Financial Sanctions to Incapacitate Russia amidst Russia Ukraine crisis: Is it Worth It?
While Ukraine’s military and population fight back against Russia’s invasion of their country, the United States and its allies placed further sanctions on Russia in an attempt to cripple its financial system. As part of the limitations, access to the Society for Worldwide cross bank Financial Cooperation has been canceled.
Many of the twentieth century’s prominent scientists and philosophers, including Karl Popper and Per Bak, have spent time thinking about how systems grow and break down. As globalization crumbles and we wait to see ‘what’s next?’, their thoughts are still relevant today.
The situation in Ukraine is yet another serious example, and it serves to explain a number of issues, including the construction of yet another trade barrier from west to east, the introduction of new geopolitical constellations, and a greater split between democratic and non-democratic countries. The German foreign minister said the day after the invasion of Ukraine that ,we have woken up to a new world, but the truth is that the “new world” has been in the works for quite some time.
Other recent challenges include the subsumption of Hong Kong’s democracy and the several lessons learnt from the corona-virus outbreak, including humanity’s triumph over medicine and governments’ incapacity to collaborate. When taken together, they point to the end of globalization, or rather, the ‘way we lived’ over the past thirty years.
While there is a rising debate on this essential matter, the danger is that politicians, analysts, and policymakers will get enamored with the concept that globalization can continue and will be subjected to jolts to their conscience similar to those delivered by Vladimir Putin. The question of ‘what’s next?’ must be emphasized.
The United States imposed a flurry of sanctions on Russia this week that are among the most punitive the country has ever faced, but many believe the delayed agony may not be enough to deter President Vladimir Putin from expanding his invasion of Ukraine.
President Joe Biden and a number of US allies, including the European Union, the United Kingdom, and Japan, have agreed to look into slapping more penalties on Moscow being a result of the invasion.
Select Russian financial organizations will be barred from using the SWIFT messaging system, in addition to the Russian central bank, the Bank of Russia, will be sanctioned. The latest sanctions have a high chance of wreaking havoc on Russia’s economy, but they pose hazards to the worldwide financial system and impose costs on the global economy.
SWIFT is a safe communications system that enables international fund transfers between global financial institutions and is the backbone of international trade. SWIFT is a Belgian-based organization with approximately 11,000 worldwide member banks in over 200 countries. Although the transfer actually is done through central banks, each international member bank has a SWIFT code, which allows the SWIFT system to process and transmit messages.
The Bank of Russia will be unable to access its foreign currency reserves held outside of Russia due to the limitations. The Bank of Russia will be unable to recover any of its $643 billion in foreign currency reverses, which are largely held by central banks in the United States, Europe, and China, and are estimated to be worth $492 billion.
Russian Trade Will Be Affected If SWIFT Is Disconnected
Without SWIFT connectivity, it will be more expensive and time consuming for certain Russian banks to move money worldwide, if not impossible. Customers will find it difficult to conduct business outside of Russia as a result of this. Russia is the sixth largest SWIFT customer, accounting for 1.5 percent of overall transaction volume and $800 billion in yearly financial transfers, according to the Financial Times. This is almost equivalent to Russia’s yearly foreign trade numbers of $490 billion in exports and $304 billion in imports (estimated) in 2021.
Consider what occurred to Iran when SWIFT disconnected it twice in 2012 and 2018, to get a feel of the impact this disconnect may have on Russia’s economy. In reaction to Iran’s refusal to comply with its nuclear programme responsibilities, the international community withdrew all Iranian banks from the SWIFT system in 2012. As a result, Iran’s exports dropped by 52%. When it was reconnected in 2015, export volumes increased, although not to the levels seen in 2011.
President Trump’s White House reimposed these sanctions in 2018 to put pressure on Iran to agree to a new nuclear deal, and Iran’s exports dropped by 49%. Its exports are still 24 percent lower than they were in 2017. As a result, implementing these SWIFT penalties on Russia can certainly have a negative impact.
Access to SWIFT is critical for Russia’s oil and gas business. Russia produces 12% of the world’s oil supply (third biggest supplier), including 8% of the supply in the United States, and 17% of the world’s gas supply (second largest supplier), including 40% of the EU’s supply. According to the Bank of Russia, crude oil and oil products will account for 38 percent ($184 billion) of Russia’s exports in 2021, while gas accounts for 12 percent ($56 billion). In 2018, oil and gas taxes accounted for more than 45 percent of the Russian government’s income, and there is no reason to believe this has changed .
Given Russia’s GDP of around $1.5 trillion in 2021, cutting oil and gas exports to zero could reduce GDP by as much as 15%, but this figure would have to be balanced against any changes in other exports and imports; it’s possible that switching Russia’s imports to domestic consumption would only result in a minor change in GDP.
Workarounds for SWIFT Sanctions
Russia may attempt to circumvent the SWIFT restrictions in one of four ways. The most obvious option is for Russia to do international business through local institutions that are not subject to sanctions. Some see this as a deliberate loophole to allow Russia to continue transacting in international oil and gas markets. It’s feasible that if Russia abuses this loophole too much, the international community will close it down.
Russia might trade through foreign banks that are prepared to work with it, including Chinese institutions. The transactions themselves would be more time consuming than utilising SWIFT, but they could be done. Furthermore, closing this outlet would be tough.
Russia has already established a ruble-based SWIFT equivalent, the System for Transfer of Financial Messages (SPFS), which it may try to use to circumvent the SWIFT sanctions. Despite the fact that it is utilised by over 400 Russian financial institutions, it is only connected to by 23 international banks and is only used occasionally.
The Cross-Border Interbank Payment System (CIPS), which only works with the Chinese renminbi, is China’s own SWIFT replacement. Presidents Vladimir Putin and Xi Jinping talked about replacing SWIFT with a combined communications system that would be impervious to third-party pressure and threats. The goal of such a financial communications system would be to recruit the cooperation of hundreds of international banks—enough to avoid economic sanctions from the United States, Europe, or Japan.
However, given the restrictions, it is unclear if they will be able to build up a system soon enough or if foreign banks would join the system.
Access to Foreign Currency Reserves is Limited
The majority of a country’s foreign currency is held by its central bank. According to reports, Russia has $139 billion in gold reserves and another $12 billion in dollars and euros. The rest $492 billion is stored in foreign central banks, namely the Federal Reserve of the United States and the European Central Bank, including $84 billion in Chinese renminbi. Although it is unclear whether these claimed figures are real, they do illustrate the size of Russia’s foreign reserves held by non-Russian central banks, which might prevent Russia from accessing them.
This Bank of Russia punishment aims at the core of Russia’s financial system, limiting Russia’s capacity to fight against a currency collapse, cutting off liquidity for Russian institutions that are unable to use SWIFT, and making international purchases practically difficult for Russians. To remove these foreign currency reserve constraints, China is expected to offer Russia access to its renminbi reserves and buy its gold.
Russians have already begun to demand foreign currencies. The ruble plummeted 25% against the dollar at one point on Monday due to a shortage of liquidity. Bank runs have begun in Russia, with Russians queuing for cash at ATMs over the weekend. The European Central Bank retaliated by declaring a subsidiary of Sberbank, Russia’s second largest bank, as failing and frozen assets.
The Bank of Russia has no choice but to raise its benchmark lending rate from 9.5 percent to 20% in the hopes of encouraging Russians to keep their money in savings accounts and increasing foreign demand for the currency. The Russian central bank also imposed restrictions on the ruble’s trading range and other capital controls.
The Bank of Russia’s financial operations will result in a sharp drop in Russian economic development as a result of higher borrowing prices and a lack of liquidity in the ruble, forcing individuals, particularly lenders, to avoid owning currency assets.
Sanctions have a price tag
Experts believe that the sanctions are likely to affect Russia’s economy, but the international community must keep an eye on whether Russia employs workarounds to escape them. Higher oil, gas, and wheat prices, as well as tighter natural gas supplies in Europe, will come at a cost to the global community. The ruble’s depreciation has already spread to other currencies and global stock markets.
The penalties raise the possibility that the SWIFT system and the international foreign currency reserve system would be viewed as too politicised as a result of the sanctions. Other nations will most likely establish their own international banking communications networks to avoid SWIFT.
Given its $6 trillion in foreign trade last year, China might easily impose an alternative to the SWIFT system. Furthermore, some countries may be reticent in the future to store their foreign currency reserves offshore, preferring to preserve them in cash and commodities at home. The free flow of cash throughout the world will be stifled as a result of this.
In certain cases, the punishments’ advantages outweigh their drawbacks. Let’s only hope they put pressure on Russia quickly to do the right thing in Ukraine, and that China stays out of it.
Experts think the sanctions on Russia are a “big deal.” However, the impacts might take years to manifest.
The sanctions targeted at punishing Russia might force the stock market to crash, the ruble’s value to plummet, and conducting business in Russia to become increasingly difficult.
The US slapped Russia with a flurry of penalties this week that are among the worst the nation has ever faced, but many feel the pain will not be enough to dissuade President Vladimir Putin from continuing his invasion of Ukraine.
Nonetheless, the Russian economy is already reeling from the crisis, and the sanctions may aggravate the slide in the stock market, harm the ruble’s value — which hit a new low on Thursday — and make doing business in Russia more difficult.
We’re banking on sanctions a lot,said Daniel Fried, a seasoned diplomat and former ambassador to Poland who worked as the State Department’s sanctions policy coordinator in 2014 and contributed in directing the West’s response to Moscow’s assault against Ukraine. He called the current penalties “a major source of worry.
When it comes to influencing a country that isn’t an ally, the US and its allies have one of the most powerful national security tools at their disposal: sanctions.
Because many transactions pass via New York City, the US sanctions are extremely severe. The dollar serves as the world’s reserve currency and is used for international transactions.. When money from sanctioned persons or corporations passes through the US, as it frequently does, those assets are immediately frozen.
In response to Russia’s invasion, US Vice President Joe Biden announced on Thursday that the US was “forming a coalition of partners representing more than half of the world economy” to limit Russia’s ability to deal in dollars, euros, pounds, and yen.
The sanctions will block over $1 trillion in Russian banking assets from passing through the US and its allies’ financial networks. The sanctions also place limitations on technology exports to Russia, putting the country’s IT industry under strain.
This is going to cost the Russian economy a lot of money, both now and in the future,Biden warned. We planned these sanctions to have the greatest long-term impact on Russia while having the least impact on the United States and our friends.
But, according to Brian O’Toole, who worked as a senior assistant to the head of the Office of Foreign Assets Control, which administers and enforces trade and economic sanctions until 2017, it might take a long time — possibly years — for the sanctions to affect the Russian economy.
I’m concerned that if there is no immediate economic impact on Russia, it may give Putin the impression that the pain of sanctions is less than he expects, giving him some incentive to keep pushing the edge, said O’Toole, now an Atlantic Council fellow.
According to Fried, it took years for the US to enforce sanctions against the Soviet Union when the former communist government invaded Afghanistan in 1979.
The International Monetary Fund claims that the 2014 sanctions imposed on Russia after it annexed Crimea were successful in impeding Russian economic development in the years after the sanctions, which were compounded by low oil prices.
Fried believes it was critical in persuading Putin to halt future military activities for the next eight years, although sanctions have now stabilised. Putin now appears to be willing to take another risk.
Sanctions are flawed, just like every other weapon of foreign policy, Fried added. However, after we smacked him in 2014, he backed off. We didn’t get there all the way, and we didn’t get there for good, but we did get eight years of relative calm. He’s back now. Perhaps we should have applied more pressure.
Sanctions are becoming a more popular diplomatic instrument for the United States, but their effectiveness is being questioned, particularly as their usage has grown.
The Treasury Department issued a study on US sanctions this month, stating that their use as a national security weapon has climbed by 933 percent from 2000 to 2021, from 912 sanction designations at the millennium’s turn to over 9,400 last year.
Following the revolt in Libya in 2011, US sanctions were credited for driving Iran to the negotiating table in 2015 and shielding tens of billions of dollars from former regime officials. as well as financially crippling Colombian drug cartels and undermining over 1,600 terrorist organisations around the world.
The Treasury Department, on the other hand, recognised that the dollar is losing favour among both enemies and allies of the United States, which “may undermine the impact of our sanctions.”
Venezuela, for example, sought to launch a cryptocurrency in 2017 to dodge US sanctions, as they are frequently reliant on banks for enforcement.
People are absolutely striving to discover loopholes, said Ben Coates, a Wake Forest professor whose research focuses on the history and consequences of economic sanctions. He believes no one has yet succeeded, but if they do, it will have a significant impact.
Economic sanctions remain the principal mechanism by which the US and its allies hold Russia accountable for the time being, and each day this week has added to the financial pain.
First, Biden issued an executive order on Monday barring investment, commerce, or financing to two hypothetical republics that Russia recognised after they declared independence from Ukraine.
The US and its partners imposed further sanctions on Tuesday, prohibiting two of Russia’s major banks from participating in US and European financial networks. VEB is “a glorified piggy bank for the Kremlin,” according to one of the banks.according to a senior administration official, while the White House believes the other, Promsvyazbank, pays Russian military activity. Russian assets worth a total of $85 billion have been frozen.
The Russian Central Bank has been denied access to funds in the United States and certain European nations as a result of the sanctions, which means Russian government bonds can no longer be sold on many Western exchanges, causing their value to plummetA tiny number of Russian billionaires are also prohibited from holding property or conducting business in the United States, according to the White House, since they are “engaged in the Russian regime’s kleptocracy.
The White House went even farther after Russia’s invasion of Ukraine on Thursday, imposing a raft of economic sanctions and export restrictions on Russia.
As part of the current sanctions, which were coordinated with the other Group of Seven important industrial nations, Russia was not booted out of the Society for Worldwide Interbank Financial Telecommunication, or SWIFT, banking system. Many members of Congress, as well as Ukrainian politicians, have encouraged the US to take action unilaterally, but the US’s power to do so is limited.
While the current US sanctions are harsh, observers feel that one of the most important components of the Biden administration’s pronouncements this week is that it organised a reaction to Russia with its partners. The European Union is following the White House’s example, with the United Kingdom implementing more penalties and Germany postponing the $11 billion Nord Stream 2 project, which would have provided Europe with cheap Russian gas.
Germany’s decision to cancel the project, which Biden exacerbated on Wednesday by imposing economic penalties on the pipeline’s company and its executives, is a major blow to Russia that surprised some analysts because it would certainly damage Germany as well.
A senior administration official said Tuesday, It’s not just about the money.This action will relieve Russia’s geostrategic chokehold on Europe by providing natural gas, and it will represent a significant turning point in the world’s energy independence from Russia.
What remains to be seen is how Russians will respond to a shift in their economic circumstances.
While the 2014 sanctions on Ukraine did have a “rally behind the flag effect,” they were aimed at the country’s elites and not the general Russian population, according to O’Toole. The current sanctions, which come after Putin’s support ratings plummeted as a result of Russia’s invasion of Crimea, may have a greater impact on ordinary Russians. It’s also unclear what the Russian people think about Putin’s current military campaign in private.
After enduring a protracted recession as a result of the 2014 sanctions and subsequent economic suffering caused by the epidemic, they may be less supportive of Putin’s foreign aspirations, according to O’Toole.
As sanctions are tightened and the Russian people are compelled to carry a bigger share of the financial burden, this might become increasingly true. There is some opposition to the claim that targeted sanctions have no harmful impact on bigger populations. Current sanctions on Afghanistan, for example, are most certainly increasing the country’s hunger issue.
“The goal is to inflict enough economic damage on Putin to make him sit up and take notice.” According to O’Toole. “They can’t do it until they do something that harms the Russian people as a whole.”
Globalization is coming to an end
The rise of a multipolar world, rather than a single (Anglo-Saxon) way of doing things, will be the main feature of the post-globalization world, with competing value-driven methods emerging in Europe and China to complement the American approach to political economy. Vladimir supports the notion of a multipolar world, despite the fact that, aside from a robust army, his country lacks many of the components – a strong economy, banking system, and soft power – needed to establish a geopolitical pole.
The image that emerges one of a more frictioned (greater inflation or lower lowflation) and fractured globe, and regular readers will know how much they have harped on this!
What’s new is that when political-economic tectonic plates separate, businesses, financial institutions, international organisations, and individual nations are being pushed to take sides. The Nordstream pipeline is a good example. Another possibility is the SWIFT payments hub.
Businesses that are taking sides
The deeper the Ukraine crisis grows, the more (or less) attached governments will be to alliances and principles, and the geopolitical landscape of the twenty-first century will become clearer.
Japan, for example, has imposed sanctions on Russia, but China has refused to do so. India, a long-time Russian friend, is an unusual example of a democracy side with a’strongman,’ which may generate friction in its relations with the United States and the United Kingdom. Another example is Poland, which may use this crisis and the security necessity it entails as an opportunity to reconcile its disputes with the EU over ‘values.’ Turkey might play a crucial geopolitical role and’return to the fold.’
Switzerland, which has enormous financial clout over affluent Russians and commodities traders, has done nothing, and the price for this may be a stricter stance by EU and US authorities toward its banks. Fintech and payment businesses will have to be more cautious about where and with whom they do business on a global scale.
Many multinational corporations, which have steered clear of developing diplomatic chasms, will increasingly be forced to pick sides, not only with Russia, but also with China. This will be especially true for companies in vital areas, such as semiconductors, and for huge multinationals with business links to China (such as Apple AAPL +0.2%). Large firms, on the other hand, may feel compelled to develop partnerships with governments in crucial areas such as AI and data, as a result of geopolitical risk.
The asset prices of two of the players that have destroyed American democracy (Facebook/Meta and the Russian state – rouble, etc.) have fallen in recent months, according to the brilliant Longview Economics team.
In that regard, it is to be desired that attitudes on the integrity of democracy harden inside political institutions, and that politicians on the payroll of foreign governments in the UK, US, France, and many other nations (including Africa, as we reported last week) face consequence. It is also to be hoped that outside funding of political parties be scrutinised and punished more severely. Any evidence of widespread opposition to the invasion in Russia, and probably even more so in Belarus, would be welcomed.
Finally, to all those European policymakers befuddled by reality, consider what the future world should look like and, more provocatively, consider how they may influence events such that Russia applies to join the EU in 10 years.
Sanctions imposed on Russia’s economy have a fair probability of destroying it, but they also pose threats to the international financial system and cost to the world economy.
As Biden has indicated, the fresh sanctions may have repercussions for the United States.
Stock markets dropped early Thursday, only hours after the invasion, and oil prices soared. According to Coates, some people believe that inflation will be driven up as well.
The idea that the US can impose sanctions without incurring significant consequences — that’s implausible, he added. We may be thinking about sanctions much differently in five years, a year, or even a few months than we are now.