The Global South holds the keys to successful Western sanctions on Russia

Hello! This is Alexandra Prokopenko with your weekly guide to the Russian economy — brought to you by The Bell. This week we focus on the G7 Summit taking place in Japan on Friday and Saturday, where the war in Ukraine and the role of the Global South in sanctions will be high on the agenda. We also look at inflation, Russian investment in an Iranian railroad, and a report that the EU is considering offering some sanctions exemptions.

The G7 ponders its next move against Russia

The G7 meeting in Hiroshima, Japan, is likely to be all about the West’s next package of sanctions against Moscow and shoring up global efforts to deter Russian aggression. But more broadly, the agenda will be dominated by the West’s interaction with the countries termed the ‘Global South’. The latter’s reluctance to join sanctions against Russia has significantly weakened their impact. Both Moscow and Beijing are well aware of this, and there is a constant battle for the hearts and minds of governments in the Global South.

New sanctions

Judging by leaked reports, most of the sanctions to be discussed in Hiroshima are intended to plug loopholes. For example, the EU wants an official ban on Russian oil coming through the Druzhba pipeline to Germany and Poland, Bloomberg reported. This is a largely symbolic step since deliveries have already ceased. In 2022, Germany and Poland imported about 480,000 barrels a day on average via Druzhba. Hungary, Slovakia and the Czech Republic received an average of 290,000 barrels a day. There are no plans to halt flows through the southern branch of the pipeline (which serves Hungary, Slovakia and the Czech Republic). And there is also no intention of halting deliveries via Druzhba of Kazakh oil.

In addition, there is a discussion about banning gas imports via routes on which Moscow itself has already reduced volumes, the FT reported. The article did not name specific pipelines, but referred to countries such as Germany and Poland. Both countries get gas from the Yamal-Europe pipeline. Such energy measures should be viewed as a point of no return: Europe wants to be completely independent of Russian energy supplies.

Other measures will likely include bans on exporting or transiting European goods via Russia. The EU will create two black lists for problematic third countries and banned goods, according to Bloomberg, and decisions will be taken unanimously. There will be a two-step mechanism: first, countries will be warned about existing channels for dodging sanctions. The next step is a direct ban on exporting problematic goods to that country.

It's not clear which countries are likely to make the list, but it will probably affect Russia’s near-neighbors Georgia, Armenia, Kyrgyzstan and Kazakhstan. Exports from the U.S. and EU to these four countries increased to $24.3 billion in 2022 (compared with $14.6 billion in 2021). In particular, trade in dual-use goods shot up (for example, figures from the UN’s Comtrade show that Armenia last year imported 16 times as many chips as it did in 2021). China is unlikely to be added to the list — at least not right away.

On Friday, the G7 leaders issued a joint statement in favour of new sanctions against Russia to increase the price the Kremlin is paying for the war in Ukraine. They also commited continue engaging with third countries through which restricted G7 goods, services, or technology may be provided to Russia to strengthen third-countries’ understandings of G7 measures. At the same time, the U.S. expanded the sanctions against Russia, and updated the list of goods banned for export (new positions span from sunglasses to milk machines) and the SDN list (including companies from Armenia and Kyrgyzstan sanctioned for helping Russia with sanction evasion).

Export licenses?

The arsenal of sanctions is exhausted, but there are still some bullets in the gun. An option of changing an entire export regime may still be applied in the future. Currenly an exporter doesn't need to seek a special license to export goods and services to Russia, unless they are specifically prohibited, fall under a dual-use classification, or being sold to a sanctioned party. A new, prohibitive regime would make exporters to seek a permission for selling anything to Russia. If applied, this would be a precursor of a blanket export ban, akin to that used by the US against Iran

Both the list expected to be approved by the EU and the introduction of export licenses would likely have little immediate effect. However, in the long-term they could lead to price rises for goods in Russia with imported components — due to longer supply chains, increased wait times and the need to arrange purchases via third countries.

Another way to fill sanctions gaps is to impose secondary sanctions. However, Europe has tended to oppose these. Punishing some obvious violators is an option, as is political pressure on leaders of countries in the Global South. However, as the sanctions against Russia have shown, many leaders are resisting Western pressure as they respond to rising nationalism and anti-Western sentiment in their countries.

A turn to the Global South

India’s reluctance to impose sanctions was a major boon for Russia in its confrontation with the West. Instead, in 2022, India became the second biggest consumer of Russian oil. The trade turnover between the two countries in 2022 was up 2.6 times and topped $35 billion. Russia’s share in India’s import market increased from 1.6 to 6.5%. At the same time, exports from India to Russia were worth $2.8 billion and the trade deficit for New Delhi was $38.7 billion. This is not without problems: Russia has accumulated billions in “limited convertible” rupees that it cannot withdraw. Even so, in many ways it was New Delhi’s willingness to ramp up imports that stopped Russian energy exports from collapsing.

This is by no means the only example of how Russia could take advantage of anti-Americanism (and general resentment towards wealthy Western countries) in the Global South. We can see Russian importers establishing supply chains through Turkey, Central Asia and the Gulf states, and oil sales to not only India, but also China, Turkey and Indonesia have spiked. Frequent panicked reports of military supplies for Russia from China, South Africa and Vietnam reflect an understanding of the fragility of sanctions.

The Kremlin likes to emphasize that a multi-vector, multi-polar world has always been a key aim of Russian foreign policy. The invasion of Ukraine represents a final break with the West. Earlier this year, Russian Foreign Minister Sergei Lavrov visited all the major regions of Africa in the space of a month: South and West Africa, the Sahel and the Horn of Africa, Eswatini, Angola and Eritrea, Mali, Mauritania and Sudan. In March, Putin gave a speech to African parliamentarians in which he detailed how Russia’s approach was different.

Russia wants to offer not only an anti-colonial narrative, but also oil, industrial goods and, first and foremost, military cooperation. South Africa’s Armed Forces took part in joint military exercises with Russia and China in February; Moscow is discussing the creation of a base on the Red Sea with Eritrea; and in Mali it is looking at supplying weapons and fighting terrorism. In addition, there are discussions about supplying grain and fertilizers with almost every African country. South African President Cyril Ramafosa announced this week that Moscow and Kyiv will receive an African peace delegation. The announcement came after U.S. allegations South Africa was supplying Russia with weapons.

Why the world should care

Past sanctions — from Napoleon’s continental blockade against the British Empire to Western sanctions against the USSR and Iran — took place in a less globalized age, and ways of evading them were harder to find. Right now, there are 13,000 sanctions in force against Russia — more than against Iran, North Korea and Cuba combined. Russia’s economy is facing serious pressure, but this has been greatly mitigated thanks to third countries. It is becoming clear that the Global South is the key to a successful Western sanctions policy. Europe, in particular, will have to rethink its relations with these countries. This should not begin and end with cancelling the debts of the poorest countries (China and Russia are writing them off ), but involve increased investment. Given the slowdown in economic growth, increased military costs, strict adherence to ethical principles, and domestic problems, this will not be easy for the West.

Annual inflation to pick up slightly in May

Annual inflation will speed up in May, the Bank of Russia has warned. Annual inflation in April fell due to the base effect, reaching 2.3%. A year earlier in March-April there was a sharp rise in prices (up 0.3% in two months), however, in May 2022 price growth began to slow. Thus last month’s inflation rate was at a minimum. Seasonally adjusted monthly price growth has picked up a little. For the last three months, price increases have averaged 0.29%, which represents an annual rate of about 4%.

Last month, the ruble continued to weaken. The ruble's average price compared with March was 9.1% against the U.S. dollar, 6.4% against the euro and 6.6% against the yuan. Currently, the ruble’s value still has a negligible effect on prices. However, it is reflected in the costs of individual goods and services (such as foreign travel or imported vehicles). It is not yet noticeable in the price of electronics since companies have built up large stocks.

Last week, the Central Bank updated its macroeconomic forecast. It expects annual inflation to reach 4.5-6.5% in 2023 before falling to around 4% in 2024 and beyond.

Moscow invests in Iranian railroad

Russia will allocate €1.3 billion for the construction of 162 kilometers of the Resht-Astara railroad in Iran, Deputy Prime Minister Alexander Novak said Wednesday. Moscow will loan Iran €1.3 billion of the €1.6 billion needed. Completing this section will establish a rail link along the entire “North-South transport corridor,” that is being actively developed by the two countries.

The first agreement on the North-South corridor was signed in 2000. It envisages a transport link between Russia and India through Iran and Azerbaijan. Three routes run along this international corridor: a trans-Caspian route for goods via the ports of Astrakhan and Makhchkala, a Western route through Azerbaijan to the border crossing at Astara, and an Eastern railroad route from Russia that enters Iran’s rail network via the Tejen–Serakhs border crossing between Iran and Turkmenistan.

EU looks at some sanctions exceptions

The EU may permit some financial transactions with sanctioned Russians if they are essential for European companies to quit Russia. The relevant clauses could appear in the 11th package of sanctions against Russia, according to the EU Observer. Financial transfers to sanctioned Russians will reportedly be allowed if these transactions are necessary to wind down the activities of Euro-Russian joint ventures before Aug. 31, 2023.

Figures of the week

• The average price for Urals crude from April 15 to May 14 was $55.97 a barrel.
• Finance Ministry calculations show that export taxes on Russian oil will go up $1.80 from June 1, hitting $16.20 per ton. Currently, export duties on a ton of oil are $14.40.
• Weekly inflation accelerated to 0.04% between May 11 and May 15, according to the Economic Development Ministry. The previous week saw no change. Annual inflation increased slightly from 2.32% to 2.34%.
• According to the State Statistic Service’s first assessment, GDP in the first quarter fell 1% year-on-year. The Solid Figures Telegram channel reckons that year-on-year GDP growth in 2023 will be around 0.8%.
  

What to watch in the coming week

• Inflation expectations (24 May, Bank of Russia)
• Monitoring of businesses (24 May, Bank of Russia)
• Weekly inflation, 16-22 May (24 May, Rosstat)
• Producers price index (24 May, Rosstat)
• Financial Stability Review (26 May, Bank of Russia)

Further reading

How Sanctions Have Changed the Face of Chinese Companies in Russia. Chinese companies in Russia are finding it increasingly difficult to keep flying under the sanctions radar

‘A very grim portrait’ Political scientist Erica Frantz on what Russia’s future holds after Putin

Hong Kong’s Technology Lifeline to Russia Brian (Chun Hey) Kot discovers how technological imports get to Russia

The author of this newsletter is one of Russia’s leading writers on this topic: independent economic analyst Alexandra Prokopenko. Alexandra worked as an advisor at Russia’s Central Bank and Moscow’s Higher School of Economics from 2017 to 2022 — and before that she was an economic journalist for Vedomosti, then Russia’s leading business newspaper. Today, Alexandra works as a researcher at Center for East and European Studies (ZOiS) in Berlin a non-resident scholar at the Carnegie Endowment for International Peace and a visiting fellow a the Center for Order and Governance in Eastern Europe, Russia, and Central Asia at the German Council on Foreign Relations. She holds an MA in Sociology from the University of Manchester.