Sanctions FX Impact: How Sanctions Can Increase FX Risk
Sep 15, 2022
Economic sanctions have been the chosen tool of many policymakers in response to significant geopolitical changes like terrorism and conflict. Governments and international bodies use sanctions to alter the strategies of state and non-state actors threatening their interests or are in violation of international norms. The latest one is the sanctions imposed on Russia amid its Ukraine invasion.
While the effectiveness of sanctions has met critics' disapproval, supporters argue that sanctions have become more effective in recent years, underlining its importance as an essential foreign policy tool.
What Are Economic Sanctions?
Sanctions are punitive measures imposed on foreign states or actors to influence their behaviour in favourable ways to the imposing nation. They are intended to modify the kinds of decisions their targets make, whether for political or economic purposes.
Economic sanctions are a coercive foreign policy tool used to influence a state's behaviour through its economic interests. They are normally imposed by the UN, individual states, and regional organisations and are designed to alter the target state's behaviour.
When Are Economic Sanctions Used?
The most common use of sanctions is by the United Nations and the European Union to force states to comply with international norms. These norms are usually included in international agreements like treaties on trade, fishing, and human rights. However, states also impose sanctions on other states for more political reasons, such as to punish certain parties for aggression.
Sanctions are primarily employed as an alternative to military conflict. They are also used as a form of pressure during peace negotiations.
Why Are Economic Sanctions Used?
Economic sanctions are used to change the behaviour of a country or party that is considered undesirable, such as through economic and political warfare. They can be employed to achieve strategic, political, and economic objectives or pressure groups or individuals.
Sanctions are frequently used to punish those who conflict with international law or norms. They are also used to influence the behaviour of the target state. For example, countries can use sanctions to punish an opposing state for aggression or a party for violating human rights.
In recent years, sanctions have increasingly been used to persuade bad behaviour, although more recently, sanctions have been used to wage economic and political warfare.
Types of Economic Sanctions
Broadly, economic sanctions can be categorised into three types, depending on their level of formality or stringency.
1. Commercial Sanctions
Often imposed by individual states or groups, they are loosely defined and generally involve a suspension of all trade. These are mostly accompanied by the blocking of all financial transactions and the freezing of the assets of the sanctioned state or group.
2. Financial Sanctions
These are the most common, involving a selective ban on financial transactions with the state or target entities. These can include a suspension of specific transactions or the freezing of assets and come in various forms; they are mostly used in addition to other forms of sanctions.
3. Embargo Sanctions
Embargoes are the most severe form of sanctions, especially in terms of the extent of their effects on trade, as they prohibit all trade with the target state or group. Some embargoes are also accompanied by a ban on all financial transactions or a complete withdrawal of diplomatic relations.
What Are the Main Criticism Points Against Economic Sanctions?
Sanctions are considered by many to be a useful, if not effective, tool for foreign policy. However, there is an extensive body of criticism surrounding its use.
First, sanctions have been shown to be rarely effective and criticised for their negative impact on civilian populations. Sanctions are less likely to succeed when the target state has greater economic or military power than the imposing country.
2. Cannot Stop Conflicts
Second, sanctions have not effectively halted political conflicts. Sanctions are a tool to change behaviour, but they do not solve political problems. Treaties and agreements also do not permanently change state behaviour and may even aggravate the situation.
3. Unilateral Impact on Needy Populations
Third, sanctions affect populations differently based on economic status and livelihoods. With sanctions, the poorest and most vulnerable are those most affected. Sanctions on politically unstable countries, for example, may stoke the flames of the conflict, with the targeted state using the population's suffering as a rallying cry. Sanctions also impact women and children the most, as they are most likely to be out of work and are more susceptible to hunger and malnutrition.
4. Effects on Civil Rights
Many argue that sanctions violate the human rights of the country's civilian population. Doing so would violate a state's sovereignty and citizens' right to freedom.
5. Food and Medicine as a Weapon
Fifth, sanctions can also be used as a weapon to starve the civilian population. Sanctions can be used to cut off the supplies of essential products, like food, medicine, and commodities.
What Are the Effects of Economic Sanctions on the Targeted State?
First, sanctions can decrease the quality of life of the target countries' civilian populations. Military conflicts and international political tensions can exacerbate the everyday life of the populace, and sanctions can increase the risk of domestic political turmoil.
Second, the effects of sanctions on the targeted state's economy can vary. In cases where the targeted state is a heavy exporter of goods and services from the imposing country, sanctions can cut off the funds of the target state and cause economic instability.
Third, when economic sanctions are imposed or lifted, it can affect the financial markets of the imposing country. As the imposing country's currency value may rise due to the sanctions, it can harm its exports.
Fourth, the culture of the imposing country can also be affected. International sanctions can also play a role in causing social upheaval, leading to negative feelings towards the target state and its population.
What Are the Effects of Sanctions on the Target State’s Trading Partners?
However, the effects of sanctions on the target state’s trading partners have also been noted. Although the sanctions did not target them, they were, in fact, greatly affected by the imposition of such sanctions.
Sanctions on other countries such as Russia can affect trading partners such as Europe, which may be its larger trading partner, but even the United States, which is considered less affected by the sanctions on Russia.
Sanctions have also led to political upheavals in Europe, such as the Brexit referendum and the growth of populism in Europe.
How Do Economic Sanctions Affect the Financial Markets?
For the imposing states and international organisations, the effects of sanctions are mainly economic and financial. They may cause some damage to their own economies depending on the scale of the sanctions they impose.
Often, sanctions have also been imposed on entire sectors to cut off target states' funds, such as the oil, gas, and finance sectors.
On the other hand, sanctions on a specific country may cause the value of other countries' currencies to rise. This is especially the case when the sanctioned country is a major exporter to the imposing countries.
How Do Economic Sanctions Impact the Forex Market?
Economic sanctions have a strong impact on the values of foreign currencies. They can be used to punish the sanctioned country or further the imposing state's agenda. The effects of sanctions on the value of foreign currencies can be direct and indirect.
1. Direct effects
Direct effects of sanctions include trade and financial sanctions and restrictions on the movement of goods and people.
Trade sanctions can include a complete suspension of trade with the target state or a ban on exports and restricted access to technology and finance.
Financial sanctions can include restricting financial transfers, such as the freezing or blocking of assets or the suspension of financial transactions.
2. Indirect Effects
Additionally, indirect effects include political sanctions, in which the electorates of the imposing country oppose the sanctions. In such cases, the imposing country can be forced to reconsider the sanctions and may find a compromise with the target state.
Another indirect effect of sanctions is the deterioration of relationships between the imposing country and the target state and its allies. This can result in threats of sanctions against the imposing country, which can also affect other countries.
Economic sanctions can also raise the presence of non-state actors in the targeted state, which can create security threats for the imposing state and its allies. These can include separatist movements, movements against the government, or new terrorist groups.
Economic sanctions can also lead to other states imposing sanctions on both the target and the imposing nations as they try to change the status quo and force a resolution of the conflict. This can also affect the international community, especially if the target state is a major exporter or importer of products.
The Forex Market During the Russia-Ukraine Crisis 2022
The conflict between Russia and Ukraine has been a direct and indirect driver of market trends and regional monetary policies. Since the end of 2014, when Russia occupied Crimea, the U.S. and EU have imposed sanctions on Russia that have significantly impacted the Russian economy and the forex market.
The first round of sanctions was imposed on Russia by the U.S. and EU in March 2014 after the annexation of Crimea by Russia. However, more sanctions were imposed on Russia in 2014, 2015, and 2016 in response to allegations of interference in the Ukrainian civil war.
In the Russia-Ukraine crisis of 2022, the U.S. dollar and EU economies' fluctuation was directly affected. The U.S. dollar has become the world's primary reserve currency in 2022 because of its size and influence in the global economy.
The stance of the U.S. and EU in imposing sanctions on Russia has also affected the economic policies of its allies. As a result, the euro has done badly in the forex market and has depreciated against the U.S. dollar.
On the other hand, Russia has been affected by the sanctions imposed on it by the U.S. and EU. Russia is a major oil exporter, and many of its exports are in the form of oil and gas. As a result of the crisis in 2022, the country's exports have been severely affected.
The devaluation of the Russian ruble has also had a significant impact on energy prices around the globe. Many countries and organisations have responded by imposing sanctions on Russia. Consequently, the British pound has also depreciated in the forex market.
The USD and the EUR During the Ukraine-Russia Crisis 2022
The U.S. dollar has become the world's main reserve currency in 2022. This is because the U.S. has a strong economy, and it is the biggest importer and exporter of goods.
As a result, the U.S. dollar has gained strength against many currencies, including the euro. The euro has been depreciating against the U.S. dollar due to the sanctions imposed on Russia and its weak economy.
The following table compares the values of the euro, the British pound, and the Russian ruble in 2022. The table shows that the value of the Russian ruble has declined significantly and is now worth much less than 1 U.S. dollar.
What the Ukraine-Russia Crisis Tells Us About the Future of the Forex Market
The crisis between Ukraine and Russia has shown that economic sanctions strongly impact the financial markets. Although Russia and Ukraine are not major trading partners, the imposition of sanctions on Russia has caused the value of some currencies to decline.
This crisis has also shown that the EU can be significantly affected by the imposition of sanctions. The EU is not a significant trading partner of Russia but still has imposed sanctions on Russia. As a result, the Russian ruble has been devalued, and the value of some EU currencies has been adversely affected. The crisis between Russia and Ukraine has had a stronger effect on the financial markets than the crisis between the EU and Russia.
It is difficult to predict the impact of economic sanctions on the forex market, but we can observe its effects in the crisis between Russia and Ukraine. Economic sanctions have escalated the conflict between the EU, Russia, and Ukraine and affected the value of currencies in the international forex market. This highlights the effectiveness of sanctions in achieving the desired outcome or moving the parties in conflict to negotiate.
Economic sanctions have also caused other countries to intervene and impose their own sanctions on the parties to the conflict.
Economic sanctions are one of the most effective diplomatic tools available to the imposing countries. They are a means of coercion and can be used to settle disputes between countries in conflict.
The sanctions imposed on Russia have significantly impacted its economy and the forex market. This highlights the need for the imposing countries to carefully analyse the impacts of their economic sanctions on the target states.
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