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Will new sanctions trigger a Russian recession?

With the economy already wobbling, further curtailment of investment in energy and other sectors would spell trouble

A further wave of US sanctions may spark a Russian recession, even though oil, income from which represents 40% of federal budget revenues, is trading at its highest level in more than four years.

Russia has been able to weather sanctions imposed over the Kremlin's annexation of Crimea in 2014 largely because of the collapse in the rouble, which has greatly boosted export revenues. Oil producers have also mitigated the impact of sanctions by partly replacing Western sources of funding with domestic and Asian capital, as well as attempting to develop their own technology for shale, offshore and Artic deposits.

However, new legislation from the US-dubbed the "sanctions bill from hell"-could seriously damage the Russian economy and its energy majors. The measures, intended to punish the Kremlin for interfering in US elections, may impose restrictions on new sovereign debt transactions and energy projects, such as the Nord Stream 2 pipeline.

They could be imposed after the US mid-term elections on 6 November, given a groundswell of support in the US Congress for tougher sanctions. Both Democrats and Republicans have been sharply critical of Donald Trump's meeting with President Vladimir Putin in Helsinki in July, saying the US president hasn't done enough to hold Russia accountable.

Flat growth rates

After Russia's most recent recession in 2015-16, growth has been sluggish, in a range of 1-2%, with rising oil prices helping to keep the federal coffers ticking over. The International Monetary Fund, in its October World Economic Outlook, predicted the Russian economy would grow by 1.7% in 2018 and 1.8% next year. The latter matches the economy ministry's forecast, which has become more cautious over short-term growth prospects due to volatility in financial markets, faster capital outflows and pessimism among businesses over the potential effect of new US sanctions.

"New sanctions would be ill-timed, as the economy is already showing negative trends," Vladimir Tikhomirov, chief economist at BCS Financial in Moscow, told Petroleum Economist. "We fear new sanctions-if implemented in their entirety-could hit Russia when its economy is already slowing significantly."

An economic recession now would be remarkable as it would be the first time that Russia has suffered a serious contraction without a significant dip in the oil price. Previous recessions, which commenced in 1998, 2008 and 2014, were marked by a dramatic slide in the price of oil.

Ratings agency Fitch said the threats of sanctions are weighing on Russia's economic growth but are unlikely to deprive the nation of its investment-grade rating imminently.

A year ago, Fitch said Russia's sovereign rating would be one notch higher than its current BBB- level, were it not for the latest round of US sanctions. One year on, this is still the case.

"We believe that sanctions remain a risk, and they will put pressure on the credit profile of Russia," said Fitch director Erich Aripse. "Economic growth is likely to be the main purpose of the sanctions."

The effect of sanctions depends on the political winds stateside and may also depend on whether the Democrats can take control of Congress in the upcoming elections.

Protective measures

Russia's economic bureaucrats have done as much as they can to insulate the country from sanctions and external seismic shocks. The central bank has managed to check inflation, while allowing the rouble to float freely. Meanwhile, the finance ministry has introduced a fiscal rule that protects the economy from oscillations in oil prices and helps Russia to build up its reserves.

Even if the economy doesn't lurch into recession, there's fear of stagnation as foreign and strategic investors postpone decisions and stay on the sidelines.

"Within a few years, the current stable economy will feel like stagnation and bring consequences for social stability and, possibly, political risk," said Chris Weafer, co-founder of Macro Consulting in Moscow. "The government is therefore very desperate to avoid that and is focused on trying to attract investment spending in order to boost new industries, infrastructure spending and export growth and diversification."

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