Russia braced for economically painful EU sanctions

The European Union was putting the final touches to a controversial packet of sanctions at the weekend that could cast a long shadow over Russia's already stuttering economy.

EU resolve to step up sanctions has been driven by the tragic crash of Malaysia Airlines Flight MH17 over eastern Ukraine where pro-Russian separatists are fighting government troops.

Western leaders have accused Russia of supplying weapons to the separatists, including the surface-to-air missile that downed the plane killing all 298 people on board on July 17th.

Russian president Vladimir Putin says Ukraine's new European-leaning rulers are responsible for the disaster that has triggered the worst crisis in Russia's relations with the West since the Cold War.

A packet of so called “third level” sanctions that will go to the vote in Brussels tomorrow aims at the heart of Russia’s $2 trillion economy by clamping down on EU co-operation with the country’s financial, oil and defence industries.

New bonds

If approved, the measures will bar Europeans from participating in the sale of new bonds or equity in Russian state-owned banks that dominate Russia’s financial sector and borrow heavily on western capital markets.

Other restrictions would prohibit exports of sophisticated technology Russia needs to support Arctic oil and shale projects that could help avert a looming decline in the country’s oil production.

A non-retroactive arms embargo is seen as the least painful element in the sanctions package. Under Mr Putin’s leadership, Russia has sought to regain the self sufficiency in the armaments industry that it enjoyed in Soviet times.

The EU hopes the sanctions will push the country to use its influence with the separatists to halt the violence that has driven Ukraine to the brink of civil war.

Punitive measures will also send a signal to the Kremlin not to disrupt parliamentary elections in Ukraine that, following the collapse of the government coalition and the resignation of prime minister Arseniy Yatsenyuk last week, will have to be held this autumn.

Russian officials scoffed at earlier EU and US sanctions that, imposed after Mr Putin signed a treaty annexing Ukraine's Crimea in March, slapped asset freezes and travel bans on individuals believed to be close to the Russian president.

However, even these relatively soft penalties have unnerved investors, who have slashed their Russian holdings and put planned projects on hold. The MH17 catastrophe has worsened perceptions spurring a sharp rise in capital flight and a decline in the value of the Russian rouble.

The International Monetary Fund downgraded its 2014 Russian growth forecast last week, saying geopolitical tensions were undermining business confidence and would push the economy into recession this year.

In a defiant speech last week, Mr Putin accused countries imposing sanctions of trying to weaken Russia and pledged, despite the difficulties, to push ahead with industrial projects that would provide jobs and raise living standards.

Russia should take additional steps to reduce its economic dependence on unfavourable external factors, he told a meeting of his security council.

“I have in mind not only instability on global markets, but the possibility of political risks,” he said.