Explainer | What about the EEU? Why Russia’s trade bloc is not a sanctions backdoor

Explainer | What about the EEU? Why Russia’s trade bloc is not a sanctions backdoor
Friends without benefits. / Eurasian Economic Commission.
By Maximilian Hess for EurasiaNet March 8, 2022

As Russia faces the most stinging sanctions regime imposed on a major global economy in modern times, one question often arising this week is to what extent President Vladimir Putin might employ the Eurasian Economic Union (EEU) to mitigate the impact.

Formalised in the aftermath of Russia’s 2014 annexation of Crimea and the West’s initial sanctions, the EEU is a free trade zone and customs union consisting of five ex-Soviet states: Russia, Armenia, Belarus, Kazakhstan and Kyrgyzstan. In theory, goods and labour can move about relatively frictionlessly, akin to the European Union’s single market. Notable customs barriers do remain, however.

After Moscow sent tanks into Ukraine last month, the West cut Moscow’s access to its foreign reserves, barred its central bank from borrowing, slapped crippling restrictions on its high-tech and defence sectors and blacklisted a growing number of Kremlin cronies and oligarchs. Once unthinkable asset seizures are under way. Western firms are pulling out of Russia at a faster rate than they did during the Bolshevik Revolution. Asian economic powerhouses such as South Korea and Japan have signed on to the sanctions. Even Chinese-led lenders are spooked and implying they might comply with Western sanctions.

In this environment, there have been calls in the West to pre-emptively sanction the other four EEU members to close any loopholes to this economic chokehold. The members are all dependent on Russia in one way or another, the thinking goes, so they owe Moscow. Only weeks ago, for example, Russian troops were patrolling Kazakhstan at the president’s invitation following unprecedented unrest. Armenia depends on Russian troops to patrol its borders. 

The reality, however, is that the EEU is unable to significantly temper the economic and financial disruption that Russia is already experiencing, and which will cause a substantial, and potentially protracted, recession across the region. JPMorgan on March 3 predicted that Russia faces a 35% contraction in the second quarter.

Before looking at what each member country could offer, first consider that there is little talk in the West of restricting the export of basic goods to Russia, so there is no need to find a workaround for food or consumer goods. The most biting restrictions are on computer and semiconductor technology – part of wider sanctions on the defence, aerospace and maritime sectors. Technological and dual-use goods are already closely monitored by Western enforcement agencies; oversight will only grow as countries like Singapore and South Korea join the sanctions for the first time.

Armenia is the only EEU member to have a significant trade agreement with the West: Its Comprehensive and Enhanced Partnership Agreement, which came into effect last March, lowers barriers in services trade and some licensing matters. That may seem like the most attractive backdoor for Russia on paper – but the geography (Armenia is the only member that does not share a land border with another) means any such imports would have to cross a third country.

Kazakhstan and Kyrgyzstan are major gold producers, and gold may be the one asset the Kremlin covets above all in this environment. Their gold could become more attractive to Russia, but insinuations Russia will seek a new gold-pegged ruble less than half of Russia’s.

Kazakhstan could be a route for imports from China, but Beijing could just deal with Russia directly. Already Kazakh officials are showing no interest in flouting sanctions, instead beginning to redirect imports and exports away from Russian ports.

Belarus is itself under increasingly tight Western sanctions for President Aleksandr Lukashenko’s rights abuses and role in the invasion of Ukraine. Put simply, Minsk is not in a position to help.

But what about their banks?

None of the EEU members can itself offer an economic lifeline or to serve as a financing hub to get around banking restrictions, such as the move to disconnect Russia from the SWIFT messaging system that underpins global transactions. The size of Russia’s economy and trade financing is comparatively too large – Russia’s GDP accounts for 86% of combined EEU output. And any transactions with partners in countries that have signed up to the new sanctions regime would receive a hard “no” from all but the most incompetent compliance departments.

Sanctioned entities cannot merely be replaced in a transaction by another new entity, or that entity too will be sanctioned, as Russia’s Rosneft has experienced with Swiss subsidiaries.

Kazakhstan is the only member with banks capable of processing and handling some of the Russian export activity complicated by sanctions. But its banking sector is middling compared to Russia’s. Also, the Kazakh oligarchs who run them are under a spotlight after fuelling unrest in January.

Finally, the EEU members are unlikely to provide a bolt hole for oligarch and Kremlin official funds. Beautiful as they are, Belarus, Kazakhstan, Armenia and Kyrgyzstan lack the garish allure of Knightsbridge or the yacht docks of the south of France. More importantly, their political classes are certainly not safe from Kremlin pressure – stowing money beyond Putin’s reach has long been a key factor in the development of Londongrad and its ilk.

Russian businesses affected by the sanctions may well set up new subsidiaries in the EEU. But this will likely just prove a masking exercise, and there are already plenty of jurisdictions – some even within the West, like the Channel Islands – that specialise in such efforts and which are, perhaps regrettably, not facing public sanctions threats from the EU, UK or US governments.

The reality is that the plumbing and structure of the global financial system means that the EEU is unable to dilute the pain of the most significant sanctions. China is the one country that could effectively sidestep the Western-led sanctions regime if it were so inclined. But there would be little reason for it to channel its efforts through the EEU.

Maximilian Hess is a London-based political risk analyst and writer.

This article originally appeared on Eurasianet here.