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What Kind Of Sanctions Would Hurt Russia Most?

A look from inside Russia at the prospect of an Iran-style oil embargo, travel bans and other measures the West could apply to make Moscow pay for their policy in Ukraine.

In Moscow
In Moscow
Aleksander Sotin

MOSCOW — At the beginning of March, the idea of international sanctions against Russia seemed like mere speculation. But if Crimea decides to join Russia on March 16, threats of international isolation could become a reality.

“We are considering a whole series of steps — economic, diplomatic — that will isolate Russia and will have a negative impact on the Russian economy and its status,” U.S. President Barack Obama declared. A source close to Secretary of State John Kerry said that sanctions could begin in a matter of days.

The rhetoric from Western European leaders has been less harsh, but the level of interdependence between Russia and Western Europe is also much higher. Nevertheless, Britain's Foreign Secretary William Hague said that Russia would pay a high price if it did not reverse course on Crimea.

Russian diplomats seem to be convinced that it won’t come to sanctions. The Russian ambassador to the EU said that legally speaking, international sanctions can only be put into place by the United Nations Security Council, and that anything else would simply be considered actions taken by individual countries.

Among the “softer” measures that other countries could take are a boycott of the G8 meeting in Sochi and the permanent exclusion of Russia from the club of “developed countries.” The United States could also stop negotiations regarding free trade between the two countries (an agreement regarding the creation of a free trade zone between Russia and U.S. was signed at the end of 2013). Free trade would reduce burdens on business between the two countries, but now the whole agreement is in question.

Military cooperation has also been cut off. The United States and Canada have both announced that they will no longer cooperate with Russia. NATO has ended all military contacts with Russia, the alliance’s General Secretary announced.

But there are other sanctions that would hurt more. Charles Tennock, head of the Commission for International Affairs in the European Parliament, said that Turkey should close the Dardanelles Strait to Russian ships, like it did after the Russian-Georgian war of 2008. “Ankara should close the Turkish straits not only to Russian warships, but to all commercial vessels bound for Russia’s Black Sea ports,” he said.

Tennock says he doesn’t doubt Turkey’s support, because of its concern for the fate of the Crimean Tatar people, who trace historical links to Turkey.

The crisis in Ukraine has already caused a 5% increase in food prices in Russia over the past month. In addition to the danger that deliveries from Ukraine will be stopped, there are other risks. “If Turkey closes the Dardanelles and Russian food products can’t make it to the market, the situation will be like 2010, when Russia instituted an embargo on grain exports due to drought,” explained Andrei Kusnetsov, an analyst at Wild Bear Capital. “Food prices nearly doubled then. But I still don’t think that sanctions like that are coming.”

In addition, the “Magnistsky List” is expanding, to include a number of public and private figures in Ukraine and Russia who the United States says have threatened Ukraine’s territorial integrity. Tennock has also advocated the radical move of rescinding visas for all Russian government officials.

Financial noose

The possibility of U.S. economic sanctions against Russia are even more dangerous than travel bans. According to U.S. Senator Chris Murphy, the Senate is planning measures against Russian banks, which include freezing the assets of Russian government and private investors.

“The bank accounts and assets of Russian officials that are located outside of Russia could be targeted,” said Dmitri Malyishev, the head of international development and tax law at the KCK group. “The goal is to underline the legality of what is going on. It is most likely that there would be increased taxes or fees for Russian borrowers. A more extreme and unlikely possibility is that all payments that pass through American banks could be blocked if they have a Russian beneficiary.”

Pustam Vakhitov, a partner at Baker Tilly Tax Services, doesn’t expect the international reserves of the Russian Central Bank to be frozen. “In theory, everything is possible, and the reserves could be frozen. But that is such an extreme measure, the possibility of it happening are vanishingly small.”

A more pressing issue is the American Foreign Account Tax Compliance Act (FATCA), under which all banks in the world are supposed to provide the IRS with information about their American clients by March 31, 2015. The way this type of issue is dealt with is through an agreement between governments, but if that falls apart, each bank will have to transfer information directly to the IRS or face fines. “That would be a problem,” Vakhitov says. “If there’s no standard procedure, each bank will have to work directly with the IRS. Banks will face a dilemma: either break banking privacy rules or face fines from the IRS.”

The Iranian example

Politicians in search of a hard line have yet another option on the table: financial sanctions against Russia like those that Iran has faced. The heaviest tool against Iran is an embargo on imports of Iranian oil, and Tehran continues to face high inflation and unemployment, and feeble GDP. Only two years have passed since the EU instituted sanctions against Iran, and Iranian oil exports have already been cut nearly in half.

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Is oil the solution? — Photo: Helge V. Keitel

And yes, Russia currently exports more oil than Iran. Before the EU sanctions, Iran was the seventh-largest oil exporting nation. Russia was the second, exporting more than 3.5 times as much oil as Iran did in the best of times. Russia is also the world’s largest natural gas exporter. Most of the exports go to the EU — 84% of Russian oil exports and 76% of its gas exports go to the EU. Russia accounts for up 34% of EU's oil imports and 32% of its gas markets. Europeans depend much more on Russian energy imports than it ever did on Iranian oil. It could refuse Iranian oil, but it can’t turn down Russian oil and gas.

President Vladimir Putin understands the situation. “The first people who should think about the consequences of sanctions are the people who are thinking about imposing them," he said during last week's press conference. "I know that in this interconnected world, we can hurt each other by imposing sanctions, but it will be mutual harm, and you also have to consider that.”

Nikita Filin, from Russian University for the Humanities, doubts the most extreme scenarios. “The possibility of an Iranian-style sanction is extremely low,” he said. The problem is not only the size of the Russian economy, Filin says, but that economic sanctions in Iran have not been successful, from a political point of view.

Other options

Sanctions are not the only way to hurt Russia. Europe can’t drop Russian oil and gas on a dime, but it can follow a long-term strategy to find other sources for energy.

Iran, which has been opening up under newly elected President Hassan Rouhani, could be an alternative to Russian energy exports. “Russia is becoming a less attractive partner for Europe, while Iran is becoming more attractive,” said the head of the East European Gas Analysis Mikhail Korchemkin.

Increasing U.S. gas exports to Europe could also make sanctions on Russia more feasible. Right now US gas exports to Europe are legally restricted, which Republicans in Congress would like to change. But even if that were to change, it would take time to build the infrastructure for gas imports.

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Putin shedding tears of oil — Photo: Cea.

Another option is for OPEC to release oil reserves and make oil prices crash. No one knows what Saudi Arabia — who in practice would make the decision about flooding the oil market — is planning to do. However, the last time OPEC decided to flood the market in the 1980s, it started the USSR’s downward economic spiral. Saudi Arabia has the ability and the motivation to punish Russia, in large part because of Russia’s position on Syria.

Eye for eye

Russia’s already thinking about how it would respond to potential sanctions. Sergei Glazev, an advisor to Putin, has said that if sanctions against Russian government structures were announced, the Kremlin would have to announce that it would not pay back any of the loans to U.S. banks. Although an unnamed source at RIA Novosti contested the quote, it was widely reported in the Western press and could already affect the ability of Russian companies to get loans from Western banks.

Russian lawmakers have also announced that they are working on a law that would call for the confiscation of assets and bank accounts of European and American companies in the event of sanctions against Russia.

Recent reports on the investment climate in Russia have cited political risks as a reason not to invest in the country, and leaders in government and business have repeatedly said that improving Russia’s investment climate is a priority. Now those reports will have to add the risk of property confiscation and the completely unpredictable political situation to the already long list of risks of doing business in Russia. Under the current circumstances, Russia might as well forget about becoming more attractive for investors.

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