- The speed and scope of sanctions on Russia – including against the central bank – are unprecedented, and they have sent the economy into freefall.
- Governments have been wary of imposing sanctions, partly because of concerns over energy security…
- …but there are also other consequences, and no guarantee that restrictions will have the desired effect.
When Russia invaded Ukraine on 24 February, there was a broad consensus that Western sanctions would have little to no impact: that they were too limited, too focused on wealthy individuals who have their billions stashed in shell companies around the world, and lacked the international coordination needed to truly hit where it hurts.
Yet while President Vladimir Putin has ploughed on with the war regardless, the restrictions have been swiftly ramped up – notably now covering Russia’s central bank – and are starting to bite.
“All this talk we’ve heard over the past few months – sanctions won’t bother Russia; it has huge FX [foreign exchange] reserves – all of that has gone out the window now. These measures would have been unthinkable just a few weeks ago,” says Brian O’Toole, a senior sanctions adviser to the US Treasury between 2009 and 2017.
After all, there are various reasons, other than energy prices, why governments will have been wary of taking such measures against Russia, as this article will highlight.
In this case, O’Toole and other commentators put the rapid and severe tightening of sanctions partly down to the appeals of Ukraine president Volodymyr Zelenskyy and his country’s strong resistance. And the longer the country holds out, the better the chance that the restrictions will be effective, he adds.
As Sergei Aleksashenko, former Russian deputy finance minister and deputy central bank governor, has put it, the latest sanctions are like “a financial nuclear bomb that is falling on Russia”. The economy is in freefall, with the rouble plunging, interest rates more than doubling to 20%, and bank runs and defaults taking place.
Putin will be acutely aware of this – hence, presumably, his haste to get the war over and done with.
The initial post-invasion approach had been basically to repeat the sanctions imposed when Russia annexed Crimea in 2014, but the measures have since gone considerably further, says Tobias Caspary, a London-based international trade partner at US law firm Fried Frank.
Unprecedented scope and severity
Only one central bank has ever previously been sanctioned – that of Iran – and the move could be cataclysmic for the Russian economy. It essentially means the bank cannot borrow money abroad, cannot swap some two-thirds of its $630bn in foreign exchange reserves for roubles to limit the effects of sanctions, and cannot provide support for its own banking sector.
“Sanctioning the central bank won’t make every bank in Russia go bust right away,” says Caspary. “But as they each fail to meet their obligations and people try to get their cash out, there is a risk that they start to implode – and the government won’t be able to save all of them.”
This move is far more significant even than limiting Russia’s access to global payment communications system Swift, O’Toole argues. On the flip side, sanctioning Swift and the central bank have important implications for foreign institutions, such as holders of Russian bonds awaiting coupon payments or those looking to divest Russian assets.
The crisis has, however, called for such measures. Even countries that have not previously engaged in sanctions, such as Singapore, South Korea, Taiwan and famously neutral Switzerland, have done so this time.
Even so, there is more the West can do. In an exclusive interview with Capital Monitor, former Ukraine finance minister Natalie Jaresko said sanctions should be extended to cover all state-owned banks and oil and gas companies in both Russia and Belarus, and Nord Stream 1, a system of offshore natural gas pipelines in Europe running from Russia to Germany under the Baltic Sea.
Indeed energy is arguably the biggest of several elephants in the room. Germany’s decision to suspend Nord Stream 2 – the recently completed but not yet operational second system of pipelines – is a form of sanction. But Western companies and governments are still buying Russian oil, gas and metals, in part out of a desire to limit the impact on their own economies – though energy sanctions are reportedly an option.
Hard to keep up with
Of course, energy security is not the only issue that Western nations are contending with. While a rapid tightening of restrictions on Russia is appropriate given the desperate situation in Ukraine, they have a knock-on effect well beyond the institutions they target.
Most international banks are used to dealing with sanctions, but the speed and complexity of the current programme is making it difficult even for specialists to keep up. Everyone that Capital Monitor spoke to stressed the fast-changing scale and scope of restrictions as a major challenge for compliance and legal teams.
That is in part because, even though some of the current measures have been imposed on other countries in the past, the circumstances were vastly different in those cases.
“There is no precedent for what’s happened this week – not Iran, North Korea or Cuba even, because all of those were much slower burns in economies much less connected to international markets,” says O’Toole.
Russia is the world’s 11th-largest economy and – despite nearly a decade of sanctions on certain individuals and companies, and other countries reducing their financial exposure to Russia and vice versa (see charts below) – it remains well embedded in global financial markets. In fact, total isolation of the Russian economy may not be possible for this reason.
Complexity of coordinating sanctions
What’s more, imposing international sanctions is almost absurdly complicated – particularly when very different governments try to take a coordinated approach.
And yet international coordination is key to prevent leakage or arbitrage, says Harry Broadman, Washington, DC-based chair of the emerging markets practice at consultancy Berkeley Research Group: if the US sanctions one bank but the UK does not, that bank has a clear workaround.
To be effective, sanctions must target both those most likely to suffer economically or politically from them, but also those who have the highest likelihood of forcing a change in behaviour, Broadman adds.
To be sure, targeting powerful individuals has its flaws, but early signs indicate that it may be having some effect in this case. A small number of Russian businessmen have begun to speak out against the war – though not directly against Putin himself. The most high-profile example is that of Roman Abramovich (net worth $12.3bn), who on 2 March announced plans to sell Chelsea Football Club and donate the net proceeds to victims of the invasion.
The technical elements of targeted sanctions are one thing, but a form of ‘self-sanctioning’ is also taking place: in commodity markets, which are pricing in future oil and gas sanctions; in banking, as lenders are reportedly dropping clients with suspected ties to Russia; and in respect of investment, with a growing list of asset managers, pension funds and other companies moving to ditch Russian assets.
Those divesting range from Norway’s $1.3trn sovereign wealth fund and asset management giant BlackRock to energy majors BP, Equinor, ExxonMobil and Shell. Such moves are not explicitly covered by Western sanctions, as some point out.
Norwegian public sector pension scheme KLP was exposed to 22 Russian companies via the MSCI indices it tracks but has excluded those stocks, says Kiran Aziz, the $72bn fund’s head of responsible investment (as has MSCI itself as of 3 March). “There are so many grey areas in the law and within ESG, but this is not about compliance – we’ve gone much further than the letter of the law,” she tells Capital Monitor.
What’s more, selling Russian assets is not only difficult now because of their negative association but also potentially against the law because of the sanctions.
“People seem to be getting confused [by these announcements] but it’s very difficult, and in some cases illegal, to sell any Russian assets right now – and these sanctions have only been in place for a couple of days,” says Sergei Ostrovsky, a Russian and English law-qualified lawyer based in London.
The Moscow Stock Exchange has been closed since 28 February, and the government has declared a temporary ban on foreign investors selling Russian assets.
“Even if you find a buyer, you’re trying to sell something that isn’t legally transferrable – there is no one to deal with the mechanics of the transaction,” Ostrovsky tells Capital Monitor.
Imposing international sanctions is, then, not a decision to be taken lightly, not least because of the myriad moving parts and potential unintended consequences. In the face of Putin’s aggression, though, few would argue with the strategy ‘act now, ask questions later’.