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More Western sanctions target Russia over Ukraine

Sanctions targeting key members of Putin’s inner circle are having an effect – but not necessarily the one intended

At the end of April, the West unveiled a further round of sanctions on Russia over its meddling in Ukraine that, by targeting individuals close to the regime rather than the country itself, it hopes will change the Kremlin’s behaviour without hurting western investments or its trade with Russia, particularly in energy. However, with the crisis in Ukraine only deepening, harsher sectoral sanctions are in the pipeline.

Like the first round of sanctions imposed on Russia in March, this latest round, released on 28 April by the US and subsequently by Canada, the EU and Japan, were applied to Russian individuals close to President Vladimir Putin as well as connected companies, rather than aimed at the country as a whole. 

Interlinked

Part of the reason behind applying limited sanctions is that putting effective sanctions on a country like Russia is much more complicated than, say, on countries like Iran, because western companies have major investments in Russia, while Europe relies hugely on Russian exports of oil and gas. “We might call these ‘precision-guided sanctions’, or sanctions intended to compel a change in direction without inflicting collateral damage or risking significant retaliation,” says George Friedman, of the US think-tank Stratfor.

That seems to be the case – for now. Russian foreign minister Sergei Lavrov reacted to the new sanctions by calling them “an act of desperation” and a total failure of US foreign policy. But, he added: “Russia will, at present, refrain from immediately reacting to sanctions.” (As Petroleum Economist went to press, the Russian foreign ministry announced it had expanded its list of US and Canadian officials barred from Russia, but declined to name the individuals affected. Foreign ministry spokesman Alexander Lukashevich said in a statement: “Unlike the Americans and Canadians, we have not put on a show,” he said, adding that those who are barred from Russia “will find out when they apply for a visa”.)

Snippy rhetoric aside, Russia’s calm reaction, say analysts, is because the measures are not seriously aimed at changing Russian policy over Ukraine – but designed to make it look like the US is trying to change Russian policy. And if the US sanctions against seven individuals and 17 companies were regarded as half-hearted (the country’s banks were not targeted, as some had expected), then the EU list of just 15 individuals was even more so. 

The US has now placed sanctions on 64 Russian individuals and a handful of companies that the Americans believe are the source of Putin’s personal wealth, which is estimated at around $40 billion, while the EU is targeting just 48 individuals. The latest US sanctions include close Putin confidant and president of state-controlled Rosneft, Igor Sechin; the EU list did not. “The fact that [Sechin] is actually not on the EU list is very telling. I think if the G7 wants to be taken seriously, they need to be singing from the same hymn sheet,” says Michael Hewson, chief market analyst at CMC Markets. “And I think this is really where the power lies, it lies with the US. And if the US wants to bring Putin to the negotiating table, they need to be much more aggressive.” 

The EU’s reticence is understandable. The bloc relies on Russia for about 30% of its gas (40% of which flows through Ukraine), as well as having made substantial investments into what is now Europe’s fourth largest economy. At $36bn last year, Germany accounts for almost a third of the EU’s total exports to Russia. US exports to Russia are negligible. “Putin’s readiness to maintain the initiative on escalating the Ukraine crisis is based on the assumption that the EU is unable to forge a common position and is unwilling to follow US leadership,” wrote Pavel Baev, professor at the Peace Research Institute Oslo, recently. “Putin counts on the fact that for many European states the flow of Russian money is no less important than the flow of Russian gas.” Even so, the sanctions are already having an effect – inevitably in some unforeseen ways.

With the Russian economy already stagnating, the sanctions are certainly making a bad situation worse. On 30 April, the IMF cut its 2014 growth forecast for Russia to 0.2% from 1.3% and said the country was already in recession. It now expects the economy to grow by just 1% next year. “If you understand by recession two quarters of negative economic growth, then Russia is experiencing recession now,” Antonio Spilimbergo, the IMF’s mission chief in Moscow, said. “The difficult situation and especially the uncertainty surrounding the geopolitical situation... and escalation of sanctions are weighing very negatively on the investment climate.”

Capital flight, a perennial problem for corruption-ridden Russia, has been picking up, which is depressing the value of the ruble and stoking inflation. Russia saw capital outflows in the first quarter of 2014 double from the year-earlier period to $50.6 billion and analysts expect this figure to stand at $50bn-60bn for the whole year. 

Downgraded

This capital flight prompted Standard and Poor’s (S&P) on 25 April to downgrade its credit rating on Russia a notch to ‘BBB-’. With a negative outlook on the country, another cut by S&P – and other rating agencies – is likely in the coming months.

Analysts say the Kremlin can’t help but acknowledge the impact that the sanctions are having, but it will also be able to use them as an excuse for the weakening economy, deflecting attention from a now broken economic model that relies on state spending and raw material exports. “The sanctions do give the Russian government an excuse, a scapegoat for the poor economic performance,” Timothy M Frye, director of the Harriman Institute at Columbia University, told the New York Times. Russian officials are already saying its tough economic times “are due to the West’s nefarious activities, when in reality the underlying problems are Russia’s bad governance,” he said.

Anastasia Nesvetailova of Economonitor, an economic consultancy, says that while the sanctions are clearly having an impact, “the lessons drawn from the experience by the Russian elites may not be the one the West intended”. Nesvetailova points out that Putin’s approval ratings, of around 85%, are at their highest ever, with many Russians viewing the sanctions as proof of the need for Russia to go it alone. “The sanctions therefore are having an impact. But in reality they may end up bolstering the isolationist tendencies in Russia, strengthening in the process the economic arm of the Russian state, through the financial system,” she says.

Konrad Poplawski of the Warsaw-based Centre for Eastern Studies (OSW) points out that the sanctions – and threat of more if Russia invades or interferes in Ukraine’s presidential election on 25 May – might actually be having the effect of accelerating business deals, including large energy ones, between Russian and Western companies. Just in the past two months, Austrian state-controlled oil and gas firm OMV struck a deal with Gazprom to build a spur of the South Stream gas pipeline to Austria; Germany said it would not block the sale of RWE’s oil and gas unit to the Russian billionaire Mikhail Fridman; and Wintershall and Gazprom exchanged some assets. “Some German corporations see the tension in relations between Russia and the West as transitional and believe that this is a good moment to strike deals… and to negotiate new contracts,” says Poplawski, adding that German companies hope to be big beneficiaries of the juicy contracts being doled out ahead of the country’s hosting of the 2018 World Cup football championships. Like the Sochi Winter Olympics earlier this year, the tournament will require massive spending on infrastructure and facilities. 

Rudiger Grube, head of the German railway corporation Deutsche Bahn, met in April with his counterpart from Russian National Railroads, Vladimir Yakunin, to discuss a €20bn ($27.8bn) project to build a high-speed railway connection from Moscow to Kazan. That’s more than half the country’s total annual exports to Russia and more than double the value of the Nord Stream gas pipeline that runs from Russia to Germany. 

Poplawski, like many other analysts, believes the huge opportunities that exist in Russia will outweigh any worries about sanctions for as long as the West targets individuals and murky companies rather than the whole economy through third-level sanctions, which would target Russia’s key energy sector, as well as its banking system and mining industries. “Germany’s government and companies agree that isolating Russia will bring nothing but economic losses,” Poplawski says.

But standing next to US President Barack Obama in April, German chancellor Angela Merkel acknowledged that “further sanctions will be unavoidable” if Ukraine is unable to hold its 25 May presidential election. 

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