Relief for Russia's Struggling Economy?

Russia’s GDP fell 3.7% in 2015, according to preliminary figures released by the country’s statistics agency on Monday. The contraction underscores the toll that falling oil prices and international sanctions have taken on the country. But relief might be coming sooner than expected, as American and European leaders hint that sanctions might not be renewed when they expire this summer.

Speaking at Davos on Friday, U.S. Secretary of State John Kerry said sanctions could be removed in the coming months if there was “legitimate intent to solve the problem on both sides,” referring to Russia and Ukraine.

France’s Finance Minister Emmanuel Macron told French businessmen in Moscow on Sunday that the “objective” was to lift sanctions this summer. The next day his German counterpart Wolfgang Schäuble wrote an op-ed in the Frankfurter Allgemeine Zeitung calling for closer cooperation between Europe and Russia over Middle East policy, though he did not address sanctions specifically.

These hints at relief are a welcome reversal for Russia, coming just a month after the EU renewed sanctions for the six months ending July 31.

Background on Russian Sanctions

International sanctions against Russia began on March 17, 2014, the day before the country unilaterally annexed the Ukrainian territory of Crimea. The U.S., EU and Canada led the first round of sanctions, followed soon after by Australia, Japan and non-EU countries including Ukraine. The first round mostly targeted individuals implicated in the Crimea crisis, freezing their overseas assets and imposing travel bans. A second round of expanded sanctions followed the next month.

The EU imposed a third round that July in response to Russia’s support for separatist militias in Ukraine’s Donbass region. These sanctions were the toughest yet, and included blanket restrictions on Russia’s energy, banking and defense sectors. The U.S. applied similar sector-wide sanctions the following September.

Effect on Russia’s Economy

Sanctions have taken a heavy toll on Russia, making 2015 the worst year for its economy since 2009. In addition to the contraction in GDP, retail sales fell by 10% and capital investment by 8.4%. Real wages fell by 10%, the victim of 15% inflation. The currency has collapsed against the dollar, falling by over 50% in two years. The government must borrow at a higher rate than even debt-wracked Greece, where 10-year bonds yield 9.5%, versus Russia’s 10%.

Sanctions are not the only, or even the main, culprit for this decline, however. Russia is heavily dependent on oil and gas exports, and the prolonged fall in energy prices has made life in the country difficult. President Vladimir Putin said in December that the country had based its budget on $50 oil. The current price is just over $30.

Reasons for Lifting Sanctions

Energy prices are likely one reason that world leaders are now mulling an end to sanctions. When these were first applied, the plunge in energy prices had barely begun. Now that a barrel of Brent crude costs less than a third what it did at the beginning of 2014, sanctions may seem excessive. Russia is expected to experience another year of recession in 2016, and extending sanctions past the summer could worsen the country’s predicament.

Another reason is that the situation in the Middle East, and particularly in Syria, has deteriorated. Negotiating an end to Syria’s civil war will be difficult without the Kremlin’s cooperation, since Syrian President Bashar Assad enjoys Russian military support.

Russian counter-sanctions have also taken their toll. France in particular has seen its agricultural exports decline. Dairy prices are down significantly, partly as a result of the embargo, which has led farmers to drive tractors through Paris in protest. Albert Jan Maat, president of the farmers group Copa, said in September that the Russian counter-sanctions had cost European farmers €5.5 billion.

Finally, the ceasefire agreement between Russian-backed separatists and the Ukrainian government is showing signs of holding. The first agreement was finalized in Minsk in September 2014, but had little effect on the ground. A revision, known as Minsk II, was drafted in February 2015, but a separatist offensive just days after its implementation seemed to render it a dead letter. Now, however, fighting has slowed down, and provocative early elections planned for separatist-controlled territories have been postponed.

The confluence of low oil prices, the war in Syria, European agricultural woes and lessened fighting in the Donbas could convince EU leaders to let sanctions lapse at the end of July. Whether the U.S. would follow suit is not certain, particularly given that a Treasury official told the BBC Monday that Putin is “corrupt.” In any case, Russia is much more dependent on trade with the EU than with the U.S.

Investing in Russia

Investors who think that Russia’s prospects are brighter in 2016 can gain exposure through the Market Vectors Russia ETF (RSX), the Russia-themed exchange traded fund with the highest trade volume. Its top holdings include Gazprom PJSC (OGZPY), Sberbank of Russia PJSC (SBRCY) and PJSC Lukoil (LUKOY), all of which have been affected by EU or US sanctions, or both.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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