Morning Must-Read: Sergei Guriev: Putin Costs the Russian Economy a Lot

Surgei Guriev: The Economic Costs of Russia’s Intervention in Ukraine: “What is not clear is whether Russia can bear the costs….

First, there are the direct costs of military operations and of supporting the Crimean regime and its woefully inefficient economy… several billion dollars per year….Then there are the costs related to the impact of sanctions on trade and investment…. Annual inward foreign direct investment is estimated to have reached $80 billion in 2013. A significant decline in FDI… would hit Russia’s long-term economic growth hard. And denying Russian banks and firms access to the US (and possibly European) banking system–the harshest sanction applied to Iran–would have a devastating impact.

In the short run, however, it is trade that matters much more than investment. Russia’s annual export… are worth almost $600 billion, while annual imports total almost $500 billion. Any non-trivial trade sanctions… would be much more painful than the direct cost of subsidizing Crimea…. Russian and foreign businesses have always been worried about the unpredictability of the country’s political leadership. Lack of confidence in Russian policymaking is the main reason for capital flight, low domestic asset prices, declining investment, and an economic slowdown that the Crimea crisis will almost certainly cause to accelerate…. Indeed, Russia’s response to events in Ukraine has exceeded the worst expectations of those who were already questioning whether Putin is, as German Chancellor Angela Merkel put it, “in touch with reality.”…

Regardless of whether the Kremlin is irrational or simply uninformed, its policy in Crimea sends an unmistakable signal to investors: Russia’s political leaders are impossible to predict…. Meanwhile, investment is still below its 2008 peak. Despite a wealth of opportunities across the Russian economy, the country’s hostile business climate – including bloated bureaucracies, widespread corruption, and the expansion of state-owned companies – has weakened Russian and foreign investors’ incentive to start new projects or expand existing ones. The realization that Putin has entered, to quote Merkel again, “another world” will only make matters worse….

On the Monday after Putin’s Crimea adventure began, the Central Bank of Russia reportedly spent $11.3 billion to prop up the ruble. Such support is clearly unsustainable; in fact, the CBR recently announced that it will allow the ruble to float, implying an exchange rate that reflects the market’s expectations concerning oil prices and future capital outflows…