Slow Burn

Though American and European leaders have yet to make good on threats to isolate Russia, the Ukraine crisis could still punish Russia’s already struggling economy.

Russian President Vladimir Putin laughed off the United States’ move to sanction a bank and several businessmen from his inner circle, promising to open a new account at Bank Rossiya, the first financial institution to find itself in Western crosshairs. "I personally didn’t have an account there, but I’ll definitely open an account there on Monday," he joked.

That kind of bravado comes naturally to Putin, and the initial sets of American and European sanctions were too weak to prevent him from annexing the Crimean peninsula and may not, NATO officials worry, be enough to dissuade him from invading eastern Ukraine.

That’s not to say that the sanctions are completely toothless. They may not do immediate damage to the Russian economy, but analysts say they could turn potential investors away at a time when Russia dearly needs foreign money.

"The real potential damage to Russia’s economic future is self inflicted," said Chris Weafer of Moscow-based consultancy Macro-Advisory, in a recent research note. "The real damage from a prolonged conflict in Ukraine," Weafer said, "may be to radically slow the inflow of much needed investment capital." Weafer recently cut his forecast for the Russian economy in 2014 from 1.9 percent to 1 percent growth.

Investors’ cooling interest in Russia could make it more expensive for Russia to borrow money in international markets. Rating firms Standard & Poor’s and Fitch Ratings both downgraded Russia’s outlook from stable to negative, after the U.S. rolled out new sanctions Thursday. The Russian Finance Ministry has said it might delay plans to sell $7 billion in Russian sovereign bonds this year. Russian Finance Minister Anton Siluanov acknowledged Friday that Russia’s borrowing costs are going up.

"The imposed sanctions are definitely negatively affecting the general perception of our country’s economy," Siluanov said to reporters in Moscow, according to Bloomberg.

The falling value of Russia’s currency could also be a source of pain. Companies that have borrowed money abroad and Russians planning their summer vacations could be forced to pay more, if the ruble continues its decline. It has fallen nearly 10% against the dollar since the beginning of the year.

The impact on Russia’s stock market is harder to gauge, but there were initial signs sanctions were having at least a minor impact. The Russian benchmark Micex index fell almost 3 percent Friday, a day after President Obama blacklisted 20 top Russian officials and businessmen. The U.S. sanctions on Bank Rossiya were Washington’s first against a Russian financial institution, and the move caused Visa and Mastercard to stop processing payments for the blacklisted bank and three of its affiliates Friday. Moscow responded by barring an array of powerful lawmakers and Obama administration officials from entering Russia. Putin indicated that he didn’t think Russia needed to pursue other forms of retaliation, but Russian Deputy Foreign Minister Grigory Karasin said Russia was considering additional measures, according to Reuters.

That was the second exchange of sanctions and mocking responses between the U.S. and Russia this week, after Moscow annexed Crimea, the Ukrainian province that voted to breakaway from the country on Sunday. Obama upped the ante Thursday by laying out a plan for a broad trade blockade that – if carried out — could cripple Russia’s energy or banking sectors. The U.S. is unlikely to go down that road unless Russia moves to take over broad swathes of eastern Ukraine. Even if the U.S. acted, meanwhile, it’s not clear Europe would follow. The continent’s leaders’ have expressed clear reluctance to levy broad punitive measures on Russia because of the boomerang effect they’d have on European trade.

While the back-and-forth over Russia’s annexation of Crimea has at times hit the volatile Russian stock market, broader indicators about the Russian economy could be more worrisome. Russian stocks plunged 10 percent after Russia invaded Crimea, for instance, but bounced back immediately on the weak response from the West. The bigger concern for Russian leaders could be that the unrest makes bankers and money managers reconsider Russia as a place to make long term investments.

In the first two months of this year, investors have already moved more that $30 billion out of the country because of the standoff, Weafer said. That compares to $63 billion in all of 2013. Part of that amount is just the regular flow of money from cross-border trade, but Weafer estimates that at least a quarter of it is personal wealth.

"Russia has two problems: one is attracting foreign investment and the other is convincing Russians to keep their money in Russia and invest it there," said Weafer, speaking on the phone from Abu Dhabi.

The new sanctions against businessmen and politicians close to Putin haven’t shut down the Russian economy, but they are making a bad situation worse by slashing the value of the ruble and making foreign investors think twice about putting their money into Russian companies.

The value of the ruble could be the most important indicator inside Russia, said Weafer. He said Russians are extremely sensitive to currency fluctuations because of memories of shocks in the 1990s that crushed the ruble, including the 1998 banking crisis when Russia had to default on its debt.

"You cannot walk down a street in a Russian town without being aware of what the currency rate is," Weafer said. "The yellow currency exchange signs are as familiar as the golden arches in the U.S."

Win Thin, global head of emerging-market currency strategy at Brown Brothers Harriman, had a slightly more optimistic view. He said the Russian economy could muddle through at a growth rate of 1 to 1.5 percent and investors would likely move on — as long as Putin doesn’t go any further.

"If he’s stopping at Crimea, which I think he is, then I think people just kind of forget about it," Thin said.

After all, Russia is still considered an emerging market, so investors may expect a bit of volatility.

"The Russian economy is like a large old tanker," said Mujtaba Rahman, head Europe analyst at risk consultancy Eurasia Group. "These developments are tantamount to more rust, but, at current, are unlikely to represent a serious inflection point."