EU Prepares For Stage 2+ Sanctions Against Russia

The European Union is on the verge of announcing new broader sanctions against Russia. They will not go as far as stage three sanctions, which could include sanctions on whole sectors of the Russian economy, according to some leaked press accounts.

Some thing more than stage two sanctions, which includes travel bans and asset freeze, will likely be delivered, but still shy of stage three. European officials seem to be playing up the tactical advantage of blurring the stage two and three distinctions, but it is difficult to know whether it is simply making a virtue out of necessity, given the reluctance of some southern and western members to support stiffer sanction.

The news leaks suggest four elements are being considered by the EU. First, new project funding by the European Investment bank would cease. Second the EU will likely broaden the legal basis for the sanctions to allow additional escalation if Russia continues not to cooperate. Third, the EU may cut Russia off from bilateral aid programs, mostly from the European Neighborhood and Partnership Instrument (which is the primary vehicle for European aid to non-EU countries in eastern Europe and Northern Africa). Fourth, the EU will look to other measures, like restricting new investment in Russia.

Reports suggest that Merkel has been a key advocate of toughing the EU's stance toward Russia. The US has been encouraging this as well and earlier this week hosted EU ambassadors and briefed them on intelligence purporting to demonstrate Russia's heavy weapon provisions, including tanks and missile, to the rebels in the eastern part of Ukraine.

Russian markets have begun under-performing. Recall after the initial sell-off Russian assets and the ruble recovered. Over the last couple of weeks, they have been trading heavier. The 10-Year government bond yield has risen from about 8.40% in late June to above 8.75% today, which is the highest since late May. Russian shares were resilient initially as interest rates rose. The MICEX high for the year was recorded on July 8. It has eased by about 4.8% since. The dollar bottomed against the ruble in late June near RUB33.50 and is now near RUB34.50. Since June 27, the ruble is the second weakest currency in EMEA, losing about 2% of its value.

Of course, there are a number of influences, not just geopolitics at work. The price of oil, for example, has fallen sharply over this period. For example, the price of Brent oil, a key benchmark for Russia, fell 9.8% since June 23. Given the run-up in Russian assets in Q2, it appears that what has been experienced in recent days is a little profit-taking or position adjustment.

Russia appears to be willing to escalate its efforts to either destabilize or disembody Ukraine, additional sanctions are likely. Remember, the purpose of the sanctions is to raise the cost of Russia's transgressions and behavior. The sanctions on Russia are considerably more extensive than when Russia and Georgia fought in 2008. Russia is too strong for the US and Europe to simply impose their will on it.

There are holes in the sanction regime. The French sale of warships to Russia, for example, is not counter-productive. Italy's Pirelli announced recently that the Russian state-controlled oil company Rosneft will take a substantial stake in it, and its CEO, who is on the US sanction list, will be given a board seat. This too is not helpful for the sanction regime. Russia needs technology from western oil companies to access its oil/gas reserves, but even the US does not seem prepared to prevent this...yet.