U.S. secondary sanctions menace Russian economy
Hello! Welcome to your weekly guide to the Russian economy — written by Alexander Kolyandr and Alexandra Prokopenko and brought to you by The Bell. This time we look at a new round of U.S. sanctions that seek to “strangle” Moscow’s war machine, and why Russia’s steadily falling imports are yet another sign of economic overheating.
U.S. sanctions Moscow Exchange, third country firms
Much of the attention following Washigton’s announcement Wednesday of new restrictions on Russia was on the fallout from the decision to sanction the country’s biggest stock exchange, the Moscow Exchange. In effect the measures left Russia without the exchange trading of the major reserve currencies. However, the most consequential announcement may be that the U.S. is broadening the scope of secondary sanctions on firms doing business with Russia.
What’s going on?
The U.S. Department of the Treasury sanctioned the Moscow Exchange on Wednesday, along with its subsidiaries, the National Clearing Center (NCC) and the National Settlement Depository (NSD). Being blacklisted effectively cuts off the sanctioned company from the global dollar system. Unsurprisingly, after the sanctions, the exchange announced an end to trading in U.S. dollars and euros. The next day it canceled trade in Hong Kong dollars.
As a result, many foreign banks, including those in China and Central Asia, stopped settling with their Russian counterparts in euros, U.S. dollars, and Singapore or Hong Kong dollars. China’s yuan is now the main currency for exchange trading and settlements in Russia.
This was not a surprise for the Kremlin. Sanctions against the NCC and NSD had been discussed since late 2022, and Moscow’s plans were drawn up long before the current announcement. Now, trading in U.S. dollars and euros, which accounted for less than half of the total trade on the Moscow Exchange, will move to an over-the-counter settlement. Buyers and sellers will need to seek each other out and complete deals on a one-to-one basis.
So far, there is no sign of a crisis. And there is little reason to expect one: an over-the-counter currency market works perfectly adequately in many countries.
The immediate impact, however, will be a widening of the spread (the difference between the sale and purchase prices for affected currencies). This impacts both exporters and importers, and these costs will be passed on to consumers in the form of price rises.
Not just the Moscow Exchange
While the targeting of the Moscow Exchange was significant, it’s likely to be the expanded secondary sanctions also included in the sanctions package that will pose the greatest long-term threat to Russia’s economy. In its press release, the U.S. Treasury highlighted important changes to its instructions for banks in third countries when it comes to complying with sanctions on Russia. Any violations could lead to secondary sanctions.
U.S. secondary sanctions were first given teeth in a December decree by President Joe Biden, which is arguably the most effective sanctions measure of the past two years. The decree promised to punish banks for servicing operations in the interests of Russia’s “military-industrial complex.” This meant those either working with Russian companies that were under sanctions because of their ties to the defense sector, or servicing the supply of banned goods into Russia for use by defense companies.
The new instructions, however, expand the scope of this to cover any company involved with almost the entire Russian economy. The "military-industrial complex” is now defined as:
- Any individual or company sanctioned since 2021 (for example, this includes all Russian state-owned banks);
- Any individual or company working in Russia’s technology, defense, construction, aerospace or heavy industry sectors.
The U.S. instructions gave several examples of activity that would carry a high risk of secondary sanctions: (i) credible media reports implies that a mid-sized bank from a country that has close trade relations with Russia is taking steps to profit from the refusal of rival banks to do business with Russia because of sanctions (these steps could be opening a new office in Russia, publishing a Russian-language website or promotional material, or advertising its services in Russian-language media), and (ii) a small bank that does not work with sanctioned companies, but makes regular payments to sanctioned clients.
A fresh approach
This sanctions package represents a new stage in the economic warfare against Russia. After starting with attempts to target the military and energy exports, the U.S. is now adopting a more blanket approach. It appears designed to damage Russia’s economy, which Washigton clearly considers to be entirely oriented toward meeting the needs of the Russia military. A phrase about Russia’s transition to a “full war economy” was even used as part of the headline of the U.S. Treasury’s press release.
In an article published in the Financial Times, Wally Adeyamo, Deputy Secretary of the U.S. Treasury, described the new sanctions as a means of putting “sand in the gears of the Russian war machine.”
Why the world should care
We should not expect any more major sanctions until after the U.S. presidential election in November. However, in the meantime, Washington will likely continue to tighten existing measures, making it harder and harder for Russia to work around bans, or to engage in trade and settle financial transactions. It seems that strangulation is replacing direct strikes as the West’s preferred way of waging economic war against Putin.
Customs data shows Russian imports continue to fall
Figures released this week by Russia’s Federal Customs Service that cover the first four months of this year revealed that the country’s total imports were down 9.1% in U.S. dollar terms compared with the same period a year earlier.
- The biggest fall, by almost 25%, was in minerals and wood imports. But a much more potentially damaging blow to the economy was to be found in a 4.2% drop in imports of mechanical engineering products, an 11.6% fall in metals and metal products imports, and a 19.8% decrease in chemical imports.
- It’s not all a downward trend, however. Imports of textiles and footwear, for example, are not dropping – and have recovered to the 2023 level.
- The overall sustained fall in Russia’s imports can be explained as a result of the threat of secondary sanctions, which has complicated the settlement of cross-border transactions even in countries that are not hostile to Russia.
- The difference between consumer goods, where imports are not falling, and mechanical engineering products or chemicals, where they continue to fall, is striking. And it highlights how rising consumer demand at a time of economic growth is not being matched by increased investment in production (which is what you should expect). This may be because companies are unwilling to invest in a time of uncertainty, or it could be due to Western sanctions.
Why the world should care
A decline in imports is yet another sign the Russian economy is overheating. On the one hand, this is not good for overall labor productivity in the mid-to-long term. On the other hand, if exports recover faster than imports, it will be a boost for the ruble, which has come under pressure as a result of the recent U.S. sanctions on the Moscow Exchange.
Figures of the week
There has been a fivefold rise in the number of private brokerage accounts worth more than 1 billion rubles ($11 billion) in Russia since 2021, according to the Central Bank. These high-value accounts hold 25% of all assets in Russia. Thus, a quarter of the 9.9 trillion rubles held in Russian brokerage accounts belongs to ruble billionaires.
The Russian government did not support a parliamentary proposal to increase insurance on private deposits to cover savings worth up to 3 million rubles, Interfax news agency reported Thursday. The current level of insured savings is 1.4 million rubles.
The World Bank upgraded Tuesday its forecast for Russian economic growth this year, which is now expected to hit 3.6% (their previous prediction was 2%).
Between June 4 and June 10, inflation slowed to 0.12% compared with 0.17% the week before, according to the State Statistics Service. Notably, prices for fruit and vegetables were up 0.7%. In May, month-on-month inflation went up from 0.5% to 0.74%.
Further reading
Recent trends in Russia’s import substitution of technology products
Why China Is Sabotaging Ukraine. Beijing Has No Interest in a Peace Agreement It Can’t Help Broker
