Many believed that after the Putin-Biden meeting, the sanction war would become a thing of the past. But both politicians and stock traders were waiting for the phoenix to rise from the still smoldering ashes. And so it happened: the United States House of Representatives adopted amendments to the 2022 defense budget that provide for new restrictions against Russian sovereign debt, the Nord Stream 2 gas pipeline, including a recommendation for the US presidential administration to impose restrictions on 35 Russian citizens.
Let’s take a closer look at these measures, from the least harmful ones to the most complicated that can do a slight damage to the country.
Thus, Joe Biden was advised to impose sanctions against 35 Russian nationals for either being implicated in human rights abuse or for being too close to President of Russia Vladimir Putin. The presence of the heads of security agencies, Prime Minister Mikhail Mishustin and Moscow Mayor Sergei Sobyanin on this listis understandable, as well as the presence of journalists Margarita Simonyan and Konstantin Ernst.
But what does it have to do with Oleg Deripaska whose only recent ‘sin’ was the well-founded criticism of the Bank of Russia’s decision to increase the interest rate? Roman Abramovich who has for a many years lived and conducted his main business outside Russia looks like another odd man out. If the sanctions include the ban on entry to the US and the seizure of assets there, it would be a serious blow to Abramovich. However, this would be his personal problem that barely affects Russia.
The sanctions against Nord Stream 2 are far more unpleasant. They include restrictions for those who were in charge of planning, construction and maintaining the gas pipeline. Let’s hope that those people will be able to withdraw their assets from the US before the draft law is adopted and comes into force.
Overall, only the lack of judgement on the part of European politicians can stop the launch of Nord Stream 2. However, there is a good chance that the United States will try to harm the project even more.
This desire is caused not only by the US’s striving to sell as much as possible of its own liquefied natural gas to Europe, but mostly to prevent the appearance of cheap Russian gas in the Old World, which will lower prices on electric energy thus boosting the competitiveness of the European economy on the global market.
By the way, when gas prices in Europe reached almost $1K per 1,000 cubic meters, there were no American gas carriers lining up in European ports. The US companies sold their LNG to Asia where the prices were even higher. At the same time, it is impossible to boost oil and gas production in the US in the nearest future due to extreme low investment in the sector over the past few years.
So, these sanctions are alarming but not scary, and Gazprom shares that are traded at the market level are a good proof of that. But it is still a signal to the project’s opponents who can boost their pressure, including at the certification stage.
The restrictions on the purchase of Russian sovereign debt on the secondary market for US residents will be far more harmful. The US earlier prohibited their companies to purchase government debt coupons from the Finance Ministry at the primary auction. In fact, this prohibition could easily be bypassed: a US company only needed to instruct any Russian broker to purchase federal loan bonds and resell them to the ordering customer with a minimal margin. This loophole will now be closed, although it didn’t seem that it was at all popular.
The measure will not deal a crippling blow to the Russian market of federal loan bonds (OFZ). The share of non-residents on the market reached its maximum of 34.89% in March 2020, and then was gradually lowering until May 2021 when it stabilized at about 20%.
The reduced share of non-residents is caused not only by the fact that they sold their bonds, but to a larger extent by the increasing capacity of the market: as of January 1, 2021, the OFZ market estimated at RUR 13.7 tln, and by August 1, it reached RUR 15.3 tln; the share of non-residents reduced from 23.3% to 20.6% with the volume of securities reducing from RUR 3.191 tln to RUR 3.157 tln.
However, it is possible that if the restrictions on purchasing Russia’s sovereign debt are adopted by the US, large European investment houses could informally join them in order to not taunt the US Securities and Exchange Commission (SEC), which often believes that the US requirements and restrictions regard the rest of the world as well. As a result, the OFZ prices began falling last Thursday, dropping to a new low and reaching the level of the crisis-ridden March 2020.
The return on OFZ bonds has grown and now exceeds 7% percent per annum for most securities with a maturity of between 1 and 5 years. But even under these conditions, the Russian Finance Ministry still easily can attract funds through issuing new OFZs to finance the budget.
Repo trades with OFZ is a backup option. The Central Bank can increase OFZ-backed loans for large banks thus financing the budget through intermediary banks.
On the negative side, the state has to borrow money at an increased interest rate. Government debt will increase because the economy growth is much smaller than the interest rates that are paid out for OFZs (2–3% economic growth as compared to 7% return on OFZs).
Russia’s issuance of Eurobonds — fixed-income securities denominated in a different currency than the local one of the country where the bond has been issued, not necessarily in euros — will cause even more difficulties.
In general, our budget does not really require such loans, but the rules of the game demand that the issuer from time to time places new Eurobonds to create a record. But this is not a problem too: one can offer a bigger return so that investors’ greediness outweighs their fears.
It is also possible that the adopted sanctions will be more lenient than expected, but even under the worst case scenario they will not have a serious negative impact on the Russian economy.
By Boris Solovyov, financial analyst