debt securities.
“It is a sort of time bomb,” said Andrew Shoyer, a partner at Sidley Austin, who advises corporations on sanctions. “It seems underwhelming at first. But if other things start to have an impact, it could bite.”
Biden’s initial move against Russia’s financial system also targeted two state-owned banks with links to the country’s national security complex, VEB and Promsvyazbank, rather than commercial institutions that serve Russian retail customers.
The domestic development bank VEB finances major infrastructure projects such as railways and petrochemical facilities and may be best known for its role in funding the $50 billion Sochi Olympics in 2014.
The bank’s close ties to the Russian government were illustrated in 2016 when Evgeny Buryakov, a Russian intelligence official who had been working undercover in the VEB’s Manhattan offices, pleaded guilty in federal court in New York to conspiring to act as an agent of the Russian Federation without notifying the attorney general. He was sentenced to serve 30 months in federal prison and to pay a fine of $10,000, before being deported to Russia in 2017.
Promsvyazbank finances the Russian defense industry, including by providing mortgages to Russian military officers, and operates “as part of a scheme to assist the government in avoiding new sanctions,” according to the U.S. Treasury Department.
On Wednesday, Promsvyazbank said it had prepared for the imposition of sanctions and was continuing to operate “as usual.”
To really make sanctions sting, Biden will need to hammer more prominent institutions like Sberbank, which processes more than half of Russian wages and pensions.
“Unless you see a significant ramping up of sanctions, you will not see a destabilization of the Russian financial system in a meaningful way,” said Markus Schneider, a senior economist with AllianceBernstein in London. “If the U.S. decides to do so, they could take some very, very powerful measures with, of course, a lot of collateral damage in the process.”