Russia Sanctions Have Had Some Unexpected Consequences

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(Bloomberg) -- The effect of Western economic sanctions on the Russian economy as a whole is a matter of debate, but the performance of specific sanctioned companies is easier to track, and it appears that the better-managed Russian corporates hit by U.S. sanctions have even benefited from the challenge.

In late 2016, Daniel Ahn, currently the U.S. State Department’s acting chief economist, and Georgetown University’s Rodney Ludema published a paper that attempted to assess the effect of the Russia sanctions imposed since 2014. They concluded it must be small on a macro level. “We find that oil price volatility explains the vast majority of the decline in Russia’s GDP and import demand, with very little left to be explained by sanctions or other factors,” they wrote. “Thus either sanctions had only a small negative effect on these variables or other positive factors largely canceled out the effect of sanctions.”

Ahn and Ludema, however, found a strong impact on specific sanctioned companies. “On average,” they wrote, “a sanctioned or associated company loses an estimated one-third of its operating revenue, over one-half of its asset value and about one-third of its employees after being targeted compared to non-sanctioned companies or those not associated with sanctioned companies.”

The economists came to these conclusions using the Orbis database of mostly private companies, maintained by Bureau Van Dijk, a company affiliated with Moody’s, the credit ratings agency. That, however, is likely a flawed approach.

There are 353 Russian entities on the U.S. sanctions list, most of them closely held. The financial reporting of such firms in Russia is sketchy, and it’s easy for their owners to shift operations to other legal entities once the old ones become toxic for some reason. That’s much harder to do for large companies, especially publicly traded ones. More than three years after a number of them were sanctioned by the U.S., Russian firms of this type have significantly deleveraged, and some have shrunk — but others have shown a remarkable resilience.

The sanctions imposed on Russian entities under Barack Obama’s executive orders in response to Russian aggression against Ukraine are of two kinds. One type of sanction undermines the companies’ ability to raise money in U.S. dollars. The other shuts off access to U.S. oil extraction technology. Sanctions of the second type can only have a long-term effect on Russian oil firms (or none at all if they source the technology they need elsewhere). But plenty of time has passed since 2014 to see how the capital-raising restrictions have worked.

I looked at six large companies sanctioned by the U.S. in 2014: three energy sector giants — Rosneft (oil production), Novatek (natural gas production) and Transneft (oil pipelines) — and Russia’s three biggest banks, Sberbank, VTB and Gazprombank. They are either state-controlled, linked to people from President Vladimir Putin’s inner circle, or both.

Between the end of 2013, the last year before the sanctions, and the end of 2017, all three industrial companies have significantly reduced their indebtedness in current U.S. dollars: Novatek by 44 percent, Transneft by 32 percent and Rosneft by 5 percent. The banks have shrunk their assets — Sberbank and VTB by 15 percent each, Gazprombank by 13 percent. That’s consistent with the general trend for the Russian economy: It’s getting progressively less dependent on external financing. According to the Central Bank, Russian corporates’ foreign debt dropped by $11.1 billion in 2016 and by $15.2 billion in 2017. Russian banks’ foreign obligations went down by $29.3 billion last year.

This kind of deleveraging is not conducive to expansion, and four of the six big companies have seen their net income (again, in current dollars) shrink compared with 2013.

The oil firms, of course, have also been hurt by lower oil prices, so the profit decline can’t all be ascribed to the sanctions pressure. But, for example, the net income of Lukoil, hit only by technology sanctions, not capital restrictions, only faced a 33.5 percent decline in net income between 2013 and 2017, while Rosneft lost 65 percent.

The profit drops at VTB and Gazprombank (minus 37 percent and minus 52 percent in current dollars compared with 2013) were probably mostly sanctions-driven as the banks were forced to think smaller.

Two of the sanctioned companies, however, are more profitable today than they were before the sanctions were exposed — Sberbank and Novatek. The reasons for their growth are different, though both are known for above-average management.

Sberbank chief executive officer Herman Gref, one of the architects of the economic reforms of the early 2000s which have ensured Putin’s political resilience, is highly competent, technology-oriented and well-connected. He has made sure his state-controlled bank, and not the other state-owned giant, VTB, would reap most of the benefits of the creeping nationalization of Russia’s financial sector. The central bank has purchased a significant amount of the bank’s new debt since it was sanctioned.

Novatek’s billionaire chief executive officer Leonid Mikhelson is an obsessive builder who has worked with France’s Total and China National Petroleum Corporation to complete its $27 billion liquefied national gas project, Yamal LNG. The project came online in December, 2017, too late for it to affect that year’s financial results (which were stellar in any case), but this year’s financials are likely to show how successfully a Russian company can work around U.S. restrictions. 

Russian billionaires haven’t been shy in asking for state support since the sanctions were imposed. Mikhelson wants the government to help fund the creation of deepwater drilling equipment to replace the U.S. imports that now are out of reach. Gref has tapped the central bank for missing resources. Viktor Vekselberg, whose Renova holding was added to the list of sanctioned entities this year, is reportedly petitioning the government for a whole set of compensatory measures, from large state bank loans to import restrictions on competitors’ products. Oleg Deripaska, the Russian billionaire whose aluminum business is arguably the hardest hit by U.S. restrictions, will also probably require some form of state aid to avoid debt defaults.

The damage to the Russian economy from these measures to support the sanctioned businesses is difficult to quantify. If they pull through, that investment may even end up benefiting the state. 

The U.S. has largely attempted to keep its sanctions “smart,” hurting those businesses on which the stability of the Putin regime depends the most. Though some have been hurt, in others the managers have turned out to be smarter than the sanctions. It’s a reflection of the regime’s own resilience, which shouldn’t be underestimated.

©2018 Bloomberg L.P.

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