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Sanctions are a heavy weapon

The photo shows people dressed in winter clothes, who are holding Ukrainian blue and yellow flags and umbrellas. Above them is a banner with the inscription “Sanction Russia!”.

Source: Dreamstime

Sanctions are a heavy weapon

‘They hit the Russian economy hard, but also affect – although on a smaller scale – the situation in a number of European countries, including Poland’, says Dr Maciej Woźniak from the Faculty of Management about the sanctions imposed on Russia after the military aggression on Ukraine.

On February 24, the security status quo in Europe crumbled. Has the economy also taken a knock as a result of these perturbations?

Dr Maciej Woźniak: I’d say that problems have already come up with the outbreak of the COVID-19 pandemic, however, the Russian attack on Ukraine has additionally intensified the adverse processes. One of the chief issues in the world economy right now is supply chains – one product comprises elements manufactured in different countries, and only one of them is responsible for putting the pieces together. As a result of the recurrent lockdowns in China, the parts frequently never got to Europe. At the same time, the war also disrupted transit between China, other Asian countries, and Europe, which, in addition to the sea route, ran on land through Ukraine.

The current situation may force some companies to reinvent their model of operation. Having realised the possibility of another war or pandemic, enterprises try to concentrate the production in a reduced number of countries or in those that lie close to one another, so that the supply chain shortens as much as possible – today, economists begin to talk about the deglobalisation of economy.

Can this result in the pauperisation of the affected regions and bring about, for example, another migration crisis?

It is a serious threat, especially considering the soaring prices of cereals that used to be exported to North Africa from Russia or Ukraine. Let me remind you that one of the reasons for the so-called “Arab Spring” was the rocketing prices of food. As a consequence, we’ve seen a massive influx of people to Europe from that part of the world. Today, economists also point their fingers at the increase in food prices in Latin America. Therefore, the outlook is rather bleak.

‘One of the reasons for the so-called “Arab Spring” was the rocketing prices of food. As a consequence, we’ve seen a massive influx of people to Europe from that part of the world’, Dr Maciej Woźniak says; source: Dreamstime

The photo shows a rubber raft with refugees from the Middle East. Next to it in shallow water, there are two people wearing high-visibility vests. One of them is holding a baby in his hands.

Currency deficit strikes Russia

What is the economic price that Russia’s paying for the war it had started?

The most bitter implication of the sanctions imposed by the West seems to be a significant depletion of Russian foreign currency reserves, which are nowadays treated as a kind of psychological buffer for a national currency. Let me use an example from the Polish economy. At the beginning of the 1990s, as a result of Professor Jeffrey Sachs’ actions, who was the contemporary adviser to Tadeusz Mazowiecki’s government, Poland received an additional safety buffer in the amount of 1 billion dollars. It was enough to know that the money had flown into the country and that it could be spent that caused a downturn of inflationary pressure and a toning-down of markets. Ultimately, the money was not expended but became part of the central bank reserves.

In the event of a national currency depreciation, the phenomenon we’ve seen in Russia after the war had broken out, you can buy roubles with US dollars. This removes a certain amount of this currency from the market, which causes the exchange rates to go up. However, examples from a number of countries show that this policy is only efficient so far. No central bank is able to intervene in this way over several years. At the very most, it can repeat the intervention for weeks or months, depending on the strength of the reserves.

Has cutting off Russia from Western assets been equally afflictive to private business?

I’ll use an example of small and medium companies that happen to be the focus of my research. To save its economy, Russia had to raise interest rates. We’re also dealing with this in Poland, but the Russian rates are much higher. Since the 1960s, there is this concept in economics that states that this situation is most perilous to small and medium businesses. In granting loans, banks prefer larger players, and instead of financing the small and medium, they choose to purchase government bonds – especially when the economic outlook is uncertain. As a result, many of these companies stop investing, and some of them will simply go bankrupt. Notice that we’re talking companies that are the most flexible and make up the backbone of the middle class. Therefore, I suspect that the Russian authorities will take preventive actions in this regard. Let’s not forget that a lion’s share of the available money goes to funding warfare, protecting the rouble, and paying off international obligations. All this leaves very little for the Russian entrepreneurs.

Russian companies are also weakened by the withdrawal of western companies from their market. Limits on cooperation in terms of transfer of know-how, innovation, and new management solutions will only deepen the outflow of foreign capital, which will negatively impact the balance of payments.

Russia’s reaching out to partners in other parts of the world to make up for restrictions from the West.

Indeed, Russia might find partners in China or India, history teaches us this much. After the sanctions imposed in 2014–2015 after the annexation of Crimea, the Russian economy had experienced a crisis, but managed to emerge from it. This was related to the fact that, in lieu of the American and European companies withdrawing from Russia, enterprises from the aforementioned countries entered the market. The Russians even allowed them into their strategic projects, sometimes relinquishing control over them entirely.

However, what seems to be advantageous today, in the long term might have dire consequences. Russia competes with China for the markets of Central Asia, especially those of former USSR countries. The former tries to do it by means of the Eurasian Economic Union and the latter by the expansion of its companies. Perhaps now those companies will overtake even more foreign markets, making Russia even more subordinate to China.

Oil as a political tool

The sanctions imposed after the annexation of the Crimea that you mentioned have been far less severe than the current ones. For example, they didn’t directly hit the export of Russian hydrocarbons, which makes up the main source of income for the Kremlin.

As far as this issue is concerned, it’s worth mentioning one more instrument that the West has at its disposal to put pressure on Russia. Many economists claim that the previous sanctions hindered the increase of Russian GDP by about 1%. But, there was an additional unforseen effect in the form of a decrease in oil prices. Even the Russians themselves admit that the actual GDP fall was, in fact, 5%, meaninig – five times more than the calculations based solely on the imposed restrictions. Which is why, we’re looking at actions that aim to release oil reserves even by countries such as Iran or Venezuela, which would increase the oil supply and cause the prices to fall.

Let me make another historical reference. The recently declassfied American documents show that in the 1980s, Washington was successful in convincing Saudi Arabia to produce more oil, which was aimed at the decrease of its price and, as a result, the weakening of the USSR economy.

The black-and-white photo shows a man looking at an oil well in the distance to the left. The upper part of the picture shows a cloudy sky. On the horizon, there are a few trees and elements of other installations.

‘We’re looking at actions that aim to release oil reserves even by countries such as Iran or Venezuela, which would increase the oil supply and cause the prices to fall’, Dr Maciej Woźniak says; source: Dreamstime

If the prices don’t drop, aren’t we facing a similar crisis that happened in the 1970s, when Arab countries turned off the oil tap in retaliation for supporting Israel?

It all depends on how long the war is going to last. However, if we’re talking about the 1970s crisis, it’s worth mentioning one more significant issue. For a short period, the results of the decreasing oil supply were in fact high inflation and considerable unemployment, especially in Europe. However, in the long run, it forced some companies to start using hydrocarbons more efficiently and implement technologies that today would be called “eco-friendly”. Similarly today, we’re seeing countries that want to increase the percentage of renewable energy sources in their energy mix, which is a good solution for the future.

You’ve mentioned Iran earlier. This country has been dealing with various sanctions for several dozen years. We also have countries such as North Korea or Cuba, which have been orbiting the outer reaches of the world economy due to this type of ostracism. Perhaps, after all, it is possible to function in autarchy?

It is possible, but extremely difficult. Being excluded from international trade brings about two major processes in such countries. Consumers either have limited access to certain goods or those products are considerably more expensive. This situation can benefit local manufacturers, who can replace foreign ones. However, as the world economy indicates, the losses stemming from the exclusion from foreign trade are ultimately much greater than the profits related to the rising prices and the local sales boost.

Implications of sanctions in Europe

Russia is an extensive market that has been penetrated by Western companies in the past. What ripple effects will the restrictions that hinder this process have on the European economy?

Unfortunately, sanctions are a double-edged sword. They hit the Russian economy hard, but also affect – although on a smaller scale – the situation in a number of European countries, including Poland. There’s no doubt that, on the macroeconomic scale, the steep energy prices coupled with the limited access to the Russian market will hamper the rate of economic growth. On the level of individual companies, everything depends on the sector in which they operate.

In Poland, the most severe ramifications affected transport companies and the processing industry, for which the Russian market is practically closed now. This crisis is quite prosperous for the arms industry as well as some energy and fuel producers – provided that they had secured deliveries at prices before the outbreak of war and can now sell their products at higher prices. The financial sector will also probably see large profits because rising interest rates raise the net interest margins.

‘In Poland, the most severe ramifications affected transport companies and the processing industry, for which the Russian market is practically closed now’, Dr Maciej Woźniak says; source: Dreamstime

The photo shows a large parking lot. On the left and in the background of the photo, there are lorries parked in a row. The middle of the lot is empty. The sky is blue with a few white clouds.

The rising energy prices increase the costs of any economic activity, and the rising interest rates make it even harder to get a loan – especially for small and medium companies. The costs can be passed on to the clients but, soon or later, the latter will have had enough as well. Do Polish companies have reserves to get them through this difficult time?

The problem you’re mentioning is serious indeed. We all see the rocketing inflation rate related to the increase in prices of consumption goods, such as clothes, food, or transport. In the economy, we also have the intermediate goods index, that is, energy carriers or building materials. Here, the surge is even more drastic. Turth be told, it often does translate into higher prices for the end client, but inflation had been with us for quite some time, and the consumers have indeed been growing tired of it. Companies will have to either reduce their profit margins or increase their operation efficiency so that prices do not soar above an acceptable level.

In terms of obtaining money for the daily operations of companies, possibilities have become scarce after the pandemic. Since 2019, give or take, we’ve seen a significant decrease in the deposit value of Polish companies. Some economists claim that it’s connected to the fact that enterprises had to fund themselves through subsequent lockdowns. They received some help from the state, but they have also been forced to use their own resources. This might be a problem, especially when access to loans is restricted. Therefore, this is the place for the government to step in and help those companies. At the same time, public money should be expended cautiously.

My research indicates that there is no universal pattern of spending money in a crisis. The circumstances differ from country to country and must be taken into account when planning expenditure.

Crises reward the flexible and innovative

I’m looking for a more positive culmination to our talk. This is what comes to mind. The necessity to adapt to the new reality will reward innovation, and the attacking country, even with ultimate territorial gains, at the end of the day, by being excluded from the international circulation of thought and capital, will lose.

Indeed. Especially considering the fact that the territories seized by the Russians in eastern Ukraine are severely damaged. Therefore, their economic value is negligible. However, accepting Ukraine as one of the member states to the European Union means that European money will flow there. Some think it will reduce the funds that Poland receives. But, let’s not forget that Polish companies will also have opportunities to tender in Ukraine and carry out their own projects there. As you’ve noticed correctly, strengthening economic bonds will not only serve Ukraine, but will also be a positive impulse for the entire European Union.

It’s also a favourable prospect for small and medium companies that are able to quickly switch from one type of activity to another. An example might be the sewing of face masks during the pandemic by companies operating in an entirely different field.

***

Dr Maciej Woźniak graduated from the Cracow University of Economics. He received a doctor’s degree with distinction at the AGH UST Faculty of Management, where he works as an assistant professor. He teaches classes in economics and economic policy.

Dr Maciej Woźniak was interviewed by Piotr Włodarczyk from the AGH UST Centre for Communication and Marketing.

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