Finance

Unprecedented Western sanctions strangling Russian economy

Financial sanctions imposed by the U.S. and Western allies are strangling the Russian economy.

As Russian President Vladimir Putin wages war against Ukraine, his country’s economy has begun to collapse under the weight of unprecedented penalties from the Biden administration, United Kingdom, European Union and other major economic players.

“Everyone in the economic sphere, the banking sphere, knows we’re in new territory here—a coordinated shutdown of a country’s economy with the strongest arrow being in the heart of the banking sector,” said George Lopez, expert on economic sanctions at University of Notre Dame’s Keough School of Global Affairs.

The value of the ruble plunged Monday after the U.S and its allies took action to cut the Russian government off from roughly $600 billion in reserves held by the Central Bank of Russia and further cut Russia’s ties to the global financial system. 

The Western bloc banned most transactions with the Russian central bank — along with Russia’s finance ministry and foreign investment fund — blocking Putin from funds he stowed away for years to cushion the blow of sanctions. The sanctions also cut off Russian access to the U.S. dollar, the linchpin of the global financial system, as its value climbs amid global tumult.

The U.S. and EU are also barring certain Russian banks from access to the Society for Worldwide Interbank Financial Telecommunication (SWIFT), a messaging system used by banks to conduct transactions. 

Roughly $300 billion of Russia’s reserves are now locked away from Putin in the U.S., Europe, and other allied countries. While Russia still holds billions of dollars worth of gold within its borders, experts say Moscow will find few willing buyers with its banks under their own crushing sanctions.

“The problem is they can’t convert it into something useful if other people aren’t willing to deal with them,” said Derek Tang, co-founder and economist at research firm Monetary Policy Analytics. 

“They own it, but they can’t use it.”

Without access to its reserves, the Russian government has resorted to desperate measures to keep its economy and financial sector afloat. The Russian central bank hiked its baseline interest rate to 20 percent and banned the sale of securities held by foreigners to prevent the ruble from collapsing further.

Russia also urged foreign financial firms to join a SWIFT alternative, but has seen few takers with the threat of sanctions hanging over countries who don’t toe the Western line. 

Russia may ultimately be powerless to prevent bank runs, skyrocketing inflation and deep, long-term economic damage. And while the U.S. and EU have made some exemptions meant to limit the damage to Russia, experts say the implications could ripple though global markets. 

While the U.S. has previously targeted the central banks of Venezuela, North Korea and Iran with sanctions, the country has never imposed such strict penalties on an economy the size of Russia’s, nor with the support of so many other nations. Switzerland imposing sanctions on Russia is also a massive blow to Moscow and a major turning point for a historically neutral country with a major presence in financial markets.

“This is unprecedented, you have never seen this level of coordinated action this quickly. It’s true there have been other countries subjected to other measures, but that took time,” said David Wolff, partner at Crowell & Moring in the International Trade practice group specializing in compliance with U.S. economic sanctions. 

Russian gross domestic product was roughly $1.5 trillion in 2020, making its economy slightly smaller than the state of New York’s. But Russia produces considerable proportions of the global supply of petroleum, natural gas, wheat and certain metals, giving it key leverage over Western adversaries.

“For the U.S., we’re fairly insulated but I think in Europe it is going to be extremely serious,” Tang said, adding the sanctions could be “extremely disruptive” for eastern and central European countries with closer economic ties to Russia.

Europe in particular depends heavily on Russian oil and natural gas exports, which has made European leaders wary of strict economic sanctions on Russia. If Putin responds with limits on Russian energy and food exports, he could force rising prices even higher while reaping the benefits of surging demand.

While the U.S. is a net exporter of energy, a spike in demand for American oil and natural gas could also push gas prices higher in the states after rising 40 percent in the past 12 months. A surge in gas prices could put a deeper dent in Biden’s approval rating, which has plunged as inflation spiked.

The U.S. and its allies sought to limit the blowback by exempting energy-related payments from the sanctions imposed so far. Those carveouts not only shield the Western bloc from rising energy prices, but preserves some of their economic leverage after already imposing strict penalties.

“While Russia’s economy is significantly smaller than ours, they do have the potentiality of retaliating certainly with Russian import bans of Western goods and Western services. So the possibility of Western countries and Western businesses facing bans against exporting their products to Russia could pop up here,” said Eric Ueland, the under secretary of State for civilian security, democracy and human rights under former President Trump.

Ueland said that while sanctions will have impacts that are immediate, others will take months to have a full impact.

“Some of these impacts are more midrange, so as we interrupt Russia’s ability to transact business on energy production and its operations … the short term price impact might not be as pronounced as you would see in three to six months as the real bite of this becomes clear,” Ueland added.

Even so, Russia has few options or willing allies to help loosen the stranglehold on its economy created by sanctions. Tang noted that while China and Russia have developed close economic ties, some Chinese banks are already pushing back on processing transactions for Russian oil companies.

“Chinese banks have traditionally been actually quite wary of running afoul of U.S. sanctions,” Tang said.

Tags Donald Trump Vladimir Putin

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