G7 leadership MIA on Russia sanctions

Mixed messages from the G7 around the Russian sanctions piste at a time when it should be ramping up sanctions pressure on Putin as:

a) The Russian economy is finally beginning to show the strain of sanctions with inflation spiralling, the rouble weakening and the CBR as a result being forced to hike policy rates likely to 23‰ plus later today. All this because the war in Ukraine is causing labour shortages as workers get relocated to the front, production is being transferred from butter to guns (literally - there are now butter shortages in Russia), as Putin tries to ramp up munitions productions in a “munitions war” in effect with the West, and as sanctions increases the cost of imports just as they also crimp export receipts and as Putin’s access to FX resources has been limited by the freezing of $330bn in CBR assets.

b) All sides know negotiations are coming over a peace in Ukraine, and the West should be maxing support for Ukraine and maxing pressure on Putin to improve Ukraine’s negotiating position in those talks. Remember here that it is a mission critical for Europe, as Ukraine, that Putin is not gifted a peace deal win as its absolutely clear and certain that he would take any win and go back into Ukraine at a later date. That option absolutely has to be closed out for Putin to ensure long term security for Ukraine and then for Europe.

On what has happened on the sanctions front over the past few days:

First, the US seems to have blinked on the issue of Gazprombank sanctions to prevent it transacting energy. This had seemed like a major step up in the sanctions regime when it was announced a few weeks back - and the sharp move in the rouble to a weak of 115 to the rouble some weeks back was driven by that specific sanction. But countries dependent still on Russian energy supplies - Turkey and Hungary, et al, asked for carveouts and it looks like the US has agreed. There were other options for those states including agreeing energy credits or barter deals with Russia, but the US blinked (it “Blinkened”). Fairly typical of the Biden administration when it comes to it short changing Ukraine constantly. The Biden team no doubt will argue that Putin blinked first by yesterday easing restrictions on institutions having to transact with Gazprombank for energy - it lost its monopoly. But I think that is really scraping the oil barrel.

Second, Bloomberg has repeated the story from last week suggesting that the G7 is mulling over tightening oil market restrictions on Russia - either physical restrictions on Russian oil exports (similar to Iran) or a cut in the oil price cap from the current $60 a barrel to perhaps $40. Russia’s diversion of shipments to its shadow fleet has eroded the impact of the $60 oil price cap albeit the West hopes tighter sanctions (including inspections on Russian ships in Western policed waters) on the shadow fleet will up the costs to Russia still further of shipping oil, reducing the net flow of foreign exchange earnings to Russia. What we are seeing here is a cat and mouse game between Russia and the West over sanctions. This will continue.

Third, on the sanctions front, Europe’s Trojan Horse, PM Victor Orban, threw another spanner, or hand grenade, into the spokes of the EU sanctions regime, refusing to agree another six month rollover of the sanctions regime when the EU Council met this week. He argued that the EU should hold its decision until the handover of power in the U.S., given Trump, and Orban’s push for a peace deal with Putin in Ukraine. Let’s see whether Hungary’s dependency on EU structural fund flows moderates Orban’s position. All that said, even should EU sanctions on Russia fail to win the rollover I doubt, given expectations still in terms of the direction of travel in terms of European - Russia relations, that actually international business will see this as anything other than a short term blip, and will certainly not quickly go back to business as usual with Russia.

Fourth, interesting this week that we saw two prominent EU commissioners, Kallas (foreign affairs) and Dombrovskis (economy) come out strongly in favour of allocating immobilised

Russian assets - the underlying assets, not just the interest, to

Ukraine. Dombrovskis appeared to challenge the position of the ECB which had argued that any move to go after the underlying assets would pose a systemic risk, and threaten the reserve currency states of the Euro. Dombrovskis picked up my line that as the move to immobilise caused no market moving impact, why would a move to full confiscation cause any further impact? The reality is Ukraine is not being adequately funded, it will be even less well funded from the US under a

Trump presidency, so what is the plan B for Europe and the West? And the reality is that there is simply no alternative but to allocate the underlying $330 billion in immobilised CBR assets to Ukraine. The alternative is to think about what the cost of a Ukrainian defeat will be - price that impact in terms of higher defence spending for Europe (add $360bn a year), the cost of assisting the likely tens of millions of Ukrainians moving West plus the huge impact to the standing of the Euro as a reserve currency as a Ukrainian defeat would see a crisis of confidence in the security of Europe and I would argue the whole European project.

Whether it is Lagarde at the ECB or Biden in the WH, where is the Western leadership when it comes to pushing back on Putin? MIA - quite literally.