MOSCOW BLOG: Sanctions hit a brick wall

MOSCOW BLOG: Sanctions hit a brick wall
The West has run out of sanctions that hurt Russia, but do little damage to Western business interests. It's time for the West to step up and put itself on a war footing if it wants to bring the war to an end. / wiki
By Ben Aris in Berlin June 29, 2022

Turkish President Recep Tayyip Erdogan got what he wanted. Sweden and Finland agreed to crack down on the various Turkish dissident groups, including the PKK, sheltering in their countries to unblock Turkish objections to their joining Nato. Erdogan came to the Nato summit in Madrid with a shopping list of requests and it was clear that he was going to play hardball. With Russia blasting Ukraine into the stone age it wasn’t hard for the Scandinavians to roll over.

Of course, the irony is if Russian President Vladimir Putin was paranoid about Nato expansion before, his war in Ukraine has brought about what he most feared. Russia had a tiny border with Nato before with Estonia. Now it has a much longer one with Finland. But I suspect that Putin accepts this. The only difference is that Russia is now in open conflict with the Nato members, and we are in effect back to a Cold War set-up. He was always prepared to go there, as he assumed that a conflict with Nato was inevitable.

The world is being divided into two: the West vs Russia and the non-aligned countries. The race to shore up these new relations is on and expect to see the majority try to sit on the fence, especially in the Global South.

But is it really such a bad bet? The Global South accounts for 80% of the world's population and just over half of global GDP. Russia is already a major player there and the only one of the big emerging markets to be classed as "high income" by the UNDP after Putin’s 20 years on the job.

Going forward, EMs are where all the growth is, and while the West is not stagnating exactly, it is not dynamic either. Almost all of Europe is suffering from exactly the same demographic problems as Russia and already facing labour shortages: Germany's demographic replacement rate was 1.48 last year  less than Russia's 1.5  and the EU average is currently about 1.55. You need 2.1 for the population to grow. You’ve got that and more in most EMs.

Of course, the developed world has all the technology and is denying it to Russia – the only sanction that is really working well. But this has been true since the industrial revolution a 100 years ago and the basis for the West’s leap forward to dominate the planet. That advantage has still not been undone, but surely it is only a matter of time before the EMs close this gap, even if it does take decades. In the meantime, what the EMs lack in tech they will make up for with babies as a locomotive for growth. It will be fascinating to watch this story play out.

The addition of Finland and Sweden to the Nato family further consolidates and expands the North Atlantic block and the EU has shown remarkable unity on imposing sanctions on Russia, but that process has now hit a brick wall. All the easy “one-way” sanctions (that hurt Russia, but don’t hurt the West) that could be applied have been.

I have posted an explainer from our sister publication on the proposed oil price cap sanctions that are supposed to be part of the seventh package. I have also posted a piece about Russia’s Dutch Disease, where the only way the government can control the value of the ruble is by reducing the amount of oil and gas it exports. The Central Bank of Russia (CBR) was once probably one of the best run central banks in the world and now it is reduced to using the crudest of all possible tools.

The oil price cap was supposed to be the centrepiece of the G7 summit in Bavaria this week, but I think that we can call that meeting a failure, as nothing concrete came out of it other than “proposals”. French President Emmanuel Macron admitted there were “technical problems” with the idea, which is putting it mildly.

The whole issue turns on using the threat of sanctions on oil tanker insurers to enforce the caps, and that has two problems.

First, the non-aligned countries are not on board. India has already given Russia’s fleet operator Sovcomflot safety certifications it needs to get non-Western insurance, which India will accept, and so in effect Delhi has opted out of any oil sanctions.

Secondly, even the EU countries are not as unified as US President Joe Biden and European Commission President Ursula von der Leyen would like you to believe. Note too that Erdogan also said this week that Turkey will not participate in sanctions.

I won’t go into the details here, but to make this work you would have to reopen the sixth package of sanctions where the rules on insurance are now and no one wants to do that, as it will kick off more really hard talks that would lead to the sixth package being watered down from the original proposals.

There is a fundamental flaw in the West’s economic war with Russia: it is trying to hurt Russia as much as possible but will not accept any pain itself (two-way sanctions).

The six packages in place now are full of exemptions and exclusions to protect Western interests. Extremely harsh sanctions were placed on Belarus in 2020, yet EU trade with Belarus doubled that year for the same reason. With Russia, an energy embargo and self-sanctions have been imposed on Russia’s oil business, yet Putin will earn the biggest current account surplus on record this year. What should have happened is the EU should have banned oil and gas imports from Russia in the first week of the war (with the summer to look forward to) and the Kremlin’s finances would probably have collapsed within a few months as Russia came close to a financial crisis with just the SWIFT and CBR reserve sanctions. But that would have come with a huge shock to the EU’s economy, which no one is prepared to accept. Even now, these exemptions are still being put in place: Greek shipping has been exempted from the sixth package bans on carrying Russian oil as it makes up half the international oil tanker fleet. Likewise, in Russia the largest insurer Ingosstrakh is part-owned (36%) by Italian insurance giant Generali, which has refused to sell its stake and makes the largest share of its money from marine insurance. Allianz, Europe’s biggest insurer, has a big Russian business and is also not leaving.

More generally, the International Association of Classification Societies (IACS) that gives out safety certificates that oil tankers need to get insurance has 11 members but only four of them (France, UK, Norway and the US) have stopped certifying Russian ships. And the Indian Register of Shipping (IRClass), which is the official Indian member of IACS, has just certified all of Sovcomflot’s tankers.

The conflict has catalysed a process of EMs maturing politically that had already started. Until now the EM story has largely been an economic one about fast “catch up” growth and huge returns investors can make. Increasingly it is now going to be political as well. The BRICS is one obvious focus that has gone from a Goldman Sachs marketing term to a powerful political organisation, and Russian Foreign Minister Sergei Lavrov called for Argentina and Iran to join this week as well.

The biggest change is that China and Russia have been driven together and clearly the Kremlin has to work as hard as it can to build up its non-aligned alliances in order to avoid being simply consumed by China and becoming little more than a raw materials warehouse.

Although China has kept Russia at arm’s length to avoid being sanctioned itself, there is no chance of driving a wedge between Moscow and Beijing now, as China can see its next opportunity. Biden used the G7 summit to hype a new US infrastructure fund that is designed to challenge China’s Belt and Road Initiative (BRI). While the non-aligned countries will happily take the US money, unless the US also opens its lucrative markets to them, I doubt that this will make much difference.

Trade is the key to China and Russia’s offering and this is Russia’s ace thanks to its cornucopia of raw materials (and its arms and nuclear power industries). Putin is going to work very hard to build up Russia’s relations with the non-aligned nations and actually has already been working on that for years, with especially notable progress in the Middle East.

That will continue in November at the G20 summit, to counterpoint the G7, and also the second Russian-Africa summit that will be held in Ethiopia – both important platforms for promoting Russia’s soft power.

The West has run out of one-way sanctions, and it is hard to see what it can do next without going onto a war footing. The same is true of the military campaign in Ukraine. As this increasingly looks like it will be a much longer war than expected, the West needs to go on to a war footing militarily too. The West has largely used up its stock of Soviet-era armaments and I’m seeing an increasing number of reports saying that despite the massive US defence budget it doesn’t have the manufacturing capabilities to churn out a lot more weapons quickly. Russia has used up a lot of its high-tech weapons like smart missiles, but it has huge stores of “dumb” artillery shells and as the war in Ukraine is turning into an artillery duel slugfest, that is what will make the difference.

Increasingly it seems that the US has overestimated its own economic and military power (will Ukraine turn into another Afghanistan?) and underestimated how deeply Russia is integrated into the global economy, which is causing significant leakage to the sanctions regime already. Now that one-way sanctions are exhausted, the West will have to start using two-way sanctions and the failure of the G7 summit to produce anything concrete shows how hard that will be. The West is already spending huge amounts of political capital in its effort to isolate Russia, and frankly it is not working.

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