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Ukraine

'Hurt Russia by helping Ukraine'

Tough economic sanctions would hurt Russia more than Europe, economist Georg Zachmann tells DW. He argues the EU should do more to support the Ukrainian economy.

More individuals have been put on the list of what the EU calls "level two" sanctions. Have the measures so far had any effect?

The effect is ambiguous. On the one hand, there has been little direct effect, and - from a political perspective - the Russian side hasn't moved. But on the other hand, there has been quite some turbulence in terms of financial markets. The Russian rouble came under pressure, there is significant withdrawal of capital from Russia, and investment in Russia also seems to have been postponed. It is difficult to link those effects directly with the sanctions. The effects could also be down to some geopolitical risk that's in the air. But obviously the sanctions as one step of escalation might be partially responsible for this destabilization of the Russian economy.

President Obama has announced that the US measures would also focus on defense exports to Russia. How useful are those measures?

Georg Zachmann, research fellow with Bruegel (photo: Bruegel)

Zachmann says the EU should help Ukraine increase energy efficiency

If you want to put pressure on the Russian economy it's very difficult if you do it by stopping exports to Russia. Russia is a pick-and-mix purchaser - it imports all sorts of goods from all kinds of countries. In the G20 group, Russia is the least dependent for its exports on imported intermediary goods. Russia almost exclusively exports commodities. For their export economy, they’re therefore not really dependent on buying intermediary goods in other countries. So it’s very difficult to hurt Russia by reducing exports of any type of goods to Russia.

The energy sector would still be the most suitable one for the EU if they did indeed decide to hurt the Russian economy?

Energy exports make up 70 to 80 percent of overall exports from Russia. Three quarter of it is oil, and one quarter is gas. In addition, Russia exports intermediary highly-energy intensive products such as steel and other raw materials. If the intention was to hurt Russia, then you would have to affect Russia's energy exports. Restricting oil exports from Russia is very difficult. It might mean a significant blow to the global economy. It would also be logistically difficult because Russia would be able to export oil from the different oil ports it has elsewhere.

But as far as gas is concerned: most Russian gas exports are going to Europe. They're pipeline-linked exports of natural gas. It's impossible for Russia to find alternative routes in the short-term. The only alternative they have is their liquefied natural gas terminal at Sakhalin Island which can export less than 10 percent to other places. But that's fully used, and its capacity cannot be quickly increased. All other countries that are paying a market price are European markets. So if Europe were to reduce the import of Russian gas that would obviously have a cost for the Russian economy. European imports of Russian natural gas make up about 15 percent of the government budget of the Russian Federation.

But we know why the Europeans aren't going to go down that route: it would go both ways.

Yes. Russian gas is not very easy to replace for Europe because we only have limited alternative sources. Experts are split about just how much more we could get from the global LNG market. Last year we got a historically low amount from Norway because Russian prices were so competitive. But there seems to be spare capacity in Norway to buy from. We could produce some more gas domestically. We could start reducing gas consumption in Europe by switching off gas-fired power plants and replacing them with electricity from coal or other sources. So there is at least some degree of flexibility on the European side.

If the whole thing escalates - just to speculate - and if Russia were to say: "if you're only buying 50 percent of what you bought before then we're sending you nothing," then Europe would be in trouble. Europe would then have to reduce its consumption. But we've seen in Japan for example with the Fukushima accident, where all of the nuclear power plants went off, that it's possible to replace that source with natural gas from the global market. It would certainly come at a cost, but the costs for Russia would be higher.

The EU and Russia have very close ties in the iron and steel trade. Just one example: Russian firm NLMK has threatened to close plants in Belgium if the EU goes to "level three" sanctions, and that would threaten 2,500 jobs in Europe at least. Is that a reason why the EU is reluctant to impose harsher economic sanctions?

There are two interesting points. First: Europe would be very easily able to develop sanctions that have almost equal costs to all European countries: the UK could impose financial sanctions, France could impose some regarding arms exports, and Germany could do something regarding its gas imports. They could neatly equalize the costs among the different member states. But Russia would react.

The second point is that every company in Europe has looked at its own businesses and tried to assess its own vulnerability. Some have significant exposure to Russia and they're seeing a significant risk to their business. But altogether, the European exposure to Russia is not that huge. In terms of trade, finance, FDI, because of Russia's rather limited integration into the world economy, a blow to the Russian economy might have much less severe consequences than a crisis in Brazil. One has to keep that in mind when we hear that about individual companies complaining what could happen to them in the worst case.

Why don't we talk more about how Ukraine and its economy can be supported rather than focusing on sanctions against Russia?

We are currently preparing a paper on this very topic. One stone with which you could kill a lot of birds in Ukraine is energy efficiency. Ukraine is a country that's strongly dependent on imports of Russian natural gas, which gives a strong political leverage over the Ukrainian government. We've seen prices rising to almost $500 (360 euros) per thousand cubic meters, which is $150 more than Germans are paying - even if Germany is far more distant from Russia and transit costs to Germany are higher. There is a huge degree of under-investment in Ukraine. Energy efficiency measures such as rehabilitating public building stock and district heating systems could create jobs very quickly.

Are the measures of the International Monetary Fund working?

The IMF has stepped in with a good package. The conditionality attached to the package is very important to Ukraine to help the country reform its macroeconomic systems. The increase in internal gas tariffs and the flexibilization of the currency are two steps that were postponed for many years. And the IMF involvement has helped resolve them. But now it's time for the Europeans to do something. A big energy efficiency program would be helpful in reducing the social cost of the macroeconomic reform program and hence reduce the potential political cost of the crisis. A large share of the population in Ukraine will face high energy prices at the end of the year.

Georg Zachmann is a research fellow with Bruegel, a Brussels-based economic think tank. He focuses on energy issues.

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