Sanctions haven’t stopped Russia, but a new oil ban could cut deeper - Jeanne Whalen and Catherine Belton (The Washington Post)

Sanctions haven’t stopped Russia, but a new oil ban could cut deeper

Russia may be the most sanctioned country in human history, yet the economic toll hasn’t deterred Putin’s assault on Ukraine so far

By Jeanne Whalen and Catherine Belton

 The Washington Post, February 15, 2023 

In the weeks before Russia invaded Ukraine nearly a year ago, President Biden sought to head it off by warning Russian President Vladimir Putin of “economic consequences like none he’s ever seen.”

As the Kremlin nonetheless began its assault on Feb. 24, the United States and dozens of allies were ready, unleashing a battery of sanctions and trade restrictions aimed at crippling Russia’s finances, isolating its economy and making pariahs of Putin-aligned elites.

The initial impact of sanctions looked deadly, causing the ruble to crash, the banking system to shudder and companies worldwide to stop exporting vital goods to Russia.

But one year later, Russia has remained more resilient than many expected, thanks to its oil and gas exports, deft maneuvering by its central bank and a recent rebound in trade with China and others that has allowed some banned technology to sneak through. Western sanctions have deeply wounded Russia’s economy and military and caused friction among elites — but not enough to change Putin’s calculus and end the war.

With more than 3,000 individuals and entities targeted by the U.S. alone, Russia could be the most sanctioned country “in human history,” a group of economists and Russia experts wrote in a report published in January by the nonprofit Free Russia Foundation. Despite some economic weakness, Russia has continued its military assault on Ukraine.

“Instead of growth we have a decline. But saying all of that, it’s definitely not a collapse, it’s not a disaster. We may not say that the Russian economy is in tatters, that it is destroyed, that Putin lacks funds to continue his war. No, it’s not true,” Sergey Aleksashenko, former first deputy chairman of Russia’s central bank, said at a panel discussion in Washington last month.

There are signs Putin’s luck could be starting to run out, as Western countries slap tough limits on Russia’s energy exports, which they had initially avoided out of fear that it would paralyze Europe and exacerbate global inflation. Since early December, new restrictions on Russia’s oil exports have helped widen the country’s budget deficit, prompting emergency revenue-raising measures by the Kremlin and contributing to a 19 percent drop in the ruble.

Russia’s business ties to the West took 30 years to build and one week to shatter

James O’Brien, head of the Office of Sanctions Coordination at the State Department, said sanctions are meeting their aim of sapping Russia of the finances and technology it needs to support its military. But the measures, he added, are just “one tool to stop the war.”

“They have to work with the other tools,” he said in an interview. “I think we are limiting Russia’s options on the battlefield, and its resources to restore what it’s doing on the battlefield. And that, combined with military assistance and civilian support for Ukraine, is what will win this war.”

Russia’s position looked dire in the early days of the invasion, as Western governments froze a large portion of the country’s hard currency reserves, sanctioned financial institutions and kicked major banks out of SWIFT, the international payments system that is the backbone of global banking.

The measures sparked financial panic, prompting long queues outside ATMs as Russians feared a ruble crash and cash shortages.

“There was a real risk of a bank run at the beginning of the war and shortly after the sanctions were imposed,” said Alexandra Prokopenko, at the time an adviser to the Central Bank’s first deputy chairwoman, now living in exile in the West.

Former prime minister Mikhail Kasyanov declared on Twitter that the freezing of the central bank reserves would leave the government without the means to support the ruble. “They will turn on the printing press. Hyperinflation and catastrophe for the economy is not far away,” he said.

But swift countermeasures by Russia’s central bank soon restored a measure of stability. Officials closed down markets, hiked the main interest rate to 20 percent, and imposed draconian restrictions on currency exchange, withdrawals and hard-currency transfers overseas. The measures reversed the ruble’s slide.

“It was real hard 24 hours work behind closed doors,” said Prokopenko, the former central bank official, who left the country in late March. “It wasn’t panicked. But everyone was shocked after the invasion … No one expected full-scale invasion and real war.”

Western sanctions and export restrictions also initially froze much of the world’s trade with Russia, causing a collapse in the country’s imports.

The measures banned companies globally from selling Russia computer chips and other high-tech goods it needed to build weapons and military vehicles. They also severed so many banking links that Russian importers had trouble paying overseas counterparts. By April, Russia’s imports were 43 percent below prewar levels, according to a recent report by the think tank Silverado Policy Accelerator.

The restrictions clobbered Russia’s military-industrial base, according to U.S. officials, who say that Russia’s recent reliance on older weaponry demonstrates that it can’t replenish its munitions. “They started off with some of their most sophisticated weapons and they are now using essentially retreads. They are using equipment that in some cases has been around for many decades,” Don Graves, deputy secretary of commerce, said in an interview.

“They’re also having to basically pull components out of a whole range of appliances. So we see them dismantling dishwashers and washing machines and electric breast pumps to get the components they need to keep their military moving forward, to keep their planes and weapons systems working,” Graves said, declining to detail the source of that intelligence but saying he had a “very high degree of confidence” in it.

Sanctions forcing Russia to use appliance parts in military gear, U.S. says

While Russia’s military continues to wreak destruction on Ukraine, a lack of modern armaments is holding it back, said Alan Estevez, a former Pentagon official now overseeing export controls as Commerce Department undersecretary for industry and security. “It’s much harder to take out a HIMARS battery without a precision guided weapon because you need to target the exact point in order to do that,” he said in an interview, referring to a type of missile launcher that the United States is supplying to Ukraine.

But thanks partly to Russia’s revived trade with China, the export controls are proving leaky.

By November, chip exports to Russia from China and Hong Kong alone had grown to 55 percent of median prewar chip exports from all countries, according to export data analyzed by Silverado Policy Accelerator.

Data reviewed by the Commerce Department show a 70 percent drop in the value of chips going to Russia after the war, Estevez said. But “it should be 100 percent,” he said, noting that any chip now traveling to Russia “would be a likely violation” of the rules.

“Frankly right now evasion is my number one priority with regard to Russia — closing those networks,” he said. “We are talking to the countries where lots of this trade goes on … When we see it we’re going to shut it down.” He said the United States is certain that “the highest-end chips are not getting through.”

The biggest failure in the effort to wallop Russia, experts agree, was the West’s reluctance to go after the country’s biggest cash cow — oil and gas exports. The United States quickly banned imports of Russian energy, but Europe’s dependence on pipelines from Siberia was much harder to break. The continent imported about 40 percent of its gas and a quarter of its oil from Russia.

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Soon after Russia invaded, the European Commission proposed cutting Russian gas imports by two-thirds by the end of 2022. But German Chancellor Olaf Scholz and others dismissed the idea of an immediate oil and gas boycott, worried that it would leave Europe in the dark and exacerbate already soaring global inflation.

“I think the thinking was, let’s try these financial-sector sanctions and trade controls and in the meantime we try to prepare for oil and gas measures,” said Elina Ribakova, deputy chief economist at the Institute of International Finance.

Europe’s continued purchases helped create a cash bonanza for Russia amid a sharp rise in global oil prices last spring. Far from draining the Kremlin’s war chest, Europe was helping fill it anew.

By June, the European Union adopted a measure to ban most Russian oil imports starting on Dec. 5, and to prohibit E.U. companies from insuring or financing Russian oil shipments to any buyer worldwide.

The decision “terrified the Biden administration” because it came as U.S. gas prices were spiking to $5 a gallon, said Bob McNally, an energy consultant and former adviser to President George W. Bush, who was following the discussions closely in Washington. U.S. officials worried that Europe would block too much Russian oil from the global market and inflate prices even more, he said.

Treasury Secretary Janet L. Yellen went on a global tour promoting a modification she’d first floated in the spring — price caps that she argued would lower Russia’s revenue but prevent energy price spikes. Soon, a deal was reached: Europe would proceed with its import ban but allow companies to insure Russian oil shipments elsewhere so long as the buyers paid Russia no more than $60 a barrel.

“We were supportive of Europe moving towards energy independence from Russia, and thought that the best way to accomplish that was both with the import ban, but adding the price cap to it,” Deputy Treasury Secretary Wally Adeyemo said.

Those measures, which began Dec. 5, are now starting to bite. Russia’s oil and gas revenue plummeted by 46 percent in January from a year earlier, which, together with soaring spending on the war, caused the budget deficit to balloon.

Janis Kluge, an economist at the German Institute for International and Security Affairs, predicts Russia’s budget deficit could reach five percent of GDP this year, up from two percent last year, due to the drop in energy exports and the rapidly falling tax take from the declining economy.

Economists say this will put even greater pressure on the ruble, which has already fallen since the oil embargo.

Despite rising budget deficits, the Kremlin will be able to continue funding its war machine for several more years to come, Kluge argued. The authorities are cutting spending this year on nonmilitary items such as road construction and education, “things that don’t make a difference in the next year but do over a longer future,” Kluge said. The government has also been raising money by issuing domestic debt and imposing windfall taxes on energy companies, including a payment of 1.2 trillion rubles (about $16.5 billion) Gazprom was forced to pay.

To cover the deficit this year, Russia is also expected to dip into its rainy day fund, the National Wealth Fund, now consisting mostly of Chinese yuan and gold. But economists say the fund could be depleted over the next two years.

“All of this together tells you the sanctions are a problem,” Kluge said. “But because the war is such a huge priority, it will not be the reason that makes Putin reconsider his Ukraine strategy. Yet.”

Some Russians see bigger troubles mounting. Putin has often touted Russia’s lower than expected drop in GDP last year as demonstrating that sanctions aren’t working. Western economists estimate the economy contracted between 2.2 percentand 3.5 percent, versus initial forecasts of ten percent or more. However, those headline figures could mask a deeper recession, due to signs of weakness in household and corporate spending, as well as Russia’s manufacturing and gas sectors, Russian business executives, officials and economists say.

“There is the official statistical drop, but unofficially it could be deeper,” said a senior Russian financial official who spoke on the condition of anonymity to avoid reprisals, citing a recent survey showing that Russian companies were in “survival mode” and “not making any serious investments.”

A collapse in Russian auto production last year, as factories struggled to import parts, is another ominous sign for the economy. So is the 9.3 percent drop in retail spending in the second half of 2022, compared with a year earlier, which suggests households are “in crisis mode,” Kluge said.

Increased spending on weapons production, meanwhile, has helped offset a big decline in industrial production. “The military industrial complex is helping the Russian government and Russian propaganda maintain the illusion that everything is ok, but in reality it is adding nothing in terms of people’s well being and productivity,” Prokopenko said.

Government figures show an unemployment rate of just 3.9 percent, but that reflects Russian companies’ practice of keeping employees on unpaid leave rather than firing them, the senior finance official said. Analysts at the consulting firm Finexpertiza estimated that the level of “hidden unemployment” reached almost 13 percent in the third quarter last year.

“The tension is felt practically everywhere,” said one Russian state official close to diplomatic circles, who declined to be named out of fear of reprisals. “There is construction that is not completed; equipment that never arrives. There is a lack of money among the population who are facing all these difficulties.”

Putin, unaccustomed to losing, is increasingly isolated as war falters

As the outlook has worsened, the government has begun classifying some economic data that used to be released. Most recently, Russia’s gas production and export numbers were deemed secret, after production fell by 19.6 percent in the first eleven and a half months of 2022 compared with 2021. Economists say some of the official economic data appears to be being manipulated. “They are certainly lying about the overall economic picture,” said Ben Hilgenstock, senior economist at the Kyiv School of Economics.

For much of the Russian elite, the sanctions — and Putin’s war — have shattered three decades of empire building and integration with the West. “No one approves of the war. Everyone considers it to be a mistake. But no one sees a way out,” said one Russian billionaire who declined to be named. Even those among Putin’s closest inner circle are increasingly dissatisfied with developments, said the Russian state official. That includes Igor Sechin, Putin’s deputy since the early 1990s and now president of oil giant Rosneft, and Sergei Chemezov, who served with Putin in the KGB in east Germany in the late 80s and now heads the state arms conglomerate, the official said. “The businesses that they built over all these years are under enormous pressure due to the sanctions. What can they be happy about?” the official said. Amid all the friction, western officials and some economists said they believed sanctions were working — even if the net impact has not deterred Putin from funding his war. “The way I think about sanctions is that we are shaking the tree on which the regime sits,” said Kluge. “We can’t really tell what’s going to come out of it, what’s going to happen. We are not shaking it enough for it to fall down. But we’re creating problems for them. It consumes a lot of political energy in Moscow. And it makes it clear to everyone, to all insiders, that it was a huge mistake to start this invasion.