As Ukraine sinks ever deeper into dual existential crises — territorial and financial — hawkish calls for arming Kiev against pro-Russian rebels are growing louder. Pundits are increasingly frustrated at Russian President Vladimir PutinVladimir Vladimirovich PutinThe Memo: Biden, bruised by Afghanistan, faces a critical test in Ukraine Biden holds call with European leaders to talk Russia Overnight Defense & National Security — Preparing for the Biden-Putin call MORE's ability to drive events in eastern Ukraine seemingly at will with limited visible consequences. In fact, however, the Western-led sanctions regime is beginning to deliver debilitating body shots to the Russian economy. Recent economic data indicate that while the economy may not be in tatters as President Obama claimed during his State of the Union Address, it is deeply mired in a full-blown, protracted crisis which will almost certainly perpetuate Russian dependence on its hydrocarbon sector for years to come.


The most recent data from the Central Bank of Russia (CBR) on international reserves are sobering. Reserves fell 25 percent from $492 billion in February 2014 to $369 billion in February 2015, largely because the Kremlin was forced to defend the ruble during much of 2014 before moving to a free-floating currency regime. Year-to-date reserves have fallen $18 billion, or nearly 5 percent.

Moreover, easily accessible liquid reserves total far less than the headline numbers, strongly suggesting that the Kremlin will be significantly constrained in its ability to blunt a painful recession. Almost $50 billion are invested in gold (which is generally not considered liquid and a position which the CBR has been increasing during the Ukrainian crisis) and another $11 billion are deposited with the International Monetary Fund (IMF). The Ministry of Finance administers two funds: the $85 billion Reserve Fund (which will be used to plug the federal budget deficit in 2015 that may reach 3.5 percent of gross domestic product); and the $78 billion National Welfare Fund (NWF), which in principle is used to support the indebted pension system, but is the most likely vehicle to provide cash infusions to ailing Russian companies. The remaining $145 billion is more representative of liquid assets and may be tapped to intervene in currency markets, and possibly to recapitalize Russian banks, which in turn would be expected to increase lending to companies unable to access capital markets.

The Kremlin heavily relied on the NWF during the global crisis in 2008 to 2009 to bail out companies which faced difficulty servicing their international debt obligations. As the economy recovered, the NWF reserves expanded, and committed resources to infrastructure projects in an effort to diversify the Russian economy. These commitments are now likely to be delayed or even disregarded as the Western sanctions regime has effectively shut Russian companies out of capital markets. Russian companies have roughly $130 billion in foreign debt maturing in 2015 with virtually no prospect of refinancing this debt internationally. By default, the government will likely become the lender of last resort. The prime example is state-owned enterprise (SOE) oil major Rosneft, with roughly $30 billion in corporate debt. Rosneft, headed by Putin's close associate Igor Sechin, is critical to the Russian economy, and the state will out of necessity aid the energy giant. Rosneft paid off a $7 billion debt on Feb. 12, but faces approximately $12.5 billion of maturing debt in 2015 amidst the collapse in global energy prices. Rosneft initially requested $40 billion in government support, but has recently reduced its ask to $20 billion.

Finance Minister Anton Siluanov said recently that absent major structural reforms and a recovery in oil prices, Moscow would deplete its currency reserves as early as 2016 or 2017. This might represent a scare tactic to decrease the military budget — due to increase of roughly 30 percent in 2015 — while the remaining federal budget is experiencing a 10 percent haircut across the board. More than likely, this is an accurate assessment as companies queue for government assistance. On Feb. 18, Siluanov noted that VTB (another SOE and Russia's second-largest bank) had received almost $16 billion from the NWF to recapitalize the bank. The Yamal Liquid Natural Gas (LNG) project, a major new venture in the Artic due to supply liquefied natural gas to China and currently on the Western sanctions list, is targeted to receive more than $1 billion in government aid. Thus SOEs and companies particularly in the revenue-generating energy sector, with close ties to the ruling elite, will most likely emerge as recipients of government financial largesse.

While some economic data are not nearly as gloomy (especially the very manageable levels of sovereign debt), dwindling reserves, inflation spiking at 15 percent and likely headed higher, declining real wages and the recent downgrade to junk status by ratings agencies indicate a protracted crisis for the Russian economy which eventually may bode negatively for political stability. Should the West decide to enact additional financial sanctions against Russia — a real possibility given events in Ukraine and the calls for military action — the economic consequences in Russia would grow in severity.

Colley is managing director of Highgate Consulting.