Hello! This week we focus on the economic consequences for Russia of Western sanctions amid the ongoing fighting in Ukraine. In particular, we look at how a swathe of foreign-owned businesses look set to be nationalized, the crisis in Russia’s aviation industry, a looming default, and a growing list of currency controls.
Foreign businesses set to be ‘nationalized’
Hundreds of foreign companies have announced a partial or total withdrawal from Russia in recent weeks. These include: Apple, IKEA, McDonald’s, Microsoft, IBM, Sony, Shell, Porsche, Volkswagen, H&M, Inditex (that includes Zara, Bershka, Massimo Dutti, Pull&Bear), Procter & Gamble (that covers brands including Tide, Ferry, Pampers, and Head & Shoulders), Universal, Mars, Warner and Sony Music.
In response to the announcements, Putin backed a government proposal Thursday that will impose “external management” on foreign companies that decide to leave Russia.
The legislation in question was described by the ruling United Russia party as the “first step towards nationalizing foreign-owned organizations leaving the Russian market”. Under the rules, there are two cases in which temporary administration can be imposed on a company more than 25 percent is owned by foreign individuals:
- The head or management of the company “effectively ceases” management — for example by leaving the organization without oversight;
- Company management takes decisions that could lead to an unjustified cessation of activities, liquidation or bankruptcy. These include public announcements about the cessation of the company’s activities “in the absence of clear economic reasons”.
In the first case, external administrators are appointed for three months; in the second for six. In the second case the process can be reversed: shareholders who own more than 50 percent of the company can apply to the courts to remove the external administration and resume work in Russia, or sell their stake to “suitable new owners”.
The decision about whether to appoint external administrators will be taken by Moscow’s Arbitration Court. In each case, the owners will be given five working days to inform the court of their intention to resume activities, transfer their share to fiduciary management or sell it.
External administration means state managers will be given full powers to run the company. For non-financial organizations, these will be representatives from state development bank VEB.RF; for financial companies the managers will come from the Deposit Insurance Agency. Either way, they will be given access to all information about the company and its former management, including commercial secrets.
The external administration will be obliged to resume, or continue, the company’s activities, prevent bankruptcy, and protect jobs and property, including paying wage arrears. But its main task will be to create a new organization via a bankruptcy procedure. Immediately after appointment, administrators will be obliged to start drawing up a register of creditor claims (creditors will be able to declare their claims within a month), and an inventory of property.
The end product will be a new company. Up to 6 months later, shares in the new company will be put up for auction and the old organization officially liquidated. Buyers with similar types of business will have priority when bidding and, if the shares cannot be sold at their reserve price, they will be bought by the Russian government
New owners will face some mandatory requirements: retaining at least two-thirds of the company’s workforce, and continuing the company’s activities in Russia for at least a year. The external administration will ensure these obligations are met — if they are not, the contract can be terminated and a new auction held.
Flights canceled as aviation industry woes mount
Russian airlines halted most international flights Wednesday and the government is preparing plans for the de facto nationalization of foreign aircraft. Even domestic aviation faces an uncertain future: sanctions means it will be hard to service planes.
- Russia’s aviation authorities are concerned planes could be impounded at foreign airports at the request of lessors or insurers. European Union sanctions mandate that Russian companies return all Airbus planes and any other aircraft belonging to European leasing companies by the end of this month. In addition, Airbus, Boeing and other major Western aircraft-manufacturers will no longer carry out repairs or supply spare parts for aircraft operated by Russian carriers.
- The Ministry of Transport and the government are drawing up plans to ensure planes remain in Russia. These envisage returning some aircraft to leasing companies, with a permit from a government commission required for the return. The planes that the government decides should remain in Russia will effectively be requisitioned — their European owners will be asked to accept future payment in rubles (something of course not allowed under current leasing arrangements).
- There is no consensus on which aircraft to return and which to impound, sources told newspaper Kommersant on Wednesday. On the one hand, it’s easier to maintain older aircraft and source supplies from the “gray market”; on the other hand, newer jets have more time before they need a major overhaul.
- A Transport Ministry source told Kommersant that the plans under discussion would enable carriers to “save face”. But many others are more pessimistic. European aircraft owners may be content to accept further payments, even in rubles, but are unlikely to accept risk violating sanctions, one airline source told the newspaper. A source in the leasing market described the Ministry’s plan as “pseudo-legalized robbery” that foreign lessors will challenge in court — and it will all end up in the seizure of Russian state property abroad as compensation.
- Russian individuals involved in this process risk sanctions and criminal prosecution. At least a dozen of The Bell’s sources in the aviation industry said it was this threat that led to the unexpected resignations of the head of low-cost airline Pobeda, Andrei Kalmykov, and the head of national carrier Aeroflot, Mikhail Poluboyarinov. The current whereabouts of both men is unknown (Poluboyarinov was sanctioned Wednesday by the EU). Aeroflot deputy head Andrei Panov said Saturday that he had resigned from the company and left the country. “We’ve left Russia. I left Aeroflot. The old life has ended,” he wrote on Facebook.
- Private airlines are trying to come up with ways to escape sanctions and continue flying — but with little success. The most striking example so far was the reported attempt by Russia’s biggest charter companies — Azur Air, Royal Flight Nordwind and Pegas Fly — to re-register 93 of their aircraft in Turkey. In theory, this was a way of escaping sanctions. But the Russian aviation authorities stepped in and foreign aircraft belonging to the companies were banned from flying abroad.
Russian airlines — especially private carriers — are in an unenviable position. Returning half their aircraft (in some cases — such as Ural Airlines — their entire fleet) is starting to look like the least-worst option. But, for now, a substantial requisition is the more likely scenario — something that would mean serious legal problems for the heads of Russia’s airlines, and would not resolve the problems facing domestic aviation.
“Ural Airlines planes can fly safely for two months, maybe three, without trashing the fleet, without stopping planes and without ‘vandalism’ [taking parts from one plane to repair another],” Igor Poddubny, director of Ural Airlines’ technical center said Thursday. Nor is there much hope that China could step in to save Russian airlines — on the same day as Poddubny’s comments, Valery Kudinov, the head of maintenance at regulator Rosaviatsia, said China would not supply Russian airlines with sanction-busting spare parts.
International flights also face mounting issues. For the moment, Russian carriers can only fly abroad without risk of their planes being impounded if they use the Russian-made Sukhoi Superjet 100 (SSJ). Carriers are already developing new schedules for SSJ flights to countries that have not shut their airspace to Russia, above all Turkey. But the SSJ is limited by a range of about 1,860 miles and a capacity of 98 seats.
For those wanting to fly in and out of Russia, another option is to book a ticket with foreign carriers based in countries that are still flying to Russia. But the future of this option is also far from certain. Five airlines from countries that have not sanctioned Russia last week announced a suspension of flights: Kazakhstan’s Air Astana, Egypt Air, Azerbaijan’s Azal (and its affiliated lowcoster Buta Airways), and Turkish budget carrier Pegasus. The reason in all cases was the refusal of insurance companies to cover aircraft in Russian airspace.
Default looms — but a sideshow to economic collapse
International credit rating agencies believe that President Vladimir Putin’s decree on foreign debt repayment means a default is all-but inevitable. The decree states that creditors from countries that have committed “unfriendly actions” against Russia can now be paid in (increasingly worthless) rubles via special accounts in Russian banks — and the Ministry of Finance is no longer obliged to pay debts in foreign currency.
By definition, a default occurs when a borrower fails to fulfill its obligations to the creditor. This can mean failing to pay the interest and the principal debt on time or in full, or not meeting the conditions of the loan agreements (including changing the specified currency).
Converting foreign-denominated debt obligations into rubles would mean a default, the chief economist at one of Russia’s major think tanks told The Bell.
Markets are almost certain that Russia will default. Government bonds due to mature in 2023 fell to record lows at the start of the week – just 29 percent of their nominal value. And U.S. investment bank Morgan Stanley predicted that they might even dip below 10 percent – a level only seen for state bonds issued by Venezuela and Lebanon. Bloomberg’s index of sovereign Russian bonds has slumped 81 percent since the start of the year. Only Belarus — down 93 percent — is performing worse.
For Russians, the word ‘default’ immediately triggers memories of the traumatic 1998 economic crisis, and the huge devaluation of the ruble. Back then, the default was caused by a sharp fall in the value of the ruble, soaring inflation, the failure of several large private banks and the forced conversion of foreign currency deposits into rubles. But things are different this time. “A rapid increase in prices, the devaluation of the ruble, reduced incomes and falling standards of living for Russians in 2022 will not be the result of any default,” said the chief economist at one of Russia’s biggest think tanks. He added that paying off debts in rubles is peripheral to what is currently happening to the broader economy.
Currency controls grow as Russia defends ruble
Another major parallel with 1998 is the partial freezing of foreign currency accounts, and other currency control measures imposed by the Central Bank.
Before ‘locking’ people’s foreign currency in their accounts this week, the Central Bank forced banks to set rates of up to 20 percent on ruble accounts, and advised imposing early termination fees for new foreign currency deposits. Since the beginning of the ‘special military operation’, the following currency controls have been imposed:
- Withdrawals from foreign currency accounts are limited to $10,000 in cash until September 9. Withdrawn funds will be issued in dollars, regardless of the currency in which the account is denominated. Any funds requested beyond the $10,000 limit will be released in rubles based on the exchange rate on the day of the transaction.
- Funds in foreign currency deposited in a Russian bank account after March 8 cannot be withdrawn in cash.
- You cannot wire more than $10,000 (or equivalent foreign currency) out of Russia.
- A ban on any transactions involving residents loaning foreign currency to non-residents.
- A 12 percent commission on buying foreign currency on the stock exchange. There is also a ban on cashing foreign currency held in brokerage accounts.
The situation is further complicated by the fact that payments firms Visa and Mastercard have left Russia. Now, Russian-issued Visa and Mastercard cards only work inside the country. Cross-border transactions are no longer available, making it impossible to use Russian-issued cards to pay for purchases on foreign websites. For example, this makes it impossible to use Visa or Mastercard to make purchases from the App Store or Google Play.