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Russia is already feeling sanctions pain

Russia is already feeling sanctions pain

Russia is already feeling economic pain from its Ukrainian land grab-even without tougher sanctions from the West.

A fresh round of violence in Ukraine has prompted calls for Western leaders to ratchet up economic sanctions against the Kremlin.

But with capital flooding out of the country, the local stock market falling and Russia's currency weakening, the seizure of the Crimea is turning out to be a costly move.

"Even if a diplomatic solution to the crisis can be found, this may not be enough to prevent Russia from sliding into recession over the first half of this year," according to Neil Shearing, an economist with Capital Economics.

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Investors have dumped assets this year as President Vladimir Putin annexed Crimea and massed troops on Ukraine's border, fueling a reprise of Cold War tensions and concern that sanctions could push Russia's slowing economy into reverse.

By annexing Crimea and massing troops on Ukraine's border, the Kremlin has set off a reprise of Cold War tensions that is already having a chilling effect on trade.

On Tuesday, French car maker Renault said it has frozen plans to produce vans with Russian truck maker ZIL due to a weakening of the ruble. Locally-produced cars benefit from the falling currency because they're more competitive when bought with rubles compared to costlier imports priced in strengthening euros, yen or dollars. But the ruble's ongoing slide has also damaged consumer confidence, dampening sales for all car makers.

Other global companies are also pulling back. Japanese banks have withdrawn from deals and suspended credit lines, fearing the west will widen sanctions on Moscow's business elite, according to the Financial Times. Sumitomo Mitsui Banking Corporation and Bank of Tokyo-Mitsubishi UFJ, two of Japan's largest banks, have stepped back from Russia in recent weeks, bankers and executives told the newspaper.

On Sunday, two members of the Senate Foreign Relations Committee said it was time to target industries critical to Russia's economy.

"I think the time is now to rapidly ratchet up our sanctions, whether it's on Russian petrochemical companies or on Russian banks," said Sen. Chris Murphy, D.-Conn. "Yes, there will be economic pain to Europe (under tightened sanctions). But it's time for them to lead as well."

Read More Ukraine accuses Russia of staging fatal attack

So far, the U.S. and European Union have imposed limited sanctions-including travel bans and asset freezes on about 30 close political allies of Putin. The White House is reportedly considering expanding the first round of sanctions by targeting additional individuals and adding specific companies involved in energy production.

Last week, the European Commission briefed member countries on the possible economic and financial impact of tougher sanctions on Russian energy, finance and trade sectors. Those countries have until Tuesday to respond to the proposed measures as the EU formulates its next move. But any European response will be tempered by the Continent's heavy reliance on imports of Russian oil and gas.

Still, Russia's reliance on those energy exports may prove to be an Achilles' heel, say analysts. After a sharp run-up after the global recovery from the Great Recession in 2009, global oil prices have flattened for the last two years. With oil prices stalled, so has Russia's gross domestic product, which fell from 4.5 percent growth in 2010 to just 1.3 percent last year.

"Unless Russia can reduce its dependence on the production of oil and other commodities and diversify and reform its economy, any recovery will likely remain fragile," according to a Congressional Research Service report last month.

Read More New Russia sanctions threats as Ukraine stalemate goes on

Those reforms include wider transparency into Russian companies and capital markets. The Russian banking system is still dominated by state-owned banks, and outside investment has been hampered by reports of widespread corruption, according to the Organization for Economic Cooperation and Development.

"Corruption is a serious burden on business in Russia," the group said in a report last year. "According to business surveys, it is among the main obstacles to market entry and growth."

Investors have grown even more skittish as the turmoil in Ukraine has sparked massive capital outflows. Some $70 billion has fled the country this year-more than all of 2013-sending the Russian ruble falling some 9 percent. That's raised the prices that Russian consumers pay for imported goods, adding fuel to an inflation rate that hit nearly 7 percent last month.

To widen the financial pain, Western countries could also target financial transactions involving Russian banks and companies, further pressuring the ruble and putting added stress on Russia's financial system.

Such a financial embargo would be most effective if coordinated with European banks. But even without Europe's participation, U.S. financial sanctions could have a powerful impact thanks to the outsize role of U.S. financial institutions, according to Robert Kahn, a senior fellow at the Council on Foreign Relations.

"Because payments are cleared and settled by institutions that have U.S. ownership and participation, those sanctions by themselves can have a significant effect in breaking down transactions," he told CNBC. "Even if it's only one leg of the transaction that's involved, if you can stop that piece of it, you can stop the whole transaction from going forward."

Read More Volkswagen: Russia not doing as well as expected

A broad freeze on Russian financial transactions, though, also raises the risk of a full-blown Russian financial crisis, which would create a new set of problems for the global economy. With central bankers easing up on a five-year spree of money stimulus, and global growth showing signs of slowing, the pain from any harsher sanctions on Russia could be felt beyond its borders.

UPDATED: This story was updated to include examples of global companies pulling back on plans to do business in Russia.

-By CNBC's John Schoen. Follow him on Twitter @johnwschoen or email him.



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