Russia faces being hit by a banking crisis, a deep recession and a dramatic collapse in living standards that could undermine Vladimir Putin’s power, experts have said.
Western governments ramped up pressure on Moscow over the weekend, unveiling a fresh round of punitive sanctions that caused the rouble to crash as much as 30 per cent when markets opened on Monday.
Ordinary Russians will see the price of imported goods soar, pushing inflation to 20 per cent and ushering in a period of turmoil that would echo the upheavals that followed the fall of the Soviet Union, economists warned.
Given that Mr Putin’s legitimacy rests on his image as a strongman who banished the chaos of the 1990s and restored Russian pride, any signs of a return to similar conditions risks undermining Putin’s grip on power, said Dan Arenson, analyst at political risk consultancy GPW.
"If anyone was under any illusions that sanctions were going to be largely toothless, those have clearly now been dispelled,” said Arenson.
“This is going to have a severe impact on ordinary Russians.”
Analysts slashed their forecasts for the Russian economy on Monday, predicting it will shrink by around 10 per cent this year, and said further sanctions could be on the way.
What sanctions have been announced?
While Russia has sought to sharpen its use of a new type of information war to weaken its allies, the rapid escalation of financial sanctions represents the west’s most ambitious use yet of its economic weaponry.
Two measures could seriously damage both Russia’s ability to trade with the rest of the world and to prop up its economy.
First, a number of Russian banks are to be blocked from using the Swift messaging system, a key piece of infrastructure that banks use to securely communicate details of payments.
Without it, trade becomes much more difficult. Although energy exports are exempt, commodity traders face considerable uncertainty about their risk of being exposed to sanctioned Russian entities, meaning that Russian oil and gas exports are under threat.
Most damagingly, Russia’s central bank assets held in the UK, US and EU will be frozen. The measure severely limits Russia’s ability to support its collapsing currency.
Rampant inflation
Big falls in the rouble’s value means that importing goods will become a lot more expensive, resulting in a rapid and dramatic fall in living standards.
Liam Peach, emerging markets analysts at Capital Economics, expects inflation to rise to as high as 20 per cent.
Russia’s central bank stepped in to try and combat this by more than doubling interest rates from 9.5 per cent to 20 per cent. Expensive borrowing is likely to further reduce economic growth.
“You’ve got a bad combination of really high inflation and really high interest rates that will take a toll on demand in Russia,” says Peach.
That, in turn, is expected to heap further pressure on the country’s banks.
Bank runs and crisis
“The banking sector looks like it is on the brink of a full-blown crisis right now”, says Peach. There were already reports on Sunday of long queues at Russian banks as citizens sought to withdraw their money.
Once bank runs start they are very difficult to stop. The Central Bank of Russia sought to reassure people that their money was safe and urged them not to withdraw their cash.
History provides ample evidence that such reassurances often have precisely the opposite effect, causing more alarm and alerting people to a potential problem.
Peach expects under-pressure banks to begin holding back on lending, putting an additional squeeze on the Russian economy.
Signs of strain on Russia’s financial system are growing. On Monday, the European Central Bank (ECB) warned that the European arm of Russia’s biggest lender, Sberbank, faces failure after depositors rapidly sought to withdraw their money.
Could a trade embargo happen?
The sanctions Russia now faces fall short of an economic embargo but there is appetite to go further if the conflict escalates further, says Henry Smith, a partner at risk consultancy Control Risks.
The next logical step would to directly targeting the energy and mining sectors that provide much of the Russian government’s income.
If Putin ramped up his campaign in Ukraine, particularly with greater loss of civilian life, then a full-blown trade embargo – seen as inconceivable by many a week ago – is now on the cards.
It is not just governments taking action. A growing number of businesses are expected to pull out of investments Russia in the coming days. Even where those investments are not in breach of sanctions, reputational and financial risks of remaining in Russia may be seen as to great.
Shell, Exxon and other oil companies are among those facing pressure to divest from Russian investments after BP announced it will sell its 20 per cent stake in Russian oil company Rosneft.
How could Russia deal with this threat?
Russia’s options for dealing with the crisis, support its currency and stave off economic collapse, have been severely limited by sanctions imposed on its central bank.
When a country’s currency falls sharply in value, the central bank will often sell off its foreign exchange reserves and buy its own currency to support its value.
To steel itself against potential western sanctions, Russia has in recent years built up $643bn in reserves of foreign currencies, such as the dollar, euro and yuan. But it will now find it very difficult to use these reserves.
Half of Russian central bank assets held in the west are frozen, and there are significant practical obstacles in the way of selling off the other half that are held in Russia, China and other jurisdictions.
The central bank is therefore unable to effectively support the rouble, meaning that further falls are possible, dragging living standards down even further.
Public unrest and protest
Small-scale public protests have taken place in Russia and these could broaden if the war is not successful, casualties mount and ordinary citizens face extreme hardship, according to experts.
“It takes an unimaginable amount of bravery to protest in Russia,” says Dan Arenson of GPW. “But as people’s living standards are impacted, obviously, their desperation increases.”
It has become clear that there is not a huge groundswell of Russian public support for the invasion of Ukraine, which has been sold to people through Kremlin propaganda as a limited and necessary defensive operation.
Mounting casualties would make that position appear increasingly unrealistic in the eyes of ordinary Russians, says Arenson.
While massive economic disruption will apply pressure on Putin, his power still rests on the support of a small cadre of billionaire supporters, many of whom have been under sanctions for years.
In recent days there are signs that support among this group may be fraying. Two Russian oligarchs, Mikhail Fridman and Oleg Deripaska, have denounced Moscow’s invasion of Ukraine. Putin may feel he can ride out any unrest at home, but there is one constituency he simply cannot afford to lose.
