The economic sanctions imposed on Russia by Western nations are unlikely to deter Russia’s invasion of Ukraine, due to the scope of the sanctions which makes them easy to circumvent, as well as going by how ineffective sanctions imposed on Russia in 2014 were.
THERE are long lines at Russian banks to withdraw funds, the ruble has plummeted, and the global elite who have been lying low find themselves increasingly under pressure to act; all this can be blamed on the use of the instrument of ‘sanctions’. This term has come up several times in the recent discourse surrounding the full-scale invasion of Ukraine by Russia.
I will attempt provide an overview of sanctions imposed by the U.S. as well as other international sanctions, their impact on Russia, possible ways to ways to effectively circumvent them, and finally, if they will fail or prove an actual deterrent to Russian aggression.
Overview of U.S. sanctions imposed on Russia
For starters, it is important to note that current sanctions are short of a full embargo on Russia, which simply means that not all import and export activities are prohibited. This is unlike the full embargo imposed on North Korea, Iran, Cuba, Syria, and the region of Crimea by U.S. Trade with Russia has become heavily restricted and, in some cases, totally forbidden, but it has not stopped or halted (at least not as of today).
On February 28, the U.S. Department of Treasury’s OFAC [Office of Foreign Assets Control] issued additional sanctions measures against Russia. Directives 2, 3 and 4 under Executive Order 14024 [EO 14024] expand the scope of U.S. Sanctions. EO 14024 is about “Blocking Property with Respect to Specified Foreign Activities of the Government of Russia”. The 31 Code of Federal Regulations Part 587 titled ‘Russian Harmful Foreign Activities Sanctions Regulations’ helps implement EO 14024.
Directive 1A of EO 14024 is about prohibitions related to certain sovereign debt of the Russian Federation. It extends existing sovereign debt prohibitions to cover participation in the secondary market for bonds issued after March 1, 2022, by the Central Bank of the Russian Federation, the National Wealth Fund of the Russian Federation, or the Ministry of Finance of the Russian Federation.
Sanctions will not only directly disrupt the financial life of Russia, but will play a role in its cultural seclusion too.
Directive 2 under EO 14024 prohibits U.S. financial institutions from opening or maintaining correspondent or payable-through accounts on behalf of foreign financial institutions and processing of transactions involving foreign financial institutions determined to be subject to this Directive. Russian majority State-owned banking and financial services company Sberbank and its 25 subsidiaries were prohibited from maintaining correspondent and payable-through accounts, severely limiting their ability to conduct transactions. This rule’s scope is widened by what is known as the 50 Percent rule, which simply means that any entity owned 50 per cent or more, directly, or indirectly, by Sberbank will also be prohibited.
Directive 3 under EO 14024 imposes more limited financial sanctions on certain Russian companies. These prohibit U.S. persons from dealing in new equity or new debt (with a maturity of 14 days or more) with 13 Russian companies, which include Sberbank, the Russian majority state-owned multinational energy corporation Gazprom, Credit Bank of Moscow, the Russian state-controlled pipeline transport company Transneft, Russian Railways and telecom company Rostelecom.
Directive 4 of EO 14024 prohibits any transaction involving the Central Bank of Russian Federation, the National Wealth Fund of the Russian Federation, or the Ministry of Finance, including any transfer of assets to such entities or any foreign exchange transaction for or on behalf of such entities.
The OFAC maintains a Specially Designated List [SDN List] which consists of individuals and companies owned or controlled by, or acting for or on behalf of, targeted countries. It also lists individuals, groups, and entities, such as terrorists and narcotics traffickers designated under programs that are not country specific. OFAC’s SDN List was also expanded to include – VTBBank, Russia’s second largest bank, and three other banks – Otkritie, Sovcombank OJSC, Novikombank, along with 34 of their subsidiaries. OFAC designated two financial institutions – State Corporation Bank for Development and Foreign Economic Affairs Vnesheconombank and Promvyazbank Public Joint Stock Company [PSB] that are crucial to financing the Russian defense industry, as well as 42 of their subsidiaries. OFAC also acted against five vessels that are owned by PSB Lizing OOO.
On February 25, OFAC added the President of the Russian Federation, Vladimir Putin to the SDN List. In addition to President Putin, it designated Russia’s Minister of Foreign Affairs, Sergei Viktorovich Lavrov, Russia’s Minister of Defense, Sergei Shoigu, and Chief of the General Staff of the Russian Armed Forces and First Deputy Minister of Defense, General Valery Gerasimov. Other Elites and Oligarchs close to Putin and their families are expected to be targeted soon.
U.S. Department of Commerce, through its Bureau of Industry and Security, has targeted Russia’s oil refining sector with new stringent export controls and identifies 91 entities that support Russian military activities. This will further restrict U.S. commodities, software, and technology from being transferred.
OFAC also sanctioned 24 Belarusian individuals and entities due to Belarus’s support and facilitation of the invasion of Ukraine. These sweeping restriction on Belarus include the Department of Commerce’s stringent export control policies that will prevent diversion of items, technologies, and software through Belarus to Russia.
The European Union [EU] has adopted several restrictive measures in relation to the Russian-Ukrainian conflict. These include: economic and financial asset freeze; sanctioning of Vladimir Putin and other members of Russian Duma; an airspace ban and prohibition on access to EU airports of all Russian carriers; a ban on transactions with the Russian Central Bank along with a SWIFT [Society for Worldwide Interbank Financial Telecommunications] ban for seven Russian banks; suspension of broadcasting in the EU of Russian State-owned media – RT and Sputnik; and restrictions on the export of maritime navigation and radio. The SWIFT ban was also extended to Belarusian Banks. In addition to this, Germany halted the certification of the Nord Stream 2 Gas Pipeline from Russia to Germany.
Historically, rogue States such as North Korea, Syria and Iran have failed to change course because of sanctions. This is also true of sanctions imposed on Russia post the Crimean annexation in 2014.
The United Kingdom is also imposing sanctions on an almost daily basis. These include asset freezes, economic prohibitions, other trade, and financial restrictions.
Canada imposed sanctions under its Special Economic Measures Act. These Regulations impose asset freeze and prohibit dealings with designated persons, which include both individuals and entities. It also prohibits any Russian ship from passing in Canadian waters.
Japan’s actions will deny select Russian Banks access to the SWIFT messaging system, impose restrictions on the Bank of Russia, and sanction key Russian leaders (including Putin).
Australia sanctioned 300 Russian lawmakers who voted in favor of attacking Ukraine and key Belarusian individuals and entities. New Zealand also decided to pass targeted Russian sanctions that will freeze Russian assets in their country, prevent people and companies from moving their money and assets to their country to escape sanctions imposed by other countries, and stop super yachts, ships and aircraft from entering their water or airspace.
Taiwan also joined the international sanctions regime as it has vowed to “harshly scrutinize” export to Russia (especially that of semiconductor exports).
Implications of sanctions on Russian economy
The sanctions imposed on Russia in 2014 in wake of the annexation of Crimea from Ukraine pale in comparison to the ones introduced now. The Russian financial system is closely tied with the rest of the world. While Russia exports gas and other raw materials, it also imports sophisticated technologies and consumer goods. Hence, in terms of trade, its economy will certainly hurt.
Numerous private big businesses like Microsoft, Mastercard, Visa, Accenture, Apple, Disney, Netflix, Coca Cola, Ford and BMW have decided to reduce or totally cut their services in Russia. This digital and financial isolation by multinational corporations will negatively affect the creation of jobs and investments, along with reputational loss. Mastercard and Visa bans will affect credit card payments.
Sanctions will not only directly disrupt the financial life of Russia, but will play a role in its cultural seclusion too. Tourism will suffer, since Russia is banned from participating in large international events like Eurovision. All this in the midst of news of many local Russian citizens remaining stranded due to air bans.
As robust as the sanctions regime sounds, in practice, enforcement of these multiple sanctions is tricky. There are several obvious and non-obvious weaknesses which may dilute the purpose behind their imposition and make enforcement challenging. Some key ones are listed as below:
Short of an embargoed country status – As previously discussed, sanctions on Russia fall short of a complete embargo; hence, they are not as comprehensive and complete.
Various general licenses – U.S., through OFAC, has dispensed some of the most wide-ranging sanctions yet there are several general licenses which have been issued simultaneously to allow otherwise forbidden transactions to continue. Some of these have provided an extended winding down period, leaving room for ambiguity in policies whereas some directly permit flow of transactions. U.S. financial institutions continue to process energy-related payment transactions. General License 9A authorizes all transactions prohibited by Russia-related Sovereign Transactions Directive. Similarly General Licenses 10A, 13 and 14 provide more concessions. EU sanctions also have a similar ‘carve out’ window for energy related payments.
50 per cent ownership rule – The reach of U.S. sanctions is overarching. In some cases, the 50 per cent rule allows sanctioning of parties that are majority owned or controlled by already ‘sanctioned’ entities. This complicates compliance efforts as many entities have indirect ownership structures crossing over many jurisdictions. The EU has a similar rule in effect.
Oil ban could be counter-productive – U.S.’s ban of import of oil, gas and energy from Russia could result in elevated oil prices in its domestic market. The negative impact on domestic inflation may force U.S. to re-think this move. In the meantime, EU continues to rely heavily on Russian oil, thereby further diluting the impact of this measure (U.S. imports only about 8 per cent of Russian oil versus Europe, which imports around 30 per cent).
Cryptocurrency can be used to evade the impact of sanctions – Two of the world’s biggest cryptocurrency exchanges, Coinbase and Binance, have rejected calls for a ban on Russian users, arguing that it would affect ordinary people in Russia. Hence cryptocurrency can be used to evade sanctions. Already, Venezuela successfully uses it to pay for imports from Iran and Turkey, and to beat hyperinflation caused by U.S. sanctions.
Russia’s counter sanctions – Russia has imposed a range of special economic measures in reply to Western sanctions. Russian exporters starting from February 28, are obliged to sell 80 per cent of foreign currency received from foreign trade contracts. Russian residents are prohibited from lending to foreigners in foreign currency; they will not be able to put foreign currency on their accounts and deposits in foreign banks and they cannot transfer funds to foreign banks without opening a bank account using electronic means of payment provided by foreign providers of payment services. These may have limited impact so far, but Russia may choose to intensify them.
Dealings with unsanctioned entities and individuals – Unsanctioned Russian Banks and financial institutions as well as unsanctioned Russian government can help in dodging sanctions for the sanctioned entities and individuals.
Use of shell companies and money laundering – The U.S. Treasury warned that some “red flags” for evasion include shell companies which can be effectively used to obscure ownership, the source of funds and the wealth or countries involved. Money laundering methods like investment in real estate and use of third parties can help in hiding the trail of money.
Financial institutions in western countries lack proficiency and resourcesto organize themselves so quickly – Change in policies and procedures in real time to comply; deployment of sophisticated technologies like Internet Protocol screening; implementation of strict KYC controls; conducting due diligence on distributors/re-sellers; possessing adequate knowledge of the local language (translation and transliteration of names in other scripts from the Cyrillic script), and employing robust beneficial ownership checks, are some of the many difficulties. Hence, enforcement on the ground is at best imperfect. Furthermore, compliance with other sanctions regimes globally adds to the complexity.
Will sanctions fail or prove a deterrent in Russia’s way?
The short answer here is that sanctions will likely fail to halt Russia’s aggression. In fact, bringing Russia to the negotiating table under their pressure also seems improbable. Besides the glaring loopholes discussed above, the number one concern is that historically, rogue States such as North Korea, Syria and Iran have failed to change course because of sanctions. This is also true of sanctions imposed on Russia post the Crimean annexation in 2014. Though the 2014 sanctions were tough, and they did cause economic pain, the Russian economy did not collapse as anticipated. This may go on to hold true of the 2022 batch of sanctions as well.
The second reason why Russia weathered the storm of sanctions previously and may do so now as well is due to the interactive effect between economic sanctions and the value of Russian exports. Russia is the world’s third largest producer of oil and liquified fuels, and second largest natural gas producer. Oil is a global commodity pegged to U.S. dollars and hence, as value of the ruble relative to the U.S. dollar falls, the price that Russia’s major exports command increases in local currency. Oil and gas production are controlled by State enterprises and directly account for the major chunk of Russia’s budget. The harder the sanctions hit, the more valuable Russian energy exports become and the better they are able to sustain the Russian budget. Energy prices are rising in 2022, unlike 2014 when they were falling, and this has led to the oil sector being exempt from EU sanctions as it is a major consumer of Russian energy. Sanctions on Russia reduce their supply of foreign currency, as well as the demand for rubles, which causes the exchange rate to swing in favour of the foreign currency. For energy commodities that will be traded in foreign currencies, this also creates a steady supply of foreign currency to Russia that dampens the effect of the sanctions.
The harder the sanctions hit, the more valuable Russian energy exports become and the better they are able to sustain the Russian budget. Energy prices are rising in 2022, unlike 2014 when they were falling, and this has led to the oil sector being exempt from EU sanctions as it is a major consumer of Russian energy. Sanctions on Russia reduce their supply of foreign currency, as well as the demand for rubles, which causes the exchange rate to swing in favor of the foreign currency.
Secondary sanctions have not yet been imposed by the U.S. Treasury. If imposed, their scope will lead blacklisting of any bank, anywhere in the world, found to conduct financial business on behalf of targeted Russian oligarchs and banks. This measure may prompt China to slow down its efforts to help Russia, but so far China is Russia’s biggest ally, and this is already reducing the effect of sanctions.
Again, targeting high profile individuals in Putin’s circle may be largely symbolic as in all probability, they have already and successfully hidden their wealth (or they will be compensated later by the system).
There is room for escalation of current sanctions which may include expanding the SWIFT ban on all Russian Banks, removing energy ‘carve out’ policies, and targeting more key companies in Defence, Finance and Energy sectors, but the ramifications of these will be largely long-term. The immediate price of these measures is being paid by the common populace of Russia; there will be a further drop in their living standards as money for the war chest ultimately comes at their cost. Similar is the plight of the common people of Ukraine, who are of course in a much more vulnerable spot.
The most likely outcome of this war will be Ukraine succumbing to Russia – this could happen through the installation of a Russia-friendly puppet regime, or by the formal recognition of Donetsk and Luhansk as part of Russia, or through complete surrender (especially if there is total breakdown of the Ukrainian armed forces or assassination of the Ukrainian President).
As Mahatma Gandhi aptly wrote, “What difference does it make to the dead, the orphans and the homeless, whether the mad destruction is wrought under the name of totalitarianism or in the holy name of liberty or democracy?” So, whether it is in the name of restoring democracy for which the West is arming Ukraine ,or whether it is Russia’s ruthless quest for its expansionist dreams, an ‘iron curtain’ has descended on the European geopolitical theatre, and this time on both sides of it are powerful nuclear States. Sanctions unfortunately seem like an overused, blunt weapon in this scenario, where stakes are already so high!