The Future of EU Economy: Less of Russia, More of the Rest?
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Commentary

The Future of EU Economy: Less of Russia, More of the Rest?

Davide Tentori
09 maggio 2022

Economic sanctions imposed by the EU against Russia aim at weakening Moscow’s economy by cutting it off trade flows with European countries. So far, six rounds of sanctions have been introduced, but have they been effective? Are they going to harm European economies as well, and to what extent? In the short term, Europe growth prospects will be affected; but in the medium to long run, it might be possible for the EU to strengthen its trade partnerships with other countries thanks to its extensive networks of Preferential Trade Agreements.

 

EU sanctions: their impact before 24/02

The history of sanctions imposed by the EU on Russia is not new and started well before Moscow’s invasion of Ukraine. Several rounds of sanctions were imposed – and systematically renewed – by Brussels after the 2014 and 2015 Minsk agreements with the aim of restoring the status quo — but a new autonomy status — in the Donetsk and Luhansk territories. 

What was the economic impact of those sanctions on the EU economy? Overall, one could say that European companies doing business with Russia suffered from relatively limited economic damage, as these measures generally targeted specific individuals and narrow sectors and products. However, perhaps also in view of a sort of political “stigma” around those involved in economic activities with Russia, bilateral trade flows experienced a substantial drop in most European countries: when comparing pre- and post-sanctions trade flows, our elaborations find transactions dropped by at least 20% in major European economies (-37% in France, -24% in Italy and Germany, -21% in the UK) annually. The outcome of this process was to progressively reduce Russia’s importance as a trade and investment partner for Europe: as such, by 2021 Russia represented just about 5% of the EU’s external trade (in terms both of exports and imports), with bigger economies even less exposed (for instance, Italy’s exports to Russia make up only 1.5% of its total foreign merchandise sales). This means that – considering merchandise products and excluding energy – the expected direct shock to the EU economy from trade sanctions against Russia has been relatively small and overall affordable. But what came next, and what else should we expect in the future?

 

After 24/02: six rounds… and counting?

Russia’s invasion of Ukraine forced the EU to introduce fresh rounds of sanctions, each of them including far heavier measures than those implemented in the previous eight years, and with a cross-cutting approach aimed at affecting the whole of the Russian economy through its progressive isolation from international trade and financial flows. From the ban of an (increasing) number of Russian banks from the SWIFT international payment system, to the freeze of foreign currency reserves, to the oil embargo  (which, according to the latest package approved on the 3rd of May, will only be enforced by the end of 2022), the EU has been trying to damage Moscow’s economy in an attempt to ultimately weaken its military power whilst supporting Kiev, both through the provision of weapons and with some sort of economic relief, including the suspension of any trade barriers on products imported from Ukraine.

The question is whether what has been done so far is enough to reach this objective, or more should be done, or instead sanctions might even be counterproductive and push Russia into someone else’s (e.g., China) arms. There are no doubts about the economic damage Russia will suffer in 2022, with GDP set to shrink by at least 8.5% according to the IMF (a forecast acknowledged by the Russian government itself) against a 2% positive growth that had been estimated in January. Moreover, current rounds of sanctions are cutting Russia off key supply chains in critical manufacturing industries (such as the defence, automotive, and chemical/pharmaceutical sectors), making it much more difficult for Moscow to source key inputs and exacerbating Russia’s external dependence on finished products.

Adopting a forward-looking approach might help us explore what could happen next. Considering that only Western countries are imposing sanctions against Russia, it might be possible for the latter to re-orientate its trade and investment flows in the medium term by deepening existing partnerships and establishing new ones. However, imposing a huge damage to Russia’s economy seems possible only through the adoption of a full embargo on energy products, including gas imports which still represent the biggest source of revenue for Putin’s government.  

 

Consequences on the EU’s economy and geopolitics

As a region particularly exposed to economic ties with Russia, the EU will be seriously affected by the ongoing situation. The post-Covid recovery, which was already hampered by rising inflation, is at risk of being jeopardized by the negative consequences of the conflict on the global economy: growth forecasts in the eurozone have been revised downwards to 2.8% from a 4.1% forecast envisaged at the beginning of the year. However, this substantial reduction in growth prospects seems to be explained in particular by the indirect consequences of this situation rather than by the first-order impact of economic sanctions. In fact, limited exposure to Russia as a trading partner will allow EU countries to absorb a reduction in trade and investment flows relatively quickly. Nonetheless, the “perfect storm” triggered by the war in terms of rising energy and commodity prices coupled with new transport and logistical bottlenecks is likely to severely hit member states’ economies, raising fears around a period of “stagflation” that could ultimately undermine promising hopes for the green and digital transitions that had been raised by the Next Generation EU’s funds.

As such, after six rounds of sanctions (with room for more in the future), what to expect for Europe’s economic prospects? In the short term, the supply shock triggered by the war could quickly move to the demand side, thus weakening the recovery and exacerbating economic and social inequalities. This will require  a difficult balancing act between the normalization in the ECB’s monetary policy and moderate expansionary fiscal policies, so as to “rescue” economic growth while defusing inflation. In the medium term, managing to minimize energy dependence on Russia will be key to compensate for the oil and gas supply that will still be needed for several years, while trying to further accelerate the energy transition in a context of high commodity prices that are key to producing EV car batteries and other crucial components. Moreover, diversifying trade partnerships will be of the utmost importance to enhance and strengthen the EU’s supply chains. Being involved in over 70 preferential trade agreements puts Brussels in a strategic position that could be leveraged to better exploit economic relationships (to exemplify: will the FTA with MERCOSUR ever be ratified?)., The ongoing dialogue with the US within the framework of the Trade and Technology Council could also offer a valuable opportunity to further strengthen the Transatlantic relationship, both from a geopolitical and economic point of view. In a nutshell, the overarching goal of “strategic autonomy” is not a chimera: it can be reached through a flexible approach rather than with inward-looking industrial and trade policies that risk increasing economic fragmentation at the global level.

Contenuti correlati: 
The World Won't Be the Same: The Global Impact of the Ukraine War

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EU Economy Europe Crisi Russia Ucraina Russia
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Davide Tentori
ISPI

Image credits: Andrej Hanzekovic/European Central Bank (CC BY-NC-ND 2.0)

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