By Juraj Kuruc.
There is nothing novel about economic sanctions nor the use of “soft power” as a propaganda tool. The novelty in the West’s and Ukraine’s responses, however, regards their methods and applications; more specifically, the sanctions imposed against Russia have been unprecedented in both the scope and swiftness in which they have been enforced. At the same time, there has been a realisation that Russia has deployed its financial resources to actively undermine democracies in countries it perceives as a threat, from influencing elections, to staging irregular migration crises.
In this situation, it is readily apparent that the illicit use of financial resources will recur as will the usage of sanctions. Indeed, the trend is moving towards more – not less – confrontation.
Thus, regular analysis of the effectiveness of sanctions is required. Moreover, illicit finance should be considered not only as a criminal matter but as a security threat – and one that should be treated as central to EU security and policy agenda.
Learning from Past Mistakes
The sanctions imposed on Russia following the Kremlin’s February 24th invasion of Ukraine surprised many, including, to some extent, Russian officials. President Putin likely believed that the $650 billion amassed by the Russian Central bank in foreign currency reserves would be available to Moscow throughout the war in Ukraine. But the broad scope of the sanctions and the swiftness through which they have been implemented presumably caught the Kremlin off guard.
Following the annexation of Crimea, for example, it took the EU months of deliberation to introduce largely ineffective sanctions that did very little to change the status quo on the ground. It is estimated that the trade restrictions implemented in 2014 resulted in no more than a 1% reduction in the Russian GDP. The effect of the recent rounds of sanctions is yet to be calculated, estimates vary but the World Bank is expecting Russian GDP to drop by 11%. That would be the largest drop since the collapse of the Soviet Union.
It is clear that the failure to act decisively in 2014 failed to deter Russia when considering the cost of an aggressive war whereas the eight rounds of sanctions in 2022 are having a real effect on the Russian economy.
The scale of the deterrents currently imposed by the US, UK and EU can be delineated into three levels:
(1) the ban on various Russian state-owned businesses and financial institutions;
(2) lists of people who are members of the Russian government or affiliated with it (and associated travel bans, asset seizures, revoked visas and other measures);
(3) the withdrawal or suspension of private business from the Russian market and trade embargoes.
The precise composition of sanctions against Russia can be found elsewhere. But they, notably, involve over 30 countries representing more than 50% of the global economy, underlining their multilateral dimension. Despite an initial panic and drop in the value of the rouble and considerable inflation, the Russian economy has held on for now.
One potential reason for this stems from the 2014 sanctions package and the accompanying decoupling of the Russian economy which readied the country, to a certain extent, for the latest storm. Thus, the initial threat of sanctions failed as a deterrence measure. Similarly, the earlier sanctions packages have had a limited effect on the battlefield in Ukraine, despite evidence of workarounds found within the Russian military hardware. The inability to keep troops supplied appears to be because of weak logistics rather than supply problems. We are currently in the third stage – attrition; sanctions have or will have a deep and potentially lasting impact on the Russian economy, but they may take time. Worsening economy will have a more direct effect on Russia’s army ability to regroup and reequip.
The Impact of a Russian Oil Embargo
Eventually, the global impact of trade sanctions will be particularly pertinent. The sanctions have affected commodities such as wheat, corn, sunflower oil, metals (nickel, copper, iron and platinum) The most detrimental impact on the Russian economy will come from sanctions on gas and oil. In 2021, the EU imported €48 billion worth of crude oil and a further €23 billion of refined oil products. Oil export revenues are estimated to have contributed 36% of Russia’s federal budget.
The EU has pledged to phase out crude oil from Russia in December and refined petroleum in February 2023. However, the threat of western sanctions is one of the factors that has kept oil prices high. Russia continues to export crude oil and refined petroleum to India and China, albeit with a discount. Nonetheless, this could change as Russia will find it challenging to sell the output previously exported to EU countries in January.
As the pipeline infrastructure with China is underdeveloped and non-existent with India, it will have to rely on oil tankers. Amongst many other complications, there are signs that both India and China are decreasing their imports. Moreover, EU and British shipping insurers will be barred from serving tankers carrying Russian cargo, and many third-country ports and canals may not allow uninsured Russian vessels, especially uninsured oil tankers. Simultaneously, restricted supply will make the prices rise. It, therefore, remains to be seen how much poorer Russia would become from the oil embargo.
As strong as the reaction of the EU countries was in terms of gas an oil imports, the prices are to a large degree determined by the producers of these commodities, via regulating the production output. US and the EU have been, since the start of the conflict, trying to limit oil and gas prices to strangle the inflow of revenue Russia could count on from the sale of hydrocarbons. The recent coordination meeting between Russia and Saudi Arabia led OPEC countries could be undermining these efforts.
Asset Seizures and Travel Bans
A Russian oil and gas embargo could also stifle economic growth across Europe (especially Central and Eastern Europe), particularly in the absence of an integrated EU energy market. Russia will continue to exploit this gulf as it will take considerable time and investment before the EU is ready to diversify its energy supply. The continued sale of natural resources, nonetheless, provides Russia with much-needed currency to continue its war in Ukraine. And it further must be stressed that no number of sanctions can be proportional to the distress and loss of life endured by Ukraine.
Currently, the most topical types of sanctions are travel bans on persons close to the regime and the most recently suggested travel visa ban. According to the Economist, the comprehensive list of 1455 members of Russia’s elite cannot travel to some or all Western countries. The list also includes asset seizures publicly seized by respective country police forces in celebrity hot spots and include yachts, country houses as well as jewellery and even football clubs. So far, proposals to improve asset seizure effectiveness have remained largely ineffective due to the use of techniques known to money launderers and criminal networks in obscuring ownership through shell companies or transferring ownership to family members or third persons, among others. The existing estimates show that only about $50 billion of the $400 billion blocked assets were frozen. While of great symbolic value, it is unclear if these publicised asset seizures, even when enacted, tangibly affect the Russian economy. Suggestions to use the confiscated proceeds to help Ukraine have so far not materialised.
Visa travel bans considered by some EU countries for all Russian citizens on the grounds of “security risk” have not been enacted, although EU countries have agreed to make it more difficult for ordinary Russians to travel to the EU, and it is believed that this will result in fewer travel visas being issued.
However, it remains unclear what impact this will have on the estimated 12 million visas already issued to Russian citizens. There is an argument to be made that this may make matters worse for those who oppose the Russian regime. Ukrainian Foreign Minister Dmytro Kuleba maintains that “visas should only be issued to Russians on humanitarian grounds or to help those who clearly oppose Putin’s war.” As of now, the scale and impact of skilled Russians who disagree with the regime and do not support the war remain unexplored. Depending on the continuation of the skilled workers’ exodus, there will be consequences for Russia’s workforce and, therefore, the economy as well.
The least publicly discussed effect of the Western response has been trade sanctions. The restrictions and bans on the export of components to Russia go well beyond “dual-use”. They include chips, computers, software and energy mining equipment, as well as spare parts needed for transport and aviation; this can be compared to the financial sector, which has largely rebounded from the imposed sanctions by being insulated since 2014 and applying – albeit slow and cumbersome –workarounds such as those used in the aftermath of the exclusion from SWIFT. Russia’s manufacturing is much more integrated and dependent on Western imports with some of the effects are already felt, from aviation and public transport maintenance to car making and even gas and oil mining equipment. Indeed, Russia has already eased safety standards to allow its car manufacturers to produce cars without crucial safety features, such as airbags or anti-break locking systems (ABS).
Russia has also allowed for goods to be imported without the agreement of the intellectual property owner, sparking new trade with African and Western re-sellers. Furthermore, there are indications that the trade of restricted goods with neighbouring countries, such as Kazakhstan and Georgia, has expanded. Nonetheless, it will be very difficult to run the entire economy on ersatz goods, particularly as goods such as computer chips are scarce worldwide. The result will be the slowing down of manufacturing, lasting shortages and the overall attrition of the Russian economy. In the long term, this will affect Russia’s ability to produce high-tech weapons and ammunition needed to continue the war in Ukraine.
The introduction of sanctions was also accompanied by a realisation – for many countries – that far from being a mere exercise of state sovereignty, numerous entities may attempt to subvert sanctions. The sanctioning countries, for their part, seek to restrict the flow of goods, people, services and finance, ensuring that these restrictions are enforced and effective. But illicit money also flows into these very same countries. An article by RUSI coined the term “active financial measures” to explain this phenomenon. This concept is a rephrasing of the Cold War term “active measures”, a form of political warfare that sought to destabilise different societies through the use of disinformation and deception. The goal was not necessarily to persuade anyone about the merits of Russia or the Russian regime but rather to use existing fissures within societies to wreak havoc on the democratic establishment.
It is not difficult to imagine the shape and content of these “active financial measures”. The actions are tailor-made for each country and designed and implemented to generate the most significant impact at the lowest possible price. The integration of Russian money and the exploitation of existing legal loopholes are well known. The use of complex shell corporations, the subversion of judicial systems and rules-based ecosystems, the exploitation of reputations, and the laundering of ill-gotten financial gains are all part of the repertoire. Illicit practices can additionally affect elections and other democratic processes in various countries.
The Road Ahead
The way forward is through the same methods developed over twenty years ago to combat terrorism. Following the September 11th attacks and the recognition of the importance of financial resources in orchestrating terrorist attacks, structures were set up (e.g., financial investigation units) to investigate and prosecute terrorist financing. Though far from perfect or entirely adequate, the existing system is workable. It promotes active cooperation between participating countries – expertise in the disentanglement of complex financial webs spanning many countries and jurisdictions could prove particularly beneficial. Cases of lax standards, legal loopholes and situations where regulatory oversight is lacking will need to be remedied domestically. At the EU level, new norms are needed; registers of final beneficiaries and establish bloc-wide rules on asset seizures and asset recoveries.
The transatlantic cooperation of the US, UK, and EU on intelligence sharing and their concentrated efforts to combat illicit finance may engender positive unintended consequences in other areas as well, including the protection of democratic values and the development of effective responses to transnational organised crime and terrorism. These would be pragmatic steps considering that illicit financing is necessary to sustain both terrorism and organised crime.
Democratic countries may also consider learning lessons from autocrats and deploying new tools – apart from public diplomacy – pragmatically against authoritarian governments. This could include the (covert) extension of support, for example, to political opposition, and environmental or human rights groups in dictatorial regimes. There are also lessons to be taken from Russia’s playbook on the use of social media, including the need for a profound message shift that – unlike the Kremlin – puts truth front and centre. Though repeated truth-telling efforts may not reduce the violence of brutal regimes, publicising the truth could lead to a sense of scepticism in authoritarian countries that could eventually dampen the effects of domestic propaganda. These approaches could become invaluable in the future, with more confrontation likely.
It remains to be seen if and what role sanctions will play in changing Russia’s political regime, curbing the ambitions of oligarchs and spurring an economic downturn in the country. It is important to emphasise that sanctions will not necessarily be rescinded following the end of the war though they will likely be rolled back eventually. The economies of both Ukraine and Russia will require considerable investments if they are to be rebuilt – and these aims will necessitate that financial and material support be provided to Ukraine. Though it may seem far-fetched at present, even Russia will eventually need to be reincorporated into the global economy.
 Economic Sanctions on Russia and Their Effects, Iikka Korhonen, (2019) Economic Sanctions on Russia and Their Effects (cesifo.org)