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Time to Rethink Sanctions Against Russia and Aid to Ukraine

Author: Robert Kahn, Steven A. Tananbaum Senior Fellow for International Economics
April 24, 2014
CNN Money

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As the crisis in Ukraine intensified on Thursday with the reported deaths of up to five pro-Russian militants, it's obvious the Obama administration's economic strategy for supporting Ukraine isn't working.

Mild economic sanctions, coupled with the threat of more to come, are imposing an economic price on Russia, but it's not enough to change Russian policy and prevent the continued destabilization of Ukraine. Meanwhile, Western economic assistance conditioned on IMF-backed reform provides Ukraine with essential fiscal support, but is unable to halt the rapid decline of the Ukrainian economy, and the austerity demanded threatens a backlash in the east ahead of elections. The next round of sanctions, which could come in the next few days, presents the opportunity for a reassessment. It's time for a change of course.

The cost of the conflict on the Russian economy continues to mount. Russian asset prices have fallen, the currency has dropped despite a sharp rise in interest rates, and near-record high capital outflows are causing a tightening of financial conditions and a 5% fall in investment so far this year. Growth was negative during the first three months of the year, and is expected to be negative again in the second quarter. Overall, growth looks set to fall about 1Ĺ% this year. Downside scenarios where growth falls 4% or more are being circulated and discussed. Growth was weak even before the crisis, reflecting years of policy neglect and unaddressed structural weaknesses.

These dislocations come not from the sanctions that are already in place -- such as visa bans and asset freezes on a limited number of Russians and a small bank associated with the Kremlin -- but rather from the uncertainty about what comes next. Ambiguity works in favor of the administration here. Uncertainty about whether sanctions will be extended, and how they will be applied, creates a risk that is already having a chilling effect on financial relations. Anecdotally, banks are cutting back on their banking relationships and credit lines to Russian firms, selling assets and refusing to roll over maturing loans.

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