At the beginning of March, the US prolonged Ukraine-related sanctions against Russia for another year. More negative newsflow on sanctions is due in the coming months: A bipartisan group of US senators tabled legislation on February 13 that could broaden and deepen the US sanctions regime on Russia. The senators heralded the Defending American Security Against Kremlin Aggression Act (DASKAA) 2.0 proposals as the “most radical measures yet.” The new draft legislation includes proposed sanctions on:
The proposed sanctions, which still need to be approved by the US Congress and signed by the US President before they become law, are indeed broad in scope, continuing the mushrooming of the regime to disrupt Russian foreign policy more generally, rather than to simply deescalate the armed hostilities in Ukraine.
However, most of the DASKAA 2.0 proposals are not new; either they are already in place or have previously been discussed in one way or other. Furthermore, the proposals appear somewhat softer than those included in the original DASKAA package of August 2018, which was not implemented.
Specific banks to be targeted are not listed; the names of the banking majors, such as Sberbank and VTB, are not even mentioned, nor are options like freezing operations and assets explicitly mooted. Moreover, the means of proving that Russian banks are undermining democratic institutions is unclear. Based on these proposals, disruption to the handling of Russia’s external trade and $-transactions by its largest state-owned banks seems unlikely.
Major new economic sectors are also not included in the scope of DASKAA 2.0. The shipbuilding sector – the inclusion of, which is conditional in any case – is not significant in macroeconomic terms. Past precedent also suggests that mooting new sanctions is one thing, but the complex process of adoption is quite another (including certain phasing in 60-180 days afterwards).
The Rusal case is a case in point, which was targeted in the April 6 round of sanctions. Despite being regarded as a ‘victory’ for the Trump administration, the eventual climb down in December actually reflected the White House’s pragmatism. Clearly, the Trump administration was either unable or unwilling to sanction large Russian corporates with a global presence, reinforcing the market perception that only individuals are viable targets.
More than anything, DASKAA 2.0 reflects the rather general, non-specific nature of the US confrontation with Russia, and that its scattershot strategy is not changing. At present, the sanctions hawks in Congress are doing little more than consolidating the current regime, most likely to ensure that the White House does not kick it into the long grass.
Nothing new to see here
Indeed, the muted reaction within the international investor community is symptomatic of markets already having priced in the risks of the current sanctions climate, which anticipate long-term discomfort but without any sudden shocks. Russian energy companies –, which have been the sanction focus since the start – have adapted to the US sanctions rules, working with a higher degree of technical independence. Even where more radical proposals are made – such as extraterritorial targeting of (read: EU) companies engaged with strategic Russian projects – their adoption will be slow. This will leave the “hard core” foreign investors into Russia sufficient space to operate.
In this sense, the major market adjustments have already been made. Russian issuance on global debt markets from 2015-2018 amounted to $10-15bn annually (or 2-3% of global Emerging Market issuance), a sum that could be easily replaced by local financing. Prior to the Global Financial Crisis some ten years ago Russia-related issuance on international debt capital markets amounted to some $30-50bn annually (some 15-25% of global EM issuance).
International cross-border banking sector exposures towards Russia have dropped from some $270bn in 2013/14 to around $100bn currently, mostly impacting European banks with local subsidiaries in Russia. For comparison on the much smaller Turkish economy international banks run cross-border exposures in the excess of $200bn. Moreover, compared to Russia deleveraging has been shallow here, despite a significant local financial crisis in 2018.
Elsewhere, non-resident exposures to the domestic ruble-denominated OFZ treasury bills market were also trimmed in 2014 and 2018, with drops from around 27% to 19% and 34% to 23%, respectively. The share of Russian assets in global indices and portfolio weights has decreased from 9% to 14% some seven to ten years ago to around 3% to 7%, indicating that their systemic importance and focus by global investors has weakened. If this trend continues, further financial market sanctions against Russia will no longer be a systemic risk - neither for the USA, nor global financial markets nor for Russia.
Paving the way: suffocation over collapse
The market might have priced in the risk, but DASKAA 2.0 should nonetheless not be underestimated. First, it continues to pave the way for escalation in certain areas, especially LNG, which is a relatively low-risk avenue for Washington given that it would serve its commercial interests and not antagonise the EU (in contrast to potential sanctions in, which EU majors are engaged, such as Nord Stream 2) or powerful US oil companies.
Second, DASKAA 2.0 would incorporate a wide and nebulous range of Russian foreign policy activities into the range of offences for, which new sanctions could be justified, such as the proliferation of chemical weapons, international cybercrime, electoral interference and state terrorism. Such offences are difficult to prove – and may not even impact the US directly – but that is not the point.
Third, it is significant that DASKAA 2.0 seeks to examine the finances of oligarchs and other individuals who form Vladimir Putin’s inner circle. In the event that light is shed on the murky interests of the Russian ruling elite, this could have implications for social stability, firing anticorruption protests particularly on the regional level. With such information, the USA could further thought also actively enter into the "intelligence war".
More generally, DASKAA 2.0 reinforces the likelihood that sanctions will not be relaxed for the foreseeable future. It is possible that the Trump administration, having seen many of its more hawkish ‘moderates’ resign in the second half of 2018, will not act on them. However, the political will to deepen the sanctions toolbox is very much present. Whether it is in 2-3 or 5-6 years, Washington will likely have a wide range of tools available if there are changes in the dynamics of US domestic policy or the White House itself.
These tools send the signal to rival powers that the US is the dominant global economic power, fully capable of choking off the funds which a state like Russia may use to fund its foreign policy.
However, in practice, neither side has much interest in changing the state of affairs. Russia will continue to embrace isolation and its stability-oriented economic policies, which include a careful retreat from global markets and integration. A lengthy period of stagnation is likely. Socioeconomic conditions in the regions will continue to deteriorate, but the state apparatus, with a mix of coercion and fiscal transfers, will hold the line here, albeit at a cost it increasingly cannot afford. At the same time, the public discourse in Russia also tries to portray the USA as a "stagnating economy" of the "middle class losers". The latter also explains international demonstrations of US power (incl. sanctions) according to this train of thought.
An indicator of escalation within Russia would be the delicate melange mixing economic stagnation with further US sanctions initiatives targeting the finances of the ruling elite. This would likely have implications for social and political stability; but it would be a slow-burning scenario, like the US sanctions themselves. DASKAA 2.0 shows that the US and Russia are engaged in a long-game. In this respect, the relaxed market attitude towards further sanctions and their overall slow-burning nature are perhaps unsurprising.