Could the Russian Economy Thrive Despite Western Sanctions?

The European Union is already preparing its 11th package of sanctions against Russia.

Many Russian politicians and businessmen have become dismissive of the measures. In the Russian language play on words, they are often described as a “bin liner of sanctions”, an expression that contemptuously mocks their efficacy [“пакет с пакетами” in Russian].

On 29 March, President Vladimir Putin noted that sanctions could negatively affect the Russian economy in the medium term.

But at other times the Kremlin has also said that Russia would benefit from Western restrictions because they would help “increase its economic and financial sovereignty”.

So will Russia be able to compensate for the ties that have been cut with the West through reinforced ties with other countries?

The German Marshall Fund of the United States (GMF) is a non-partisan policy organisation committed to the idea that the United States and Europe are stronger together.

From the perspective of its Vice President and Executive Director, Dr Ian O. Lesser, there is scepticism about the opportunities available for Russia.

“Obviously, the country is actively looking for those markets,” he said. 

“Because [for] Europe in particular, Western Europe was such a large part of the Russian export economy and also its inward investment. And that now of course, if not entirely cut off, is certainly in decline and so the country is clearly looking for alternatives. There are not a lot of good ones actually.”

Pivot to the East

One of the main targets of Western sanctions has been Russian energy resources. Very soon after Russia’s invasion began, the EU sought to reduce imports from Russia as much as possible. 

In March, European Commission head Ursula von der Leyen said “dependence on Russian oil and gas is a thing of the past”. Gas deliveries from Russia have dropped by 80 per cent, and the EU has managed to compensate by using other sources.

The Kremlin claimed it would compensate for its own losses by “turning to the East” – by reorienting exports to China and other Asian countries. It said it would make those sales “on more favourable terms”.

Last year the biggest buyers of Russian oil were indeed China, India and Turkey. India had almost never bought Russian oil before the war.

Western experts look at it from a different angle. Firstly, the share of these countries has increased drastically mainly because there are no other major buyers left. Secondly, the sharp increase in demand from them was in the first months after the start of the invasion: the new buyers were able to get hold of shipments initially intended for the West at huge discounts. However, by the end of 2022, Turkey had actually sharply reduced its purchases.

And the “more favourable conditions” have not materialised for Russia. Since there are fewer countries buying from Moscow, those who do are able to dictate their own terms. India and Turkey bought Russian oil precisely because the price was much lower than the market price. In other words, Russia finds itself in the same situation in the East as in the West, selling oil within the sanctions “price ceiling.”

Furthermore, the “switch to the East” concerns oil only. Russia has not yet been able to compensate for losses in gas exports to Europe. According to analysts, last year, exports of pipeline gas were down by 45%, and this year they could be down 90% compared to 2021. The Power of Siberia-2 gas pipeline to China is still under construction.

Europe has partly found a way out through the development of its liquified natural gas (LNG) infrastructure. Both in the EU and in Russia, precisely because of the “Russian pipes”, little consideration was given to LNG. But now Europe, with the help of the US, has everything needed to set up such a system. Russia, however, will find it much more difficult in the context of technological sanctions.

“If Western Europe in particular continues to adjust away from Russian energy, and in a sense, we’re only at the start of that process,” says Dr Lesser. “Russia’s going to face a very difficult time replacing those markets”

The Iranian example

Iran is a country that has been living under sanctions for four decades. Against this background, Tehran has developed ties with Moscow, and they grew even stronger at the beginning of 2022. According to the Iranian government, Russia became the country’s largest foreign investor in 2022, with two-thirds of investments coming from Moscow. Russia invested approximately €2.8 billion in industrial, mining and transportation projects.

In addition, Russian representatives were sent to the Islamic Republic to learn from the experience of life under comprehensive sanctions.

According to the West, Iran itself has become an arms supplier for the Kremlin. Russia is accused of actively using Iranian “kamikaze” drones against Ukraine. Both Moscow and Tehran deny this.

The problem with the Moscow-Tehran relationship is that the two countries do not have much to offer each other. Both nations’ key revenue streams lie in the sale of hydrocarbons.

And Dr Lesser says potential partners for Russia have economic motives not to push things too far.

“The truth of the matter is that the fear of extra-territorial sanctions from the United States and the European Union – more from the United States – is a huge inhibition for long-term economic tie-ups with Russia,” he says.

“Investors globally are going to be very concerned about the reliability of their investments in the country, but also the kind of sanctions they might be exposed to themselves by doing that.”

Grain for the “forbidden movement”

In Russia, the Taliban is considered a terrorist organisation and its activities are banned. Moscow, like all other world capitals, has not recognised the Taliban as a legitimate power in Afghanistan.

But that did not prevent the two sides from beginning to establish diplomatic relations soon after the Taliban came to power. And, in September 2022, the Taliban signed a trade agreement with Russia that was their first – and so far their biggest – international deal. Russia plans to supply 2.5 million tons of oil and gas and 2 million tons of wheat to Afghanistan annually.

However, according to experts, Russia’s interests in Afghanistan are more political than economic: the Taliban will not be able to pay much for Russian goods anyway.

Moscow, though it officially labels the Taliban extremists, considers the so-called Islamic State group a much greater threat. It was a group close to the self-declared IS that blew up the Russian embassy in Kabul in 2022. Support for the Taliban – including through trade – is seen in Moscow as countering radical Islamists.

Turkish transport links

Relations between Russia and Turkey have changed repeatedly in recent years from chilly to warm.

Turkey is a member of NATO, but it has not supported sanctions against the Kremlin and has not, for example, cut off transport links with Russia or banned travel by Russian citizens. And as a result, a year ago it ended up as a de facto “transport intermediary” between Russia and the West.

And according to a number of Western officials – notably the US Treasury – it was also a “staging post” for circumventing sanctions. It was reported repeatedly that Turkey (along with, for example, Kazakhstan and the UAE) re-exports goods banned by sanctions to Russia.

Ankara denies such accusations. Nevertheless, under pressure from the US, and for fear of secondary sanctions from Washington, Turkey is gradually starting to follow at least some of the restrictions.

Thus, as early as last autumn, Turkish banks stopped servicing cards of the Russian payment system Mir. In mid-March, Turkish aviation authorities announced that, at the request of the US, they would stop servicing and refuelling US-built aircraft registered in Russia and Belarus.

The sharp decline in Russian oil purchases in Turkey is also attributed to fears of secondary sanctions.

“Russia obviously has been looking for effective ways to get some of its unsanctioned, or even some of the sanctioned merchandise, through to global markets,” Dr Lesser said. 

“Turkey has been a conduit for much of this recently. Turkey is of course, in a sense, in the Western camp, in NATO’s, but is not applying the sanctions. Russia has been able to take advantage of Turkey as a relatively open market.”

Modernisation

Russia is again discussing the possibility of “using” sanctions to fundamentally change Russia’s foreign trade structure – to move away from raw material exports, since they are becoming increasingly difficult under sanctions, and to modernise the economy. But the sanctions will make this process extremely difficult, Dr Lesser argued.

“Western sanctions on Russia are designed, in fact, in large part to prevent that,” he said. “The kind of high-tech inputs, electronic components and other things that would be needed to upgrade Russian manufacturing to revive its arms industry, even to modernise its energy production is increasingly constrained, not to mention the problem of human capital: highly skilled people who will not want to work in Russia, and global capital, that will not want to come there to invest in modern industry.”

The rouble and the yuan

The visit of Chinese President Xi Jinping to Moscow in late March was presented by many Russian media as “the end of US hegemony”.

Vladimir Putin did not even rule out that Russia would increasingly switch to the yuan in foreign trade payments, abandoning the dollar and the euro. And according to the Bank of Russia, the share of the yuan in Russian foreign trade in 2022 increased from 0.5 per cent to 16 per cent. However, it is stated that this is the currency in which the actual payments were made, not the one in which the contracts were concluded.

Russia expects that China will be able to largely replace both export and import trade relations with the West.

The West, however, believed that Xi’s visit spoke of political unity – but not of a large-scale expansion of economic cooperation. The presidents signed statements on the development of partnerships until the end of the decade, but no specific large-scale projects were reported.

For Russia, in terms of individual countries, China was and remains its largest trade partner. But for China, Russia is not even in the top five.

In fact, the volume of trade with China even declined last year. A report on the strategic partnership between Russia and China was presented last September to the pro-Putin Valdai Discussion Club. According to its authors, although Beijing does not officially support anti-Russian sanctions and urges companies to resist Western pressure, businessmen in some cases prefer to err on the side of caution.

Russia counts on China, not least of all, as a supplier of industrial technologies to replace those prohibited by sanctions. But China itself is largely dependent on the US in terms of technology. And experts are highly doubtful that, for the sake of Moscow, Beijing will aggravate relations with Washington, even if today they are far from ideal.

“I think there’s a question of risk for China, but there’s also simply a question of ability and whether there’s a compatibility there,” he said. 

“You know, for the long term, modernisation is not just a question of exports. For the long-term modernisation of the Russian economy, its competitiveness over the longer term requires access to finance, it requires access to innovation. Both of those are highly constrained.”

For the same reason, “yuanisation” does not look like a solution to the problems. Transactions with Russia in yuan would be attractive for small Chinese companies, but large Chinese banks are not willing to take the risk of falling under secondary sanctions.