By Bryan Bayne (2020-2022, Olomouc and Uppsala).
The West has often been criticized for not doing enough to stand up to Putin’s war in Ukraine. Viral social media posts imply that Ukraine fights alone, while Western powers talk tough but do nothing. That could not be further from the truth. In addition to the considerable military and financial aid that Western countries have provided to Ukraine, they have also imposed harsh economic sanctions on Russia. This article aims to analyze the sanctions imposed on Moscow and their likely impact.
To begin with, it should be stated that the main objective of economic sanctions is not to revert an ongoing invasion, as is often assumed. Policymakers are well aware that economic sanctions rarely force an aggressor to back down or even to change behavior. Rather, there are three other goals. First, to substantially raise the cost of Russian aggression against Ukraine, which is expected to give Kyiv a better chance at fighting and a better position at the negotiating table. It is also expected that this raised cost will deter Putin from attacking other countries, as Russia will simply not be able to afford another invasion. Finally, the sanctions aim at raising discontent against Putin’s regime to hasten his demise.
So, what kind of sanctions were imposed against Russia? Three main types of economic sanctions were applied: personal, trade, and financial.
First, the West imposed sanctions against Putin and his supporters. It froze and in some cases seized their assets in the EU and America. These are designed specifically to undermine Putin’s support; it is hoped that the threat of financial demise will lead Putin-friendly oligarchs to support the opposition. It is also the least likely to work, as many of these measures can be circumvented. For instance, Putin could get around a bank account freeze by simply using his daughters’ accounts. Seizing Russian yachts in Southern France is surely annoying, but hardly apocalyptic.
These sanctions unfortunately do nothing to slow Russia’s war machine or deter future aggression. They will also prove ineffective at deterring top political leaders in the Kremlin, as those people are motivated by anti-Western ideology and do not care about being sanctioned. However, it might yet turn the Russian billionaires against Putin, which in the long run could threaten his regime – but unfortunately, Ukraine cannot afford to wait that long. This is where trade sanctions come in.
The West has imposed a truly staggering embargo against the Russian economy. It has nearly completely isolated Russia, banning most exports and imports. These have ranged from the highly targeted, such as banning the export of luxury goods to sow discontent among millionaires, to the more broad-based ones. Economists talk of a “restalinization” of Russia, the rebirth of the “Iron Curtain,” and the “North Koreanization of Russia,” as Russia has been almost completely cut out from the global economy.
The key sanctions to pay attention to are banning technological exports to Russia and drastically curtailing energy imports from Russia. The sanctions are expected to cut off more than half of Russia’s high-tech imports, such as microchips, phones, and computers. This will disrupt the entire economy, from car factories to banks and government agencies. Most importantly, it will deliver a blow to Russia’s war machine, as many of these high-tech components are required to produce modern weapons. Even if we assume that Russia has taken steps to ensure the delivery of critical military supplies from non-Western countries – and thus protect the war machine in the short term – these sanctions will curtail Russia’s capacity for military research. They will also raise the cost of supplying the war machine, as countries like China might take advantage of Russia’s inability to choose its clients to charge a premium for supplies. Then there are the sanctions on oil and gas.
Unlike nearly all other sanctions, the West is divided on what to do on oil and gas. Countries that do not rely on Russian energy imports, like the United States, embargoed Russia outright. Others, like Germany, promised a phase-out of all energy imports. Even if China and other non-Western countries purchase some of the oil and gas that the West has refused to, it will not fully compensate for the lack of Western demand. Moreover, it should be stated that many Chinese banks are refusing to finance Russian oil and gas firms and projects – despite China and Russia being allies – simply because the sanctions make these investments too financially risky. China does business, not charity. And now, trading with Russia is simply bad business. Energy exports are expected to fall by roughly 50% this year, and probably even further if the conflict drags out.
The final and most painful set of sanctions are the financial ones. First, the West has threatened massive fines against any Western firm that assists Russia in breaching sanctions. This has contributed to an astonishing mass exodus of Western companies. More than 300 have left Russia, from Adidas and Burger King to YouTube and ZHA. Perhaps the most symbolic departure is McDonald’s: the opening of its first branch in Moscow symbolized the dawn of a new era for Russia; now all branches are closed and tens of thousands of employees are about to lose their jobs. In effect, the business exodus will drive up unemployment, starve Russia of foreign investment, and, hopefully, signal to middle-class Russians that the official narrative about Ukraine is false. After all, if it really is a “minor military operation” against “Nazis” as Putin claims, then why would all these businesses leave Russia in protest?
Secondly, the West has cut some Russian banks from Swift. Swift is a banking message system that enables secure, real-time transactions. Being cut-off means that doing business abroad becomes much more difficult – though not impossible. There are less efficient alternatives to Swift and authoritarian powers like Russia and China are looking for an excuse to reduce their reliance on the Western system.
This will cause intense financial pain to some Russian banks – Sberbank, Russia’s biggest, is believed to be on the verge of bankruptcy – but, on its own, cutting banks from Swift still is a manageable disruption. This is where the final set of financial sanctions comes in.
The West has taken the extreme measure of freezing Russia’s central bank’s assets abroad. Putin had built a massive reserve of 630 billion dollars meant to create a “fortress economy” and finance his war machine for a few years until the sanctions wear off. But central banks do not stash their cash under their mattresses: any financial advisor will tell you that this is a terrible way to handle your savings. Central banks invest their savings in safe assets, such as lending money to other countries (i.e. purchasing bonds) or buying physical gold; in other words, investments that earn the central bank some interest and protect it against inflation. Although Russia owns 630 billion in reserves, at least 53% of these reserves are in Western countries and have been frozen.
The remaining 47% is divided into investments in China and physical reserves of gold. Russia can still access its reserves in China, but they are not enough to keep its economy afloat for very long—and they are denominated in yuan, meaning Russia can only use that money to trade with China and not any other countries. It could sell its gold, but this presents it with the logistical challenges of transporting tens of thousands of tons of gold through Siberia to China, which may also demand a discount on the gold. To make matters worse, the West can still apply secondary sanctions against any firms purchasing Russian gold, meaning that there also are ways to cut Russia off that revenue if necessary.
Freezing a Central Bank’s assets abroad is an extreme measure that has only been employed against minor powers. It has been used against Iran, against the Taliban regime in Afghanistan, and against Venezuela after Maduro stole the last election. This is the first time it is used against a developed superpower: it was often assumed that globalization made it impossible to apply such a measure against powerful states. The results have been much more crushing than pundits had expected. It now looks like globalization actually makes freezing the Central Bank’s assets even more damaging.
The impact of sanctions
The Russian Central Bank has already doubled its interest rate to try to prevent a currency collapse. The government has imposed tight capital controls, limiting how much Russians can withdraw from bank accounts and banning them from taking their dollars and euros abroad. This is intended to prevent a run on banks; the Russian banking system already is on the verge of collapse and if a panicked population decides to withdraw their money en masse, it will cause an economic calamity. In addition, the stock market remains closed since February 25th, one of the longest closures of all time. Analysts argue that Russia closed its stockmarket to prevent a total collapse in the value of its stocks as well as to prevent investors from taking their investments away from Russia while they still can.
Despite these tough measures, the Russian rouble has lost over a third of its value compared to January 1st since the war began. Inflation and unemployment are rising quickly. Even if sanctions only remain in place for 6 months and foreign companies eventually return to Russia, unemployment is expected to rise from 4 to 6%. If sanctions remain in place for the entire year and into 2023, as seems likely, job losses could be even harder. It is expected that inflation will at least double, reaching 20% or higher. Within just 3 weeks, inflation has already surpassed the government’s yearly target. This inflation shock is now causing shortages of goods throughout Russia.
The Russian government may very soon find itself in default—the financial term for being unable to pay your debts in time.
Morgan Stanley, a major US bank, has predicted a “Venezuela-style” economic collapse by mid-April. Oxford Economics, a major forecaster and analyst, reckons that Russian GDP, which was expected to grow 3% this year, could now decline by up to 6% this year, a similar figure to the 5.3% decline in the 1998 Russian financial crisis; JPMorgan, another major bank, expects an even bigger decline of 7%. Russian economists are even more pessimistic, forecasting the decline at 8%. But this time, there is a caveat: unlike 1998, Russia’s economy will not rebound and recover quickly. As long as sanctions remain in place, these banks reckon that the economy will grow 1% or less in 2023 and in the foreseeable future. Translated into simple terms, all this means that hundreds of thousands of Russians will lose their jobs, while those who manage to keep their jobs will see their earnings stagnate while everything around them becomes more expensive or, even worse, simply inaccessible.
Furthermore, financial sanctions are complementing trade ones to truly isolate Russia from the world economy. Nearly all world trade is conducted in hard currencies: the dollar, the euro, the British pound, and the Japanese yen. These are attractive to businesses around the world because they are stable; trade between, say, Russia and India is conducted in dollars simply because neither country has faith in the other’s currency. The rupee could lose its value to inflation, India could suffer a financial crisis, and of course: you cannot spend rupees elsewhere. So Russians demand that Indians pay in dollars, while everyone else demands that Russians pay in dollars.
The big question is, of course: will all of this slow down Russia’s war machine? Probably not in the short term, but it will play a role the longer the conflict draws out. Estonia’s former Commander-in-Chief, general Riho Terras, estimates that the war in Ukraine costs Russia €20 billion per day in terms of logistics, salaries, and weapons production. That is purely the cost of war without taking into account sanctions.
Even if this figure might be exaggerated—the true cost is a closely-guarded secret and probably lower than 20 billion—this is worrying. Without access to its savings (Central Bank reserves), international trade, foreign investment, and tax revenue from all the Russians who have lost their jobs, it is hard to see how Putin can sustain the war for long. No wonder he is recruiting foreign volunteers to fight and asking China for military help. Those are desperate acts. The sanctions probably will not diminish his capacity to wreak destruction on Ukraine for the next few weeks, but they have almost certainly shelved Putin’s rumored plans to invade Moldavia.
Of course, Putin claims that Russia will recover from the sanctions. He stresses that this will encourage his country to become more economically independent and less reliant on the West. He does concede that inflation and unemployment will rise somewhat but promises this will be temporary. Materials that cannot be produced in Russia can still be imported from China, to some extent. Sanctions also facilitate the adoption of import substitution and autarky economic models. These models used to be popular in African, Latin American, and Communist countries throughout the Cold War. Evidence shows that they are highly inefficient, encourage corruption, and contribute to the empoverishing of one’s population, but still allow for some development in areas that the state deems high-priority.
The impact of Western sanctions has been massive and cannot be understated. If the war drags on for long, Russia will suffer one of the worst economic crises in its history. Thus, all the memes about the West doing nothing while Ukraine fights are, in the end, just memes. The West has applied an unprecedented amount of pressure which, hopefully, will give Ukraine a much better chance at fighting and negotiating with Russia.
Picture credits: Neah Monteiro.