The Coup in the Kremlin
How Putin and the Security Services Captured the Russian State
With sanctions beginning to bite, Russia is starting to play a new economic game. To alleviate the pain of Western restrictions on its financial and energy sectors, Russia is turning for help to non-Western partners. Last week alone, Russia and China signed over 40 agreements that provide Russian firms with lines of credit worth billions of dollars and establish strategic partnerships in the energy sector.
The United States, in turn, is looking to step up its own game. Policymakers are considering giving global companies a choice: stop providing long-term financing and energy assistance to major Russian companies or be kicked out of the U.S. financial system. Such measures resemble the sanctions the United States placed on Iran a couple of years ago. But Iran was a different problem. And treating Russia the same way would be a mistake.
Sanctions can be an effective tool for forcing engagement and negotiation. But the pace and implementation must be tailored to the target. In the case of Iran, the United States was able to tighten the screws by pressuring foreign firms to stop dealing with the country. That move created some angry blowback, but it generally worked. And partially as a result, Tehran is at the negotiating table. When it comes to Russia, though, the political pushback that would come from blacklisting dealings with the strategic Russian energy and banking sectors would be much more severe because Russia is a more important market. Further, more companies would likely be willing to forego access to U.S. markets in order to continue working with the Russians. And that would undermine the sanctions’ effectiveness.
More generally, policymakers in the United States should be wary of continually relying on sanctions that penalize foreign firms by preventing their access to U.S. markets. Ultimately, such a strategy could backfire. At some point, foreign companies may decide that doing business in U.S. markets -- and being subject to U.S. sanctions policies -- is simply not worth it. That would hurt the U.S. economy and diminish the United States’ ability to use economic levers to advance its foreign policy.
Since March of this year, the United States and the European Union have used sanctions to pressure Russia to cease its support of separatists in eastern Ukraine and to relinquish control of Crimea. A series of narrowly-tailored economic sanctions designed to degrade Russia’s banking, energy, and defense sectors has slowly cut off pathways to U.S. and European capital markets and to critical technology. Yet as U.S. and European firms have wound down many of their relationships with Russian companies, these companies have turned to the Kremlin for financial lifelines or to alternate partners in Asia. For example, Russian companies such as Rosneft are picking up Chinese financing for major energy development projects and are partnering with state-owned Chinese oil companies to help develop certain Russian natural resources.
Obama administration officials have urged Asian countries not to fill the economic void in Russia left by exiting U.S. and European companies. However, policymakers are considering hammering the message home by threatening punishment should its message go unheeded. For example, proposed legislation in the U.S. Senate would provide the president with the authority to prevent foreign firms that significantly invest in certain areas of the Russian energy sector from accessing the U.S financial system. Likewise, lawmakers in the Senate are considering granting the president authority to target foreign firms conducting certain financial transactions with a number of Russian companies and effectively freeze those firms out of the U.S. financial system. Such powerful prohibitions would apply to a vast universe of global companies and make them choose between maintaining access to U.S. markets or dealing with Russian partners. They would not be able to do both.
This choice is remarkably similar to the one that the United States put to foreign companies as it ratcheted up the sanctions pressure on Iran. Beginning in 2010 with the passage of CISADA (Comprehensive Iran Sanctions, Accountability, and Divestment Act) -- which gave the president authority to cut off foreign banks from U.S. markets if they did business with Iranian institutions on the U.S. sanctions list -- Congress and the president worked to prevent Iran from circumventing U.S. sanctions by seeking alternate business partners. Although only a few foreign companies have been sanctioned under CISADA, since its passage and the enactment of additional tough sanctions laws, foreign companies have virtually shut down their business relationships with Iranian institutions, choosing instead to stay on the good side of U.S. regulators. This significantly damaged the Iranian economy and helped bring Tehran to the negotiating table.
Although policymakers may be eager to emulate the success of the Iran sanctions regime in Russia, the Iran-inspired approach won’t be as effective there. Moreover, it may create significant -- and underappreciated -- problems for U.S. policymakers in both the short and long term.
For example, targeting foreign firms for their work with Russian companies can create major diplomatic tension between the United States and its partners and allies abroad. During the implementation of CISADA, officials at the Treasury Department spent a tremendous amount of time soothing relations with European and Asian countries, who viewed the United States’ ability to sanction their companies as nothing short of a violation of international law. Eventually bringing many of these countries on board was one of the most extraordinary diplomatic feats of the last several years.
And, even though they have been constructive partners on Iran policy, foreign capitols have remained uneasy with Washington’s attempts to prevent foreign companies from doing business with Iran. This partly explains why so few foreign companies have actually been sanctioned under CISADA. When the Treasury Department did try to crack down on the few global companies that cast their lot with Iran in defiance of U.S. sanctions, such as the Chinese Bank Kunlun, it caused a diplomatic row. Given that Russia has reached out to many Chinese companies to help mitigate the pain caused by U.S. and EU sanctions, the United States would likely be risking dramatically more diplomatic tension with the Chinese by imposing such sanctions again. And that could complicate other issues in the U.S.–China relationship.
There’s another reason why potential new Russia sanctions that set East Asian banks and companies in U.S. sights might not be as effective as policymakers hope. Unlike Iran, Russia has a large, globally-integrated economy. It is more than five times the size of the Iranian economy and is an attractive investment opportunity. For many companies -- big banks in particular -- their business with Iran was not worth losing access to U.S. financial markets. However some firms, particularly in China, may conclude that their strategic interests and financial future lie with Russia. If they make this decision, there is very little the United States can do to get them to cooperate again.
It is hard to conceive of a large, reputable, multinational company that would pursue its business completely outside of the U.S. financial system, avoiding U.S. dollar transactions and U.S. citizen employees -- all things that could subject them to penalties under U.S. sanctions. But if enough smaller, regional businesses abroad try to chart such a course, it will take a toll on the sanctions regime and the U.S. economy.
TAKE A STAND
Rather than rushing into new, Iranian-style sanctions that will create more problems than they solve, policymakers should consider further narrowing Russian firms’ access to U.S. and EU financial markets and to a larger universe of critical and unique Western oil and gas extraction technology and field production services, and defense technology and equipment. It would also be worth targeting a larger number of Russian firms with the existing sanctions, such as additional companies in the energy, financial, and defense sectors. Creating incentives for Asian partners to go along with U.S. and European sanctions would also maintain the pressure on Russia without penalizing our partners and allies with penalties. These incentives could include promoting cooperation and investment in Western energy and financial sectors.
U.S. policymakers will need to work overtime to keep international partners together in the stand against Putin. United governments will collectively keep foreign companies from undermining the sanctions on Russia. They will also make it harder for Russia to strike back with asset expropriation against U.S. corporate interests in Russia. Transatlantic sanctions cooperation will be a must, as will close cooperation between the United States and its partners in East Asia.
Before the going gets any tougher with Russia, Washington’s policymakers should also work more with foreign business leaders and their regulators to better understand which companies abroad would abandon U.S. markets if they were directly threatened with new sanctions. That will help U.S. policymakers judge whether certain sanctions measures may ultimately undermine the United States. Only with such an understanding will Washington be able to calibrate its strategy in Russia to achieve the same success seen in Iran.