The Future Implication of Transatlantic Sanctions Dossier on the Russian Economy
It has been over 7 years and countless instances since the US and the EU − separately and collectively − imposed various sanctions and restrictive measures on Russia. What started as a reaction to the 2014 Ukrainian crises and led to the Ukrainian-related sanction package was further supplemented by other restrictive measures against Russia, connected with allegations of Moscow’s interference in the US presidential election campaign, cyber attacks, human rights abuses, the Navalny case, WMD non-proliferation, etc. The US and EU’s coercive economic measures against Russia have failed to achieve any tangible political results they were designed for (presumably, aimed to radically change Russia’s foreign and domestic policies), but they indeed had a negative impact on Russia’s economy − largely those sanctions that are related to the Ukrainian case.
The US and EU have pursued very similar approaches to sanctioning Russia, but with some differences in timing, in details, and in how the restrictive measures were adopted. Since 2014, all in all, several types of sanctions were imposed on Russia, including asset freezes and travel bans on selected individuals and entities (largely those associated with Ukrainian case or Putin’s close circle), restrictions on investing and doing business in Crimea, sectoral sanctions targeting the oil and gas, financial, and defense sectors in Russia, including an arms embargo, and restrictions on economic cooperation between Western development banks, including the European Bank for Reconstruction and Development, and Russia.
Moscow has made its best to adapt to sanctions and minimize or avoid direct impact of sanctions on the Russian economy and business circles by taking various measures, regulations, and policies. For example, for key Russian businesspeople subject to asset freezes, the Russian Government has offered lucrative public procurement contracts to compensate for the impact of sanctions on them. Eventually, sanctioned Russian individuals and companies have found options to work around and limit their vulnerability to sanctions, however at times using more expensive strategies to service debt and obtain project financing. In a broader sense, Russian Government started to pursue multiple policies aimed at reducing Russian reliance on the US-centered international financial system, US dollar, Western technologies and markets, etc. Russia launched its national payment system (called “Mir” − a Russian equivalent to Visa or Mastercard), undertakes measures to de-dollarize the Russian economy and foreign trade, diversifies Russia’s trade, economic, investment and technological partners, pursues import substitution policies (specifically in the technology domain), etc.
The most sensitive and painful have been restrictions on Russia’s access to Western capital markets and advanced technological equipment, in particular, for oil and gas exploration and production. The imposition of sanctions resulted in the EU’s stop of providing Russia with services and technologies for deep-water oil exploration and production, Arctic oil exploration and production and the development of shale oil deposits. The US has taken similar measures, including a ban on the export of equipment for specialized hydrocarbon exploration. Noteworthy, while the EU measures touched upon the oil industry (not gas industry, which would be harmful to Europe, which is a large importer of Russian gas), the US sanctions are aimed at both the oil and gas industry. The EU shielded the Russian gas companies, including Gazprom and Novatek, from the sanctions. Moreover, the EU restrictions on Russian oil sector affect only the contracts concluded after September 12, 2014.
These sanctions negatively impact Russian oil and gas industry, which traditionally greatly relies on Western technologies. Such dependency on Western technologies is especially typical for offshore drilling rigs (including self-elevating floating drilling rigs), pump-and-compressor and downhole equipment, power generation equipment, and software. Alternative technological partners, like, for example, China is not yet able to adequately replace Western equipment and services in this area. The creation and construction of Russian indigenous technologies and equipment − a goal of Moscow’s import substitution policy − are on the agenda, but are expected to take considerable time, finance and efforts.
According to Russian SKOLKOVO Energy Center’s analysis, published in March 2018, so far, Russian oil companies have fully adapted to the sanction regime. Numerous tax breaks provided by Russian Government and Russian currency devaluation, which cut US Dollar production costs and increased the competitiveness of Russian oil in foreign markets, enabled not only to avoid reduction in oil production, but also ensured its record growth. Despite the US and EU’s sectoral sanctions against Russia and the slump in oil prices, oil production in Russia has been steadily growing in the past years. Until 2020, oil production in Russia has been growing for 11 consecutive years. In 2019, Russia set a record for oil production for the entire post-Soviet period − 568 million tons of oil and condensate. However, in 2020 and 2021, amid a pandemic-related collapse in oil demand and a new OPEC+ deal, Russian production fell to its lowest level in 9 years. Russian energy analysts underscore, however, that seemingly small immediate impact of the sanctions on Russian oil industry can be misleading, because the investment cycle in oil sector takes at least 5-7 years, and to prevent a sharp fall in production after 2025, it is indispensible to take active measures to develop domestic technologies in oil production. Without the development of Russian domestic technologies and competencies, the decline in oil production may become noticeable.
Major publicly owned Russian companies in the energy sector (Gazprom Neft, Rosneft, Transneft, etc.), as well as state-controlled banks (Sberbank, VTB, VEB, Gazprombank, Rosselkhozbank, Vneshekonombank, Bank of Moscow) have also been affected by transatlantic financial sanctions. In particular, the ban on circulation of new bonds and shares of listed companies and banks was tightened: the maximum possible duration of these instruments was reduced from 90 to 30 days. The US restricted access to the US capital market for such energy companies as Gazprom Neft, Rosneft, Transneft, Novatek, and their subsidiaries. This restriction was not applied to Lukoil and Surgutneftegas, but these two private energy companies also faced the problem of worsening terms for attracting financial capital.
Moreover, there are two additional forms of financial sanctions. First, there are the more severe SDN sanctions prohibiting foreign exchange payments, which affects banks and companies whose owners were subjected to personal sanctions. Second, many Russian banks are affected by the “soft” sanctions, meaning stricter technical control over transactions that typically slows down execution, significantly increasing transaction costs.
In sum, the financial sanctions limited foreign borrowing opportunities for relevant Russian banks and energy companies. As an indirect result of the sanctions, leading rating agencies, like Moody’s, Standard & Poor’s and Fitch, lowered the credit ratings of Russian energy companies, which has led to higher costs of borrowing in the Asian markets as well.
Basically, sanctions also had an indirect, yet significant impact on Russian economy, because its imposition has led to the decline in confidence in Russian economy within international society and foreign investors. The decline in confidence spurred capital outflows from Russia. In 2014, the net capital outflows from Russia nearly tripled compared to 2013, reaching a record $151.5 billion, up from $61 billion in the previous year. As a matter of fact, sanctions deterred foreign investment in Russia, as investors are unable to develop a strategy for working in the Russian market without knowing when the sanctions will be lifted. On top of that, Russian businesses have been experiencing so-called “overcompliance effect” with the US and EU sanctions, when Russian partners from third countries avoid transactions even in cases when they do not violate sanction regime.
According to some estimates, dated back to 2017-2018, every year due to sanctions and Russia’s own countersanctions, largely targeted at the EU’s agricultural sector, Russian GDP loses from 1% to 1.5%. However, some recent evaluations suggest, that influence of the sanctions on Russia’s macroeconomic indicators has been quite low. In 2019, an IMF concluded that the “weight” of sanctions in slowing down Russia’s economic growth was only 0.2%. Compared to the sanctions, a far greater impact on the Russian economy was exercised by the COVID-19 pandemic, the global economic recession, the drop in oil prices, fiscal policies, financial and monetary factors, etc. However, while the overall impact of sanctions on the Russian economy is relatively low, the risks and influence on individual Russian companies and projects are quite high.
Russian analysts are almost unanimous with the prognosis that there seems to be no chance of the sanctions being lifted any time soon. The transatlantic sanctions are likely to remain in place and additional sanctions may be introduced in the mid and even long-term perspective, given Washington and European unfriendly attitude towards Putin’s political regime. On a positive side, over the past 7 years, there have been no dramatic changes in Ukraine-related sanctions; there has been basically the prolongation of sanctions that have been already in place. Importantly, according to the IMF estimations, compared to the initial imposition of sanctions in 2014-15, at present Russian authorities have stronger policy and crisis management frameworks in place, and larger buffers.
