Do Sanctions Work? Depends on their Objective.

Two years after being implemented, what have sanctions over Ukraine achieved?

In March 2014, the EU, the US, and other Western countries began to implement economic and diplomatic sanctions against Russia in response to the annexation of Crimea and escalating violence in Eastern Ukraine.

Western economic sanctions against Moscow fall broadly into two categories. The first is an embargo on trade of certain military and industrial equipment with Russia. This includes oil production equipment as well as military and dual-use goods, ranging from basic GPS systems to French-built, Mistral-class amphibious assault ships.[1] The second restricts access to Western financial services for designated Russian businesses, mainly in the defense and energy sectors.[2]

In retaliation for Western sanctions, President Putin announced a ban on food imports from the EU, US, Australia, Canada, Norway, and Switzerland in August 2014, which remains in effect today.

These sanctions and counter-sanctions, along with other macroeconomic challenges such as the more than 70% decrease in the price of oil since March 2014, have contributed to the recession in Russia.

In the last year especially, the Russian government has had significant difficulty gaining access to foreign financing. Last month, the Russian Finance Ministry invited more than a dozen American and European banks to bid on its first bond offering since 2013.[3] Following informal pressure from the US State Department and several European governments, none of these banks are following up on the offer.[4] This situation, along with the formal barriers imposed through the sanctions have caused Russia to use large parts of its foreign exchange reserves to cover the deficit. Russian Finance Minister Siluanov warned that the reserve fund could be completely empty by the end of 2016 a result.[5]

Furthermore, the Russian Central Bank stopped defending the value of the rouble in December 2014, followed immediately by the first rise in interest rates since 2008. This, combined with the fall in foreign exchange reserves, contributed to inflation.

However, Russia’s own sanctions worsened the inflation of the past two years as much as, and possibly more than, any Western influence. The states Russia banned food imports from in 2014 made up 19 of the top 20 food importers into Russia in 2013.[6] As a result of such a sudden decrease in food imports, food prices increased by 28% in the three months after the ban was enacted.[7]

Combined with EU and US bans on the trade of designated military and industrial equipment with Russia, the food import ban deeply hurt Russian trade. Between March 2014 and February 2016, total Russian trade fell by roughly 63%.[8]

Taken together, these shocks to the Russian economy brought about a recession, with GDP growth below -4% for the final three quarters of 2015. Forecasted growth for 2016 is under 0%.[9]

Western sanctions have succeeded in their immediate objective of hurting the Russian economy. At the same time, the effect of the sanctions on European economies has been minimal. Although trade with Russia decreased almost to nothing by the beginning of 2015, trade increased between EU countries and other markets more than made up for the deficit. Only two EU member states experienced net losses in trade across all markets.[10]

In short, Western sanctions have been effective over the last two years in damaging the Russian economy and demonstrating unity and resolve against Russian actions in Ukraine. Furthermore, the minimal drag on the economies of EU member states reveals the affordability of these coercive sanctions.

Despite the success of the sanctions regime, there is already high-level discussion of beginning to remove economic sanctions. Earlier this year, French Economy Minister Macron stated that France hopes to lift EU sanctions against Russia “this summer”. US Secretary of State Kerry said in January that “it is possible in these next months to find” sanctions against Russia lifted.[11]

Furthermore, even if Western sanctions were to remain in place in their current form, they are likely to show diminishing returns to scale. The US State Department expects their effects to be roughly half as severe in 2016 as they were in 2015.[12] As Russia finds new export and import markets and brings interest rates back down, its economy will become less vulnerable to manipulation. In order to keep the pressure on the Russian economy, the West will need to change its sanctions strategy.

Western sanctions have done considerable damage to the Russian economy. Whatever effect they have in the future depends on the West’s dedication enforcing the Minsk II ceasefire. Since their implementation two years ago, however, sanctions have been an effective tool. Indeed, as one US official put it recently, “if the sanctions weren’t in place, it’s pretty easy to imagine that Putin would have gone a lot further”.[13]

[1] The European Commission defines dual use goods as “products and technologies normally used for civilian purposes but which may have military applications”, and the application of the term is extremely broad. By banning trade of dual use goods, over a thousand categories of products cannot be exported to Russia.

European Commission, “List of Dual-Use Items”, http://trade.ec.europa.eu/doclib/docs/2015/october/tradoc_153894.pdf.

EU Newsroom, “EU Sanctions against Russia”, http://europa.eu/newsroom/highlights/special-coverage/eu_sanctions/index_en.htm.

[2] For example, EU nationals and companies may not make financial trades with five state-owned Russian banks, and several major companies in the defense and energy sectors.

[3] Wall Street Journal, “U.S. Warns Banks of Russian Bonds”, http://www.wsj.com/articles/u-s-warns-banks-off-russian-bonds-1456362124.

[4] Goldman Sachs had reportedly filed paperwork to be included in the final offer, but the deal is “very unlikely” to get approval from senior bank executives. According to people familiar with the matter, “Goldman was the only bank to submit an offer to the Russian government”.

Wall Street Journal, “Goldman Likely to Drop Likely to Drop Bid”, http://www.wsj.com/articles/goldman-likely-to-drop-bid-on-russian-bond-deal-following-u-s-pressure-sources-say-1456954183.

[5] In March of 2014, Russia held more than 20 trillion roubles of reserve currency (~$500 billion). Minister Siluanov admitted that it is unlikely the fund will begin to be replenished until the price of oil reaches $70. “There is no immediate hope” of this.

CNBC, “Russia’s Reserve Fund Could Run Empty in 2016”, http://www.cnbc.com/2015/10/27/russias-reserve-fund-could-run-empty-in-2016.html.

[6] Belarus is the only state in the 2013 top 20 food importers not to be sanctioned by Russia.

Source of Data: Russian Federal Customs Service. Source of Table: Wall Street Journal (http://www.wsj.com/public/resources/documents/st_RUSSIABAN20140807.html)

[7] Source of data: Federal State Statistics Service (http://www.gks.ru/wps/wcm/connect/rosstat_main/rosstat/en/main/)

[8] Source of data: Central Bank of Russia (http://www.cbr.ru/eng/statistics/)

[9] Wall Street Journal, “More Banks Steer Clear of Russia’s Bond Sale”, http://www.wsj.com/articles/russia-struggles-to-find-global-banks-to-handle-bond-deal-1458750539.

[10] These two states were Greece and Sweden, both of which faced other economic challenges most likely responsible for this export decrease.

All data from Eurostat trade statistics (http://ec.europa.eu/eurostat/web/international-trade/data/database)

[11] NDTV, “France Hopes to See Russia Sanctions Lifted ‘This Summer’”, http://www.ndtv.com/world-news/france-hopes-to-see-russia-sanctions-lifted-this-summer-french-economy-minister-1269643.

[12] EU, “Sanctions to Have Little Impact on Russia In 2016”, https://euobserver.com/foreign/131812.

[13] Ibid.

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