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Risk Management

Sanctions, what sanctions?

Posted by on 14 March 2024
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Last September, I had argued why “a war of arms and a peace of commerce cannot co-exist”. This is a follow up to that and events of the last 2 years sadly reinforce the point.

With Russia’s GDP (troublingly) growing by 3.6% in 2023, Putin is overseeing the fastest-growing G7 economy with unemployment at an all-time low and wages growing strongly despite high inflation.

Following Putin’s invasion of Ukraine 2 years ago, 3 dozen countries slapped economic sanctions on Russia. They were unprecedented in their scope for a target of its size. Russia quickly crossed Iran as the most sanctioned country and by end-2023 there were >18,000 active measures targeting Russian entities. Ships that carry Iranian oil are on the US list, as also Hamas’s leaders and financiers for Latin American drug lords. Sometimes individuals’ assets are frozen or entire banks are banned. Russia’s central-bank reserves in Europe (half its total) have been frozen, 80% of its banks face sanctions and 7 are locked out of SWIFT.

But the problem is, sanctions are NOT working well.

The West is relentlessly adding Russian firms and individuals to its blacklists. In Dec White House said it would put the dollar system out of bounds for any bank helping Russia gain access to sensitive goods. The EU signed off on its 13th round of sanctions, which also target Chinese firms found to be helping Putin. US said it would impose 500 new sanctions and also place export restrictions on 100 entities providing support to Russia. But just as the West ratchets up sanctions, ways to evade them are also getting more innovative.

Economists are surprised by the resilient Russian economy. They had believed the sanctions would cause a terrible recession. IMF revised its own GDP forecast to 2.6% in 2024, a 1.5% rise over what it had predicted last Oct. The war has shown just how quickly global trade and financial flows can circumvent hurdles that are put in their way. As widely reported:

  • Asia’s commercial appeal is diverting trade that Russia previously conducted with the West. That’s despite 3 of the 6 Asian nations which have joined the sanctions—Japan, Australia, S. Korea—being among the region’s 5 biggest economies. Any plans to use “secondary” sanctions to coerce Asian nations could dilute the West’s hold on the global financial system, by incentivising them to escape its reach by avoiding dollars.
  • For the first time in 2023, more of China’s X-border payments were conducted in yuan, not the dollar. Will other countries follow suit? Trade turnover between China and Russia hit a record $240bn last year. Moscow sold China its oil that used to go to Germany and France. China and HK are now Russia’s chief suppliers of microchips, frustrating Western efforts to starve Russia of the integrated circuits critical to the war effort. China has also swiftly become the top supplier to Russia of cars and mobiles.
  • Western sanctions and booming Russian energy exports to China have added to the yuan’s appeal. Russia’s use of the yuan has overtaken the USD in its exports, jumping to 1/3rd of the total. Russian firms are also increasingly borrowing in yuan while households are stashing savings in it.
  • Pre- invasion, Europe bought 60% of Russia’s oil; that has plummeted. But Russia’s oil exports to Asia have jumped to more than half its total. Half of Russia’s oil exports in 2023 went to China with India the biggest buyer (imports up from 2% pre- war to 35% in 2023) as Russia was forced to sell oil at a discount due to a price cap. Unfortunately, implementation of this cap was undercut by a few western operators, that sold their oil tankers to “undisclosed” buyers — allowing Russia to export oil outside the cap. A “shadow fleet” accounting for 10% of all tankers have mysteriously become key suppliers. More oil is being traded in Dubai and HK than in Geneva these days. Today Russia’s earnings from oil exports are above the past 10 years’ average. Singapore is the only ASEAN member to sanction Russia but oil is exempted. Russian oil products are also being blended and sold as non-Russian oil with a juicy margin.
  • The huge rise in western exports to central Asia and the Caucasus is another example of western business at work with Russia finding a route through ex-Soviet republics (“Eurasian Roundabout”). Moscow has been able to source everything from Western washing machines to luxury cars.
  • There was a ban on imports of Russian diamonds but industrial diamonds were exempted. Croatia secured a waiver on importing Russian vacuum gas oil. Hungary gained an exemption on nuclear energy services for its power plant. Despite sweeping sanctions, Russian military firms are managing to acquire sophisticated machine tools from Taiwan; Turkey and UAE middlemen are sourcing what Russia needs by acting as fronts for others under sanctions.
  • European exports to Central Asia doubled from 2021 to 2023. Logistics industry expanded by 20% in 2023. It’s not difficult to guess the eventual destination of many of these goods. German exports of cars and parts to Kyrgyzstan have zoomed 5,000%. They are going to Russia and the same thing is happening via Armenia, Belarus, Kazakhstan etc.…all key conduits for shady “parallel imports” into Russia.
  • Russia imported >$1bn-worth of computer chips and other dual-use items designed in the West—none of which should have been within its reach. These are made in China and Philippines, sold via HK and reach Ukrainian battlefields in Russian weaponry. (The circuitous routes are hitting consumers hard and weakening the ruble, which lost 30% of its value against the $ in 2023.)
  • Central bank forex reserves were also frozen, but that targets a stock of assets, not continuing flows, which matter for economic activity. Economic sanctions can be effective when imposed on countries with a current account deficit. With its current account surplus forecast by IMF to be 4% of GDP in 2024, Russia effectively lends to the rest of the world. By sanctioning some Russian banks, the West just caused the accumulation of foreign assets to shift from sanctioned to non-sanctioned banks. Gazprombank effectively replaced Russia’s sanctioned central bank as the main financial intermediary with the external world. This shift in no way curtailed payments to Russia for its exports, so had no impact on its ability to pay for imports. (Russia’s imports in 2023 were 20% above pre-pandemic levels.)

As The Economist noted, at a time of increased geopolitical tensions “sitting on the fence is not only possible, but often profitable”. Sanctions evasion is a predictable reaction for firms attracted to lucrative markets and short-term interests. If Trump is re-elected, US support for Ukraine might end leading to a lot of bickering in Europe over who pays for the defence of Ukraine.

Also, much of the world’s population lives in countries that decline to enforce Western sanctions. Indonesia warned it would “not blindly follow the steps taken by another country”. The 120 members of the “non-aligned movement” produced 38% of global GDP in 2022, up from 15% in 1990. They are home to 5 of the world’s 20 most important financial hubs, and produce many things that a modern army might need. If US strongly asserts its power, say, in the form of “secondary” sanctions, it could alienate those very powers that it hopes to woo as the world polarises.

At a time when political support for war funding is brittle, sanctions hold an irresistible allure for Washington and Brussels …. a cheap way to weaken Russia and defend Ukraine. Yet the last 2 years show just “how delusional such thinking is”. Although a heated debate has started on the US proposal for the G7 working groups to explore ways to confiscate $300bn in frozen Russian assets to rebuild Ukraine, the West still seems to be a one-trick pony.

Krishnan Ranganathan is an Executive Director with Nomura and is responsible for the execution of global regulatory and transformation projects across Risk, Finance and Operations in Nomura India. He is an alumnus of Harvard Business School and is a member of the Young Scholars Initiative at the Institute for New Economic Thinking. Views are personal.

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