Issued by CEMO Center - Paris
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Sanctions are making Russia weaker — but Putin stronger

Sunday 24/July/2022 - 02:34 PM
The Reference

After Russia invaded Ukraine, the West and its allies imposed a package of sanctions that was unprecedented in scale and scope. It is hoped by many in western capitals that applying severe sanctions will at some point change President Putin’s calculus and force him to withdraw.

There was an immediate impact. Assets held abroad by the Russian state and its richest citizens have been frozen. Russia’s banking sector is nearly locked out of the western financial system, with only essential transactions permitted. And Russian firms can no longer access a range of critical technologies, ranging from microchips and civilian passenger aircraft to parts used in oil and gas extraction. To top it off, hundreds of international companies have voluntarily pulled out of Russia because of fears of reputational damage that might be caused by continuing to do business there.

But despite the dramatic changes seen in Russia over the past few months, the country is slowly adjusting to its new circumstances. While it is almost certainly in recession, the depth of the fall does not look likely to be as severe as first anticipated. Meanwhile, elevated prices for Russia’s main exports — oil, gas and grain — mean the Kremlin has plenty of money to wage war and protect its support base from the worst effects. Perhaps even more importantly, sanctions are inadvertently pushing Russia’s elites closer to the state and accelerating its turn to China.

The impact so far

Five months into Europe’s biggest war since 1945, sanctions have imposed a heavy cost. About half of Moscow’s foreign exchange reserves held in western currencies are frozen. Imports have collapsed, partially caused by the sharp depreciation of the rouble in the first two months of the war, which caused the price of imports to soar, but also because Russia is prohibited from buying a wide range of manufactured goods from the West and its allies. And Russia is unable to sell billions of dollars’ worth of goods, including coal and gold, to sanctioning countries.

Access to a whole host of goods is either impossible or, where it continues to take place, more expensive. While the Russian government is no doubt seeking to replace sanctioned goods with substitutes from friendly countries such as China, or from local producers, the quality and cost of the alternatives are unlikely to compare.

The noose will probably grow tighter. Sanctions on the purchase of oil from pipelines to Europe are scheduled to kick in early next year, while the EU has devised a strategy to wean the continent off its dependence on cheap Russian gas. Diplomatic efforts are also under way (so far unsuccessfully) to persuade other countries in Asia and the Middle East to join the West and its allies in shunning Russia economically.

Oil and gas production — vital to Russia’s position as an “energy superpower” — look set to decline due to shortages of foreign technology and know-how. Moscow’s ability to produce weapons is also threatened by the denial of vital western components, many of which have been discovered in weaponry used in Ukraine. Russia’s military has already spent eight years trying to adjust to previous western sanctions targeting the defence industry. Moscow’s efforts to produce high-tech weaponry such as satellites, precision-guided munitions and naval power units were all interrupted by the sanctions put in place in 2014 after the annexation of Crimea. The new, tighter sanctions are likely to generate greater disruption.

Sanctions are causing Russia serious economic pain, which is likely to grow stronger. However, generating economic pain is rarely enough to cause a shift in a country’s behaviour. After all, if there were a strong link between economic pain and favourable political outcomes, Iran would have ceased its nuclear ambitions years ago and North Korea wouldn’t still be testing long-range missiles. Russia itself has been living under sanctions since 2014, yet the prospect of inviting more severe restrictions did not deter it from launching its attack in February.

A bad track record

There are several reasons why sanctions tend to have a poor track record in forcing countries to alter policy course.

First, sanctions often create opportunities for enrichment. The price of goods that are sanctioned rises sharply, offering the political leadership in the target country an opportunity to transfer resources to key political allies who promise to supply these goods. Lucrative contracts are awarded to those who promise to replace sanctioned goods with domestically produced alternatives. Russia is no different. Already, expensive policies to develop homegrown alternatives to imported technology are emerging, which will benefit those close to the political leadership. While the aggregate economic cost to the economy of sanctions is often high, politically well-connected individuals can still benefit enormously. This can have the counter-intuitive effect of bolstering elite cohesion rather than weakening it.

Second, the longer sanctions remain in place, the more the target country can adjust to the new circumstances. This is already happening in Russia. The collapse in the value of the rouble in March is a case in point. In the early days of the war this was presented as a success of western policy. However, adaptive measures were soon put in place in the form of capital controls. Russia’s problem today is not that the rouble is too weak but that it is too strong and hurting those, such as oil and gas exporters, who book profits in foreign currencies.

Elsewhere, parallel imports — which allow Russian importers to circumvent western sanctions on the export of goods to Russia by importing them from third party countries (such as China or Kazakhstan, both of which share long borders with Russia) — already show signs of alleviating pressure on consumer good markets.

As long as life appears relatively normal to the average citizen, and as long as the well-connected elite continue to enjoy opportunities for enrichment, the impulse within Russia to change policy course is likely to be muted.

Russia’s new reality

This is where Russia finds itself today. While the economy is undoubtedly getting smaller, and the range of products available to its citizens is more limited than before the war, a semblance of normality has returned after the shock of the first few weeks of war. Foreign computers and mobile phones are beginning to find their way back on to shelves, albeit at higher prices. McDonald’s has been replaced with Vkusno i tochka (Tasty, full stop), which serves the same food as before under new names. And a grand programme is being designed to ensure Russia’s “technological sovereignty”. The principal beneficiaries of this will not be the Russian consumer but the insiders connected to Putin and the ruling entourage who will make huge profits for delivering lower-quality goods at higher prices.

Of course, many Russians are aghast at the Kremlin’s decision to go to war. But these represent a politically weak minority who, for the most part, never supported Putin anyway. The bulk of the population depend either on the state or on its vast publicly owned enterprises for their livelihoods. More susceptible to state-controlled media, and more likely to benefit from the Kremlin’s “anti-crisis” measures, the ever-reliable backbone of Putin’s support base looks unlikely to push for change from below.

We shouldn’t expect the so-called oligarchs, whose assets have been targeted by sanctions, to put up much resistance either. The incentive for them to push for a more moderate policy course in the Kremlin is even lower than it was before the war because their overseas assets have been frozen and they have been ostracised from the western economy. To continue enjoying their still-considerable wealth, these potential agents of change must now show unequivocal fealty to the Kremlin lest they be accused of representing a treasonous “fifth column”. Putin’s ability to weather the sanctions storm and to keep his support base on side has also been boosted by the second-tier consequences of the economic war. Russia’s export basket is dominated by geopolitically sensitive goods such as oil, gas and grain whose value rises in line with political risk. The perception of precarious supply for all these critical goods is high and could rise further still. As a result, prices have risen. Combined with capital controls and the sharp decline in imports, this has resulted in Russia recording a record current account surplus.

For as long as the Kremlin is sitting on such a large pile of cash, its ability to buy support from key constituencies is unlikely to waver.

The effect on Putin

Which brings us to the question of when, if ever, western sanctions will force a change in the Kremlin’s strategy. Again, the answer is unlikely to comfort western policymakers.

The attack on Ukraine, and the severe allied response, has caused relations between Moscow and the western alliance to deteriorate to depths not seen since the lowest points of the Cold War. As well as reshaping the domestic landscape, sanctions are also reinforcing a longer-term geopolitical shift. Even before the war, there was a tendency to see greater value in establishing stronger relations with the “non-West”, led by China, than in seeking to repair Russia’s strained relations with the Euro-Atlantic community. The West, as the Kremlin sees it, is in decline and Russia’s future prosperity and sovereignty are better served by reorienting its centre of gravity to the east.

Sanctions will only strengthen this conviction. The essence of Russia’s response to the economic warfare of the past five months — and indeed the past eight years — illustrates this vividly. China is Russia’s single most important trade partner, a relationship that grew much stronger after 2014. While Russian imports from Asian countries allied with the West have slumped, the volume of imports from China has barely changed. Recent trade data suggests that Beijing has moved to fill the gap in microchips created by sanctions. Elsewhere, India has imported millions of barrels of Russian oil that is available at a discount owing to western sanctions, while Iran is reported to be supplying military drones. In short, sanctions are entrenching Russia’s estrangement from the West.

What happens in the future

Putin will continue to do his best to turn sanctions in his favour and use their existence to justify greater repression at home and an even more anti-western policy abroad.

We in the West should revise down our expectations of what can realistically be achieved with this approach. While sanctions will almost certainly make Russia a poorer and in some ways weaker country, they won’t change the most influential minds in the Kremlin, they are unlikely to strengthen western allies’ economies and, most importantly, they may do little to help Ukraine.