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Grounding of Russian airline first corporate casualty of EU sanctions

Russian President Vladimir Putin speaks to the media at Benouville castle on Friday, June 6, 2014. Western sanctions imposed on Russia tighten as fallout from the Ukraine crisis threatens to trigger a new Cold War.

Alexei Nikolsky/AP Photo

Passengers of Russia's new discount airline Dobrolet were greeted with an alarming notice on Sunday when they went to the website to check their holiday flights.

"Due to EU sanctions against Dobrolet, we have suspended all fights since August 4th," it said.

The grounding makes the subsidiary of state-controlled Aeroflot the first direct corporate casualty of the Western sanctions imposed on Russia as fallout from the Ukraine crisis threatens to trigger a new Cold War. Dobrolet's maiden flights were made only two months ago.

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But the sanctions are cutting both ways and the collapse of Dobrolet may also hurt U.S. aviation giant Boeing, which had supplied the airline's small fleet of new twin-engine 737-800 jets. By the end of this year, Dobrolet had planned to put eight of the Boeings into service and the number was to rise to 40 by 2018. It was not immediately clear whether the new aircraft leases would be put on hold or cancelled.

Dobrolet landed on the sanctions list because it offered direct flights from Moscow to Crimea, the Ukrainian region on the Black Sea that was annexed by Russia earlier this year. The new round of sanctions, which came into effect after the July 17 destruction of Malaysia Airlines Flight 17 over rebel-held territory in eastern Ukraine, meant that Western counterparties could not provide aircraft insurance or fulfill maintenance and leasing agreements.

On July 30, the European Union said that Dobrolet's service to Crimea "facilitates the integration of the illegally annexed Autonomous Republic of Crimea into the Russian Federation and undermines Ukrainian sovereignty and territorial integrity."

Economists and analysts agree that the new tier of sanctions will inflict more damage on the Russian economy than the initial round of sanctions, which largely targeted businessmen and corporate entities with links to the seizure of Crimea. But they also think Western economies and corporations will have to absorb some collateral damage. Since it appears the sanctions are unlikely to convince Russian President Vladimir Putin to abandon his geopolitical strategy in Ukraine, at least in the short term, the sanctions seemed destined to hurt both sides for some time.

"Everything so far points to a further hardening of Russia's stance," said Nicholas Spiro, managing partner of Spiro Sovereign Strategy, a London consultancy that examines sovereign credit risk. "Mr. Putin has too much invested – from a geopolitical and, just as importantly, a domestic political standpoint – in his standoff with the West to be swayed by sanctions alone."

At least one Russian oligarch who is close to Mr. Putin, Gennady Timchenko, predicted that the sanctions would backfire. "It is naive to think that with such methods anyone will scare us or force us to retreat," he told the Itar-Tass news agency Monday, adding that Russian businesses are not putting pressure on Mr. Putin to reverse course in Ukraine.

In late July, Europe and the United States, with Canada at their side, launched a variety of sanctions that targeted industries ranging from banking to energy. Russian banking got hit hardest. The sanctions will make it exceedingly difficult for the state-owned banks, among them Gazprombank and Vnesheconombank, to raise debt and equity in the European and North American markets. There was also an embargo on the export of Western oil-field technology, which will do nothing to crimp Russia's oil and gas production in the near term but could slow the development of new fields in the Arctic.

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The Economist magazine reported that the financial sanctions were hitting the Russian economy even before they were toughened up in July. The flow of dollar-denominated loans to Russia dropped to $7.9-billion (U.S.) in the first half of 2014 from $25-billion a year earlier. Bloomberg reported that no Russian companies received loans in dollars, Swiss francs or euros this past month, the first such instance in five years.

The fall does not mean that Russian businesses are suddenly devoid of financing; it does mean that they have to rely on potentially more expensive domestic sources of financing, or Chinese lenders, to fill the vacuum.

The big European countries, including France, Germany and Italy, are supporting the new round of sanctions, but may be reluctant to toughen them up once again. That's because of the extensive bilateral trade and investment links with Russia.

French auto maker Renault SA said that deliveries to Russia had fallen by 8 per cent in the first half of the year. British oil giant BP PLC, which owns 20 per cent of Russian oil producer OAO Rosneft, warned last week that "sanctions could adversely impact our business." Poland, one of Russia's biggest trading partners, but also one of Mr. Putin's biggest critics, said the sanctions would dampen Poland's growth by about 0.6 of a percentage point this year. In retaliation for Poland's support of the sanctions, Russia has banned some food imports from Poland.

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About the Author
European Columnist

Eric Reguly is the European columnist for The Globe and Mail and is based in Rome. Since 2007, when he moved to Europe, he has primarily covered economic and financial stories, ranging from the euro zone crisis and the bank bailouts to the rise and fall of Russia's oligarchs and the merger of Fiat and Chrysler. More

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