Heavy Sanctions against Russia Could Usher in a Wider Economic War

Sweeping Sanctions Invite Countersanctions

The round of sanctions imposed on Russia following the annexation of Crimea in 2014 were limited to travel bans, freezing of the assets of certain Russian officials, and a prohibition of credit and technology transfers to Russian state oil companies and banks. After the invasion of Ukraine, in addition to the freezing of the financial assets of Russian oligarchs close to the regime, sanctions were escalated to the technology, steel, energy, and financial sectors. The US stopped imports of Russian oil and gas, and the European Union moved to drastically reduce its dependence on Russian energy too. Several Russian banks were cut off from the SWIFT system, and, most important, the reserve assets of the Central Bank of Russia (CBR) were frozen, together with its sovereign wealth fund. Experts estimate that Russia has lost access to about 40 to 60 percent of the CBR’s international reserves, valued at $640 billion, which is a huge financial blow. In addition, the US banned the trading of the CBR’s gold reserves, estimated at $136 billion, or another 20 percent of its total foreign reserves (graph 1). Finally, over five hundred foreign companies have announced that they are voluntarily suspending operations or leaving the Russian market altogether.

Russia likened the sanctions to an “act of war” and retaliated by prohibiting exports of certain commodities and raw materials and demanding payment for its energy exports in rubles, to undercut some of the West’s financial sanctions. After the reciprocal closure of air spaces, Russia also allowed Russian airlines to reregister and fly domestically about five hundred planes leased from abroad, worth about $10 billion, which is tantamount to their seizure.

Moreover, Russia threatened to nationalize the assets of multinationals that suspend their operations in the country. But the German government moved first, taking control of the Gazprom subsidiary in the country to ensure the security of the German energy supply.

Russia hosts a sizeable stock of foreign direct investment (FDI) of about $500 billion, the majority, about 75 percent, of which originates in the EU (in particular in Cyprus) and around 5 percent in the US. If the US and its allies move to confiscate Russia’s forex reserves, the latter could seize the Russian assets of Western companies, which are worth roughly the same amount. Russia owns a smaller amount of FDI abroad of about $390 billion, which is likely more evenly spread between Western and emerging economies. Russia could also stop servicing its external debt if some of its external assets get confiscated, in particular now that the US Treasury has stopped Russia from making bond payments from its frozen reserves. Russia’s external debt of about $480 billion, of which close to $100 billion is owed by the government, is also large. These figures illustrate well that financial stakes would be very high in the case of tit-for-tat asset seizures and contract defaults, not mentioning the severe consequences of foregone future trade and business.

Mere Sanctions or a Harbinger of Economic War?

So far, the impact of sanctions has not undermined Russia’s will to continue the war. Despite the drop in hydrocarbon exports to the Western economies, Russia’s current account surplus increased to $39 billion in January–February of this year from $ 15 billion a year before, on account of surging energy prices and compression of imports. The ruble has also recovered nearly all the losses incurred against the US dollar when sanctions were announced. The pressure on external accounts and the economy will mount as the West cuts its energy dependency on Russia, but the latter’s energy and commodities exports will most likely find other outlets in emerging economies. Economic interdependencies cannot be undone overnight, and markets will redirect international trade flows to reduce the economic cost of the sanctions.

President Joe Biden no longer claims that economic sanctions will work in the short term but still wants to keep them in place for much longer. It may well be that seized Russian assets are kept to cover for future war reparations in favor of Ukraine or that sanctions are applied for as long as Putin remains in power. Other US allies, such as the UK, are also in no hurry to lift sanctions as soon as the war stops. Moreover, the sanctions are not as effective as hoped for, because Russia continues trading with other emerging economies, which together make up about 40 percent of the world GDP (gross domestic product) nowadays. The US and its allies have put pressure on China, India, and others who have not condemned Russia or applied economic sanctions, also threatening them with secondary sanctions, but most have stood their ground so far. Even US partners in the Middle East have ignored Biden’s calls to pump up more oil in order to tame petrol prices.

It cannot be ruled out that the economic war against Russia will eventually spread to China and others via secondary sanctions and growing political animosity. Before Russia’s invasion, the US was already in a trade and technology war against China. EU countries have also taken a tougher stance against China by shelving an investment agreement and screening more carefully technology transfers. A decoupling of the world economy into two opposing blocs of “democratic” and “autocratic” regimes does not seem a farfetched prospect anymore. Certain Western leaders may even welcome it as the only “solution” to counter the mounting economic competition from fast-growing emerging economies (graph 2).