The Interpreter

A special project of Institute of Modern Russia
Jean-Claude Juncker, the next European Commission President, and Vladimir Putin

What Strong Sanctions Against Russia Might Have Accomplished

The offices at VTB headquarters in Moscow’s burgeoning new financial district, which lays a short hop away from the Kremlin, were eerily quiet. No one was talking as every employee was gathered around the TV waiting for President Obama to announce the first series of sanctions against Russian and Crimean officials in response to Russia’s annexation of the small, economically depressed strip of land.

The rhetoric leading up to this announcement was making people all over Russia—and the bankers and businessmen in the west who facilitate the flow of capital from Russia—very nervous. It was assured that the sanctions would target some very high-level and close associates of Putin, but what was truly making people nervous was the threat of sanction against Putin himself or sector-wide or targeted sanctions against state-owned industries such as Rosneft, Gazprom or VTB itself. Sanctions like that would be the death knell for Russia’s economy, killing foreign investment and shutting the most important parts of the economy from access to international finance.

When President Obama finally came on screen and the names of individuals were announced, there was a collective sigh of relief and a quick return to the break neck speed that is the banking world. No one cared what he had to say after the names; the list had said all the bankers needed to hear. The West would impose sanctions, and it would be inconvenient to some, but they would not impose sanctions that would truly have an impact and also negate any western foreign investment in the country—Crimea and Ukraine were not worth it.

I recently had the opportunity in Moscow to hear about scenes like this and others when I had a chance to speak with several bankers and lawyers who specialized in managing investments for clients—particularly in setting up offshore ventures. And while they all had different jobs and roles they had one thing in common; they spent a lot of their time initially calming down clients that the sanction threat would diminish and the West would not continue to impose harsh and meaningful sanctions.

The initial rounds of sanctions that targeted the likes of the Rotenberg brothers, Gennady Timchenko, and heads of major industries like Rosneft CEO Igor Sechin and Rostec Corp. head Sergei Chemezov, actually did provoke unease among Russia’s internationalized elite. They were worried that their business interests and banks would be increasingly wary of doing business with individuals in Russia and would start looking harder at the provenance of their capital. They were worried their vacations in Monaco and their plans to send their children to school in the West were under threat.

And it shows that, at least initially, the elites were worried about the U.S. imposing costly sanctions. As Brian LeBlanc of Global Financial Integrity, a Washington D.C. based think tank, has shown, there was a significant departure of Russian deposits in U.S. banks; down from $21.9 billion in February to $8.4 billion in March. Although it could be that they simply moved their deposits to different financial institutions from other countries, it is a telling sign of the worry that Russians had over the sanctions.

But the bankers and lawyers who advise them knew better. And they were right. Despite listing a few more significant confidants of Putin, the U.S. and especially the EU have instead targeted the local separatist leaders with sanctions that, if anything, undermine and further reinforce the view that the sanctions are mere diplomatic maneuvering and of little long-lasting importance. Anders Aslund, a respected economist at the Peterson Institute for International Economics, went so far as to label them a “whimper” compared to the tough rhetoric. Even America’s strong initial series of sanctions has seemed to have worn off. Two U.S. federal agents recently confirmed to me that they no longer see the impact of the sanctions on money flows between Russia and the U.S.

By looking at the most recent round of sanctions—the list of U.S. designations can be found here, and the EU here—which primarily only target the separatist leaders present in Ukraine and spare targeting the political leaders and sectors of the Russian economy that support the Kremlin’s adventurist policies, one can see how Russia understands that the West is losing interest in Ukraine and further sanctions.

It is also due to the fact that after the forceful start, the sanctions were quickly undercut by a combination of business interests and misguided attempts at trying to incentivize Putin to positively contribute to a diplomatic solution. Instead of forcefully impacting the Russian economy and government they have been face-saving measures which have decreased rather than increased in severity with each new round.

The UK does not want to impose sanctions for fear of losing the massive amounts of capital that flow into the city each year (as evidenced when British deputy national security advisor Hugh Powell was photographed carelessly walking into No.10 Downing with documents stating that Britain would not support harsher sanctions against Russia or “close London’s financial centre to Russians.”); France is in the middle of completing a $1.7 billion deal to build Mistral class amphibious assault ships for the rapidly modernizing Russian military; Germany is reliant on Russia to provide it with a majority of its energy, to say nothing of its significant business interests with Moscow; and the U.S. is worried about pushing too far for fear of alienating the EU which, as above demonstrates, has significantly more ties with Russia than the U.S.

These ties have hamstrung efforts to apply harsher measures. Imposing weaker sanctions serves to only further embolden the Russian elite and Putin. Without the follow-through of the threat of significant and meaningful sanctions, and by only imposing token actions against individuals who have neither the assets in the West nor enough assets at all which would be impacted or threatened by sanctions, the actions that have been taken by the West serve to undermine the credibility and threat of Western commitment to stopping Russian support of separatists in Ukraine.

Despite hopes that the EU will discuss stronger sanctions at an EU summit tomorrow, along with purported pressure by the Obama administration, the election of Jean-Claude Juncker to become the next European Commission President does not endear much hope. It was under his term as prime minister of Luxembourg from 1995-2013 that he turned the small country into one of the largest tax havens and offshore financial centers in the world.

This is especially dangerous as after a seeming lull in the Russian support and grandstanding for separatists in Ukraine, tensions are beginning to rise again. The U.S. even admitted as much saying, “We have no evidence that Russia’s support for the separatists has ceased. In fact, we assess that Russia continues to provide them with heavy weapons, other military equipment and financing and continues to allow militants to enter Ukraine freely.”

Tensions will continue to rise as it is evident that Putin is playing a double game of publicly promoting negotiations while secretly (and not so secretly) arming the separatists. The difference is this time the West no longer has the threat of sanctions to temper Russia’s ambitions.