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Russia’s economy may be headed for a fall

Decades of diplomacy ushered Russia into the international tent, where Western powers like the U.K. and U.S. seemed mostly content to ignore aggression on its borders and human rights violations within, in the interest of keeping them inside.

This not-so-Great Game of diplomacy only works when all sides are prepared to at least preserve the façade. Closer economic ties should, theoretically, mean that everyone is motivated to stay friendly, or at least polite. Yet recent events in Ukraine demonstrate that Russia is not overly concerned about whether or not it falls out with Europe, by far its biggest trading partner.


A unit claiming to Cossack and other citizen pro-Russian volunteers arrive to take up position outside a Ukrainian miltary base where heavliy-armed unidentifed soldiers have surrounded Ukrainian soldiers inside as Russian flag flies behind in Crimea on March 3, 2014 in Perevalne, Ukraine.
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A unit claiming to Cossack and other citizen pro-Russian volunteers arrive to take up position outside a Ukrainian miltary base where heavliy-armed unidentifed soldiers have surrounded Ukrainian soldiers inside as Russian flag flies behind in Crimea on March 3, 2014 in Perevalne, Ukraine.

(Read more: Why market panic over Ukraine may be short-term)

Now, Russia has stabbed at their perceived enemy of a new pro-European regime in Ukraine – but, like Hamlet, they may be surprised by the body in the arras when they rip aside the curtain. Their economic success could the real victim if military conflict with Western powers ensues.

If oil and gas prices are bolstered by the threat to supply, this would of course help boost Russia's natural resource-driven economy, as well as harming Europe's still-fragile economic recovery. This would be far outweighed by a series of negatives for the country.

(Read more: Why Crimea matters)

The plunge in the value of the ruble, already the worst-performing emerging markets currency this year except for the Argentinean peso, would continue as foreign investors pulled out. Russia would have to defend the value of the ruble further, probably through the central bank buying up rubles to bolster prices, at potentially huge expense to its coffers. The bank might also raise interest rates even higher than Monday's emergency hike from 5.5 to 7 percent, which could further hamper the economy.

Russia's economic growth, predicted to pick up to 3.1 percent this year by the World Bank, would slow or even fall into recession.

(Read more: Is Russia ready to pay the price for Ukraine intervention?)

Some of Russia's elite have amassed eye-watering fortunes in the years since the Iron Curtain fell, and ten of the world's hundred richest people are from Russia, according to the latest Forbes Billionaires list.

The country's super-wealthy, many of whom are close to President Putin, could be targeted by economic sanctions such as asset freezing. Plenty of them have bought property in European cities like London, put their money with banks outside Russia, or educated their children in the West. They are unlikely to be pleased with Putin if his actions lead to their comforts and wealth being threatened. There is plenty of debate over the use of sanctions as a weapon, but they can be effective – you only have to look at Iran's recent tentative steps into the international arena to see.


- By CNBC's Catherine Boyle. Twitter: @cboylecnbc

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