Western sanctions begin to weigh on Russia

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Russia is beginning to feel the impact of Western sanctions related to the annexation of Crimea, and the World Bank says the country's economy could contract sharply if the crisis gets worse.

In a study released Wednesday, the bank said no matter how the Crimean conflict ends, the Russian economy will do worse than expected this year because of the dispute. And it said the long-term consequences of a prolonged power struggle with the West could do even more damage because it will divert attention from badly-needed reforms.

"Recent events around the Crimea crisis have compounded the lingering confidence problem [in Russia] and exposed the economic weaknesses of the economic growth model which is based on large investment projects, continued increases in public wages and transfers," the bank said.

The World Bank came up with two scenarios for 2014 based on the fall-out from the tensions over Crimea. Both projected lower economic growth than the 2.2 per cent increase the bank forecasted for Russia in November.

Under the bank's low-risk outlook, meaning sanctions are short-lived and the issues resolved peacefully, Russia's economy will grow by 1.1 per cent this year. If the Crimean situation worsens and the West introduces tougher punitive measures, the bank said Russia's economy could shrink by 1.8 per cent in 2014.

While the sanctions imposed by Canada, the United States, the European Union and others have largely targeted a handful of individuals, involving asset freezes and travel bans, Western diplomats said they are having an effect.

They argue the Russian central bank has had to spend about $10-billion (U.S.) propping up the ruble, which has fallen sharply in value in recent weeks. They also point to intangible factors such as increased political risk, which has scared off investors and the growing international isolation of Russia. And while Europe is reliant on Russia for much of its oil and gas, the diplomats note that Europe is also a critical market for Russian goods.

"Of course, we don't want to see the Russian economy veering toward collapse, which is why we've been pushing for a diplomatic solution," one Western diplomat said Wednesday.

Russia's economy has been faltering. After growing by 3.4 per cent in 2012, growth fell to 1.3 per cent last year and will likely be even smaller this year. Business confidence has also been shaken by the events in Crimea, falling 12 per cent in March from February according to a monthly poll of Russian business people at companies listed on the Moscow Exchange. And capital outflows are expected to go as high as $70-billion in the first quarter of 2014, which is more all of 2013. This week Russia's largest bank, Sberbank, cut its growth forecast for 2014 to 0.2 per cent from 2.3 per cent, because of Crimea.

However, there are also plenty of indications Russia has weathered the sanctions fairly well. The Russian stock market has gained 9 per cent since March 16, when Crimea held its disputed referendum to join Russia.

Mr. Putin also got a boost on Wednesday from a visit to his official residence by the chief executive of German engineering giant Siemens AG. The company has several projects with state-run Russian Railways, whose president, Vladimir Yakunin, is on the U.S. sanction list.

Siemens' CEO Joe Kaeser said the company plans to keep doing business in the country and go ahead with more than $1.3-billion in investments. "We support a trusting relationship with Russian companies," Mr. Kaeser said after the meeting.

German Chancellor Angela Merkel has been among the strongest advocates for sanctions against Russia. Asked about Mr. Kaeser's visit, Ms. Merkel said business contacts will continue with Russia "but Russia must know that if certain further international treaties are broken, then we are ready for a tough reaction. That's an important message."