Sanctions One Year Later: Did They Even Matter?
By Sergey Aleksashenko, Former Deputy Finance Minister of Russia

One year ago on March 6, the Western nations adopted the first targeted sanctions against Russian companies and citizens linked to the conflict in Ukraine. Today we can say those sanctions have been barely effective.

The main goal of the sanctions, which were introduced in stages, was to stop Russian aggression in Ukraine. Instead, Russia paid no attention to the sanctions and subsequently 1) annexed the Crimean peninsula; 2) unleashed an armed conflict in eastern Ukraine; 3) effectively transformed a significant part of the Donetsk and Luhansk regions into a territorial entity independent of Kiev by autumn of 2014 (the time of the first Minsk agreements); and 4) sharply expanded the territory under the separatist’s control, including the logistically important Donetsk airport and the city of Debaltseve, in February 2015 (Minsk-2).

Thus, not only did each stage of sanctions fail to stop Russian aggression in Ukraine, but it didn’t even prevent Russia from escalating the conflict in a “stop-and-go” manner. Moreover today neither Western politicians nor experts have a clear understanding of Russia’s end goal in Ukraine.

President Obama has stated on several occasions that although the sanctions have failed to bring about the intended political outcome, their introduction had a significant impact on the Russian economy by significantly weakening its stability. This statement, however, is far from obvious not only in regard to the Russian economy as a whole, but also as it pertains to Vladimir Putin’s cronies.

The individual sanctions that were imposed against the friends of the Russian president did not extend to their family members, who were either the legal owners of their assets, or became the legal owners once the sanctions were imposed. In addition, individual sanctions didn’t take into account combined ownership, which relieved such companies as Gazprombank and SOGAZ (an insurance corporation) from their punitive effect.

Many Western officials believe the introduction of sectorial sanctions created the conditions for a sharp deterioration in the Russian economy and provoked the financial crisis of December 2014. This assertion also fails to pass the test, for the following reasons:

  1. Sectorial sanctions against the Russian oil and gas industry apply to Arctic deep-sea and shale exploration. These projects are currently in the earliest stages of geological study and none of them is being developed at the moment, meaning sanctions have no impact on the current volume of Russian hydrocarbon production.
  2. In the immediate aftermath of the sectorial sanctions, Western service companies refused to sign any new agreements with Russian oil and gas companies. If this scenario had continued, we would see a decline in Russian hydrocarbon production as early as by the end of this year. However, this threat disappeared in late-2014 when Western companies began to sign contracts with Russians through their daughter structures, or subsidiaries. The Houston-based Schlumberger went even further by purchasing a 45.65-percent stake in the Eurasia Drilling Company, the largest provider of drilling services in Russia.
  3. Financial sanctions that prevent Russian state-controlled banks and companies from raising new capital in international markets turned out to be more effective, and practically resulted in the complete closing of the capital market to all Russian corporates. In these circumstances, scheduled foreign debt payments inevitably put pressure on the Russian balance of payments and led to the weakening of the ruble at the end of last year, when foreign debt repayments reached their peak. At the same time, the global price of oil began to fall in the middle of last year, dropping to less than half of its mid-summer level by the end of 2014. It is safe to say that the decrease in oil prices turned out to be a much stronger factor in sparking the Russian financial crisis in December: the drop in oil prices that month to $48/barrel meant the loss of approximately $200 billion in export revenues per year. By comparison, the amount of funds needed to pay off the foreign debt of Russian banks and companies scheduled in 2015 is about half that amount.

Yet while the direct effect of economic sanctions is limited, their ongoing indirect effects may turn out to be much more serious and long-lasting. First, the resulting sharp acceleration of inflation inflicted significant pain on the Russian economy. The embargo on Western food products imposed by the Russian government only exacerbated the growth in prices, which became uncontrollable in December 2014-January 2015 due to the sharp devaluation of the ruble.

Second, the combination of rising inflation, devaluation of the ruble and the drop in revenues from oil exports created the need for a radical rewriting of the Russian federal budget for the current year. This interfered with the normal functioning of many state-funded structures, which to this day remain in the dark about the amount and conditions of their future funding.

Third, the sudden drop in export revenues and the need to pay off foreign debts led to a significant decrease in imports. This will negatively affect the current consumption of Russian citizens and, more importantly, will lead to the freezing of many investment projects. The decline of investment in Russia has already continued for the third year in a row, and is expected to be the main driver of the current economic crisis.

Why did the sanctions have a weak effect? This may have been no accident. Most likely the West didn’t want to use harsher measures to pressure Russia, in hopes that it would be able to move the conflict toward the stage of negotiations.

For Europe, large business projects in Russia are an important factor in its own development. Since European business clearly didn’t want to lose its position in Russia, it didn’t let up its lobbying pressure for a minute. For the United States, whose economic ties with Russia are negligible by comparison, Moscow is mainly important as a partner in resolving the conflicts in Afghanistan, Iran, North Korea, Syria, and cooperating in the battle with ISIS. Meanwhile, any new talk of tightening sanctions against Russia led to additional losses for European business, and was therefore viewed with suspicion in Europe.

Moreover, since hydrocarbons account for more than 2/3 of Russian exports –which the European economy is currently unable to refuse – then imposing any kind of sanctions that limited Russian exports would have been impossible from the outset.

In summing up the past year, we can draw the following conclusions:

  1. The West doesn’t have a clear strategy when it comes to adopting and/or expanding sanctions; each time, this question has been approached from scratch. This became obvious when the most punitive, sectorial sanctions were imposed after what was generally a localized episode – the downing of MH-17 – that had no effect on the military situation in the conflict region. On the other hand, despite numerous statements that it would do so, the West did not respond with any sanctions either to the summer offensive of pro-Russian separatists in Mariupol that fundamentally altered the balance of power in the region, or to their winter offensive in Debaltseve that had improved transportation links between Russia, Donetsk and Luhansk.
  2. For various reasons, the West does not seek to increase the economic pressure on Russia and doesn’t see sanctions as the main instrument through which to influence Russian policy. Instead, the West prefers traditional methods of diplomacy – an apparent mistake in the confrontation with the current Russian leadership, which has clearly decided to employ nontraditional forms of international relations.
  3. Russia’s “stop-and-go” politics in eastern Ukraine (characterized by the constant rotation of military operations and negotiations) is the optimal approach toward Russia’s goal of minimizing the threat of additional sanctions.

 


Sergey Aleksashenko is former Deputy Minister of Finance of Russia and former Deputy Governor of the Russian Central Bank. A former scholar-in-residence in the Carnegie Moscow Center’s Economic Policy Program, he is currently and independent consultant for Private Solutions LLC. 

 

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