In the years prior to Vladimir Putin’s very decision to order the full-scale invasion of the sovereign state of Ukraine on 24th of February 2022, his regime vehemently tried to make necessary preparations to thwart the effectiveness of any future round of Western economic sanctions. Indeed, the economic sanctions introduced as a reaction to Russia’s annexation of Crimea and its tacit support for Donbas separatists back in 2014 eventually led to widespread stagnation of the Russian economy. In per capita income terms, Russian citizens are 40% poorer than on the eve of the Crimean annexation.
However, those sanctions were far more limited than the ones that had been imposed on the Iranian economy in the 1990s and which were additionally escalated in the ensuing years. As opposed to the narrative on the effectiveness of the hitherto applied sanctions, the main culprit for Russia’s economic stagnation is to be found in the low price of crude oil that fluctuated south of 60 USD per barrel in the period between 2014 and 2021. In spite of this unfavorable price development Putin’s regime became even more decisive in amassing large foreign exchange reserves to serve as a buffer against the future rounds of sanctions. Instead of spending the money obtained via commodity exports on raising the living standard of ordinary Russians and improving decaying social security systems, Russian central bank built up impressive central bank reserves to the tune of 630 billion USD, starting from the low point of 385 billion at the end of 2014. At the same time, Putin launched ‘Fortress Russia’ campaign in order to boost food production and self-sufficiency, especially staple food such as meat and milk products. Interestingly, the only area where Russia has been quite deficient refers to fruit and berries, with estimated 1/3 self-sufficiency. Simultaneously, the Russian military modernized heavily and improved its cyber-capabilities. Finally, Russia started to gradually diversify its trade ties and the growing reliance on Chinese market can be seen from the fact that only 7,5% of Russian exports had gone to China in 2014, while this percentage almost doubled in 2019 and China climbed to the position of Russia’s top-trading partner.
Having all of this in mind, on the eve of Putin’s full-scale invasion of Ukraine his calculation was the following one. The EU and the USA will remain divided over Russian sanctions while Russian military will ensure a swift military victory, that will usher in the installation of the pro-Russian puppet government. Putin and his Kremlin advisers were encouraged by the fact that EU’s Russian gas dependency paradoxically increased during the period of imposed sanctions, from 124,319 to 152,648 million cubic meters. Reinforcing this rationale was Kremlin’s conviction that not only US and the EU could mutually agree upon a coordinated list of stinging economic sanctions, but also that this was not even possible within the EU format itself. Namely, the EU applies the principle of unanimity when passing all foreign policy decisions such as sanctions. Furthermore, the EU’s announced net-zero emissions strategy and the corresponding energy transition would make Russian energy exports less important in the long- run, weakening Russia’s position in the process. According to this logic, the Kremlin had the limited ‘window-of-opportunity’ to launch an invasion, counting that the economic co-dependence between the EU and Russia will act as an economic equivalent of the mutually assured destruction (MAD) doctrine. In the worst case, Putin counted on a new batch of sanctions such as SWIFT expulsion, restricted trade in certain technologies, partial financial sanctions targeted at raising capital on behalf of Russian banks and SOEs, partial asset freezes and a ban on foreign travel to Kremlin insiders. Following this calculation, nothing could go wrong since Russia decided to cushion the impact of sanctions by diversifying its central banks reserves in terms of its currency composition, as well as the choice of jurisdiction where the money is being invested to serve as a rainy day fund.
Even before the Crimean annexation Putin’s regime was aware that US dollar is the most lethal and effective weapon in the US foreign policy toolkit. Since the greenback is the leading reserve currency globally (60% of all central bank reserves) and next to 45% of global cross-border payments is conducted in the US dollar itself, denying access to US-related liquidity is an especially powerful weapon. According to the weaponization of finance view, US secondary sanctions are so powerful since they are extraterritorial and even prohibit third parties from dealing with a sanctioned entity. Knowing the extent of US financial hegemony, since the early 2010s, Russian central bank embarked on a massive de-dollarization campaign and significantly curtailed its investment in the USA, France and Germany, while the opposite was true in the case of China and Japan, as well as an increase in gold reserves. According to some estimates, 10 years ago almost 90% of the assets held by the Central Bank of Russian Federation were prone to potential freeze abroad, while at the beginning of 2022 this amounted to approximately 45%.
And here we come to the early March of 2022. Putin’s campaign of destruction could not break the Ukrainian resistance as a part of his Blitzkrieg strategy and every consecutive day of war mobilization will strain Russian economy. What is even more important, Western allies mounted an unexpectedly coordinated and swift pressure on the Russian economy via a raft of economic sanctions which are always a middle ground between diplomacy and outright war. This certainly wrong-footed Putin and his Kremlin advisers. E.g. Kremlin was only afraid of the potential impact of sanctions on the part of foreign currency reserves held in US dollars and under the US jurisdiction, while discounting any possibility of EU joining the ranks with its transatlantic partner on the issue of sanctions.
Furthermore, not all sanctioning options have been used and the EU keeps the option of a full-scale embargo on Russian energy imports as the ultimate weapon. Namely, Russian daily export of commodities is in the range of 700 million USD, while the military costs certainly exceed this number without taking into account losses in equipment and personnel. Refraining from Russian purchases of energy would be the most powerful weapon in undermining aggression, but the EU still falls short on this count due to existing dependencies. Still, regardless of previously mentioned remarks and contrary to many expectations, the EU unity was on display. Even Putin’s ‘Trojan horses’ were made silent and clung to the EU’s common stance. As of this writing most of Russian banks have been expelled from the SWIFT (Society for Worldwide Interbank Financial Telecommunication) which will effectuate all Russia-bound financial transactions less secure, slower and more expensive. Russian financial institutions have been fully constricted in raising capital across Western capital markets, their shares turned worthless as of this writing, requiring Russian financial officials to prepare for expensive bailouts. Trading in Russian stock markets has been suspended for days. The announcement of an asset freeze applied to foreign exchange reserves held by The Central Bank of Russian Federation in Western jurisdictions has wreaked havoc on the Russian financial system, causing massive cash withdrawals, especially of hard currencies such as US dollar and the euro. Hence, the value of the ruble has plummeted, which will cause a major spike in inflation amid growing economic sanctions, even on behalf of countries that burnish the status of neutrality. In addition, in spite of Russia being self-sufficient in foods and energy, the access to advanced technology remains its Achilles heel. All of this will cripple Russian economy but the ultimate trump card held by the Western allies is the full embargo on Russian energy imports, which is still a taboo among European political circles if we look at the issue from the short-term perspective.
Therefore, while Putin has been surprised by the demonstrated unity of Western alliance and certainly disappointed with his war machine campaigning, it is hard to expect that the current form of sanctions will significantly alter his calculus. As long as Russia manages to run current account surpluses to cover for the war efforts and the cost of running an extensive repression machine, his degree of freedom won’t be significantly hindered. Namely, much of the Western media reporting points out to the oligarchs themselves as a bulwark against Putin’s course. However, this logic is almost like a fortress built on sand. The new generation of oligarchs is a direct result of Putin’s personal choices on how to divide the ‘Russian wealth pie’ and they have to demonstrate loyalty if they want to protect their wealth, lives and security. In addition, they are themselves internally divided and lack coordination on how to fill the power vacuum after Putin’s demise. Finally, they are scorned by the large majority of ordinary Russians and are more content with having smaller pie under Putin as opposed to potentially losing everything in the aftermath of democratic transition.
On the other hand, there is another group of Russians which might act as a force for change in Russia, the Russian middle class who will become even more impoverished under sanctions. According to the Levada-Center opinion poll, which is a rare source of objective information stemming from Russia, at the beginning of February Putin enjoyed staggering 71% approval rate. This support is especially strong among the older cohorts of population, but he also enjoys approximately 30% approval rate among the Russian youth. The existing impact of sanctions will breed more dissatisfaction among the general population but is it very questionable whether this will create the necessary tipping point to enact a political upheaval. The ability of young people to emigrate in combination with the impact of propaganda and nationalist discourse on the older cohorts of population will gradually weaken the pressure on changing the status quo
Furthermore, over the next couple of years China will increasingly throw an economic lifeline to impoverished Russia, while Russia will also try to use its influence in Afghanistan to build the TAPI pipeline in order to divert large amounts to energy to India’s burgeoning economy. However, this ‘silver bullet’ of Russia re-orienting itself towards Asian markets is out of reach until at least 2024 because of non-existing infrastructure that is so essential for Russian export diversification. Hence, the Western allies are running against time since their own ‘window-of-opportunity’ to alter Putin’s calculation at the minimum or effectuate a regime change at the maximum, will be getting narrower and narrower, especially after Kremlin adjusts itself to this new reality.
As the time passes, the domestic environment will be less and less conducive to political change, making widespread public protests and civil disobedience less probable, while Russia’s diversification strategy will reinvigorate its economic position. Therefore, the only chance for Western allies is to act swiftly and in a coordinated fashion, with the goal of choking Russian energy exports, while intensively searching for alternative supplies. Only this step can reinforce pressure on the Kremlin and create internal fissures among the security apparatus that might lead to the removal of Putin and his cronies. Alternatively, the mounting pressure could motivate deprived and impoverished Russian middle class to decisively demand for change, prior to the iron fist of repression gets insurmountable. Now is the opportunity to act, but the ultimate question at hand is whether we Europeans are ready to pay higher gas and petrol bills to sap the strength out of Putin’s war machine and make a genuine contribution to Ukraine’s fight against aggression, as well as our own security.