Sacrificing His Core Supporters in a Race Against Defeat
The economic sanctions that the West has imposed on Russia have been unprecedented in their speed, scale, and scope. Within just a week of Russian President Vladimir Putin’s attack on Ukraine in February, the United States and its allies prohibited their people and companies from doing business with the Central Bank of Russia, the largest entity targeted since U.S. sanctions against Japan before Pearl Harbor. They also levied an array of other penalties, including sanctions on state-owned Russian banks and controls on critical technology exports to Russia. By any measure, the West delivered on the “swift and severe consequences” that U.S. President Joe Biden had threatened before the invasion.
But these sanctions are not yet comprehensive, nor are they imposing enough economic costs to have any hope of changing Russia’s short-term calculus. Just one of Russia’s five biggest banks, VTB, is under full blocking sanctions, which freeze its assets and ban U.S. firms and individuals from transacting with it, and is cut off from the SWIFT interbank messaging service. Outside the financial sector, none of Russia’s biggest state-owned enterprises—such as the oil giant Rosneft, the gas behemoth Gazprom, and the defense-industrial conglomerate Rostec—are under full blocking sanctions. And Russia’s oil and gas sales—the lifeblood of Putin’s economy, accounting for half of the country’s export revenues and roughly 40 percent of its budget—remain largely untouched.
Claims that Russia is the world’s most sanctioned country—based on simply counting the number of individual targets—are misleading. Compare the penalties applied to Russia with those enforced on Iran. Every major Iranian bank and state-owned enterprise is under full blocking sanctions. The United States maintains a complete financial and trade embargo on Iran. And Washington has spearheaded a global campaign against Iran’s oil exports, backed with the threat of secondary sanctions—penalties on third parties that transact with Iran. This international effort has devastated Iran’s oil sales.
As the horrific scale of Russia’s atrocities in Ukraine, including the reported massacre of civilians in the Kyiv suburb of Bucha, comes to light, the gaps in the sanctions that permit ongoing business with Russia are becoming hard to justify. Some argue that it’s important to keep sanctions arrows in the quiver so that they can be used to deter further Russian aggression. But Russia is already bombarding Ukrainian cities, and there’s no evidence that the prospect of harsher sanctions is holding Putin back. With the gaps in sanctions that remain, Putin earns roughly $1 billion each day selling energy. Russia is also finding ways to adjust to the initial rounds of sanctions, so new measures are needed to keep up the pressure.
Now is the time to maximize sanctions against Russia. Although new measures are not guaranteed to change the course of the conflict, they will enhance the West’s leverage while undermining Putin’s war. More fully isolating Russia from the global economy and cutting off its oil and gas revenues will limit the Kremlin’s capacity to fund its military in the future.
The United States and Europe must act immediately, as Russia’s economy is starting to adjust to the initial shock. After falling more than 70 percent, the ruble has bounced back to nearly prewar levels. Russia’s banking system is stabilizing, and Russian oil and gas shipments continue to rake in billions for the Kremlin. The only way to keep the pressure on Putin—and close off Russia’s ability to mount an economic recovery—is to ratchet up sanctions.
The Russian government did not expect the initial round of sanctions to hit so hard. Russian leaders had bought into their own propaganda about having “sanctions-proofed” their economy by having built up massive foreign currency reserves and developed alternative payments mechanisms in case Russian banks were shut off from SWIFT or prevented from using Visa or Mastercard. None of this sanctions-proofing worked. Russia’s reserves have been frozen, while banks such as VTB have been largely cut off from international transactions.
To forestall a banking crisis and prop up the ruble, the Kremlin has resorted to strict capital and banking controls. The Central Bank of Russia hiked interest rates to 20 percent to support the value of the ruble. Withdrawals of foreign currency from Russian banks were capped at $10,000, essentially freezing the wealth of any Russian with a large stock of foreign currency. Informal markets have emerged for individuals buying and selling foreign currencies, yet big businesses have been hit, too. Regulators imposed a substantial fee on currency trading. And the country’s biggest exporters—the oil, gas, and mineral firms that earn most of the country’s export revenue—are now forced to convert 80 percent of their foreign exchange earnings to rubles.
Although these measures have buoyed the ruble, they are throwing Russia’s economy into a deep recession—probably more severe than what it suffered during the 2008 financial crash. Financial restrictions and higher interest rates will slash consumption (which may fall 14 percent this year according to one forecast) and investment (down 20 percent over the year). This will be a severe hit to Russia’s economy. A survey of economists by Russia’s central bank predicted that the Russian economy will shrink by eight percent this year, while other leading forecasters see a ten or 15 percent decline in GDP. Investment in Russia, which is crucial for the country’s future economic growth, will probably stay below prewar levels for some time.
The only way to keep the pressure on Putin is to ratchet up sanctions.
A deep recession, however, will not necessarily cause a political crisis. Russians will get far poorer this year. But measured by inflation-adjusted disposable income, Russians have gotten poorer for most of the past decade, with few consequences for the Kremlin. Some of the sanctions have yet to fully bite. For example, export controls on technology and machine tools will create supply chain difficulties and problems in Russian industry that will escalate over the coming months. Nevertheless, the Kremlin has the propaganda skill to deflect blame for the economic misery—and the repressive apparatus to ensure that no organized opposition emerges.
From the Kremlin’s perspective, the current sanctions are regrettable but manageable. The hit to Russia’s growth trajectory is serious, but Putin and Russia’s other leaders have never focused on maximizing the country’s long-run economic outcomes. Despite the damage caused by sanctions, the Russian government’s financial position is strong and the country’s current account is in surplus.
This is because sanctions have left by far the biggest sector of the Russian economy—energy—basically untouched. Russia’s biggest export, oil, was briefly disrupted by the sanctions, and the country was forced to sell its oil at a discount to international benchmarks. Sanctions can be disruptive to products such as oil that are transported via ship, because shipping firms and insurance companies may balk at working with Russian cargos. However, the gap between Russian prices and world prices has begun to close, suggesting that Russia is slowly finding a way around these obstacles. At any rate, the price of oil is far higher than it was last year. So even if Russia exports somewhat less oil and continues to have to offer discounted prices, it can still count on substantial revenue.
Russia’s second-biggest export, natural gas, has been even less affected, because the country’s gas exports mostly flow through pipelines, some of which Russia owns, and are therefore less vulnerable to sanctions-induced disruptions. Gas exports from Russia to Europe have in fact increased since the conflict started, as Europe has tried to fill its reserves and as Russia has let gas flow freely, in contrast to its restrictive policies from earlier this year.
All told, it seems likely that Russia is making at least $1 billion each day by selling energy abroad. The biggest customer, of course, is Europe, which has participated in the banking sanctions and tech export controls. The EU, however, remains reluctant to cut off imports of Russian oil and gas—largely because of German opposition. The Biden administration has embargoed imports of Russian oil into the United States, but this has only a marginal effect on Russian export revenue since these cargos can be sent to other destinations. The Biden administration’s plan to send more liquified natural gas to Europe, meanwhile, will help wean the continent off Russian gas—but only in the future. The impact on Russia today is negligible.
It is no exaggeration to say that Europe’s purchases of Russian energy have sustained Putin’s war effort. Because Russia and its largest companies have been largely severed from international financial markets, the country cannot easily borrow from abroad, so any goods it imports must be matched by funds earned from exports. Thanks to European energy payments, the Kremlin hasn’t had to try hard to balance its accounts. Most Russians believe that this year will be painful but that their economy will muddle through. If the United States and Europe work harder to curtail Russian energy exports, however, the Kremlin would face a far tougher set of choices between prosecuting the war in Ukraine, paying salaries and pensions, and preventing an even more severe collapse in living standards.
The United States and the EU retain ample room for escalating sanctions. A major reason that sanctions haven’t yet been maximized is Germany’s opposition to an embargo on oil and gas purchases from Russia. But the United States has also held back in recent weeks, likely because Washington is reluctant to get out in front of Brussels. If Germany continues to drag its feet, however, the Biden administration should not hesitate to increase sanctions unilaterally—as the United Kingdom has already done, ratcheting up its own penalties on Russian banks and shipping companies late last month.
The easiest step for sanctions escalation is expanding restrictions on Russia’s banking sector. In the leadup to the invasion, the Biden administration opted to focus its sanctions campaign on Russian banks, since doing so could deal a serious economic blow to Russia without directly affecting oil and gas sales. In the first week of the war, the Biden administration imposed full blocking sanctions on VTB, which holds 15 percent of the assets in Russia’s banking sector. The EU followed suit by cutting off VTB from SWIFT. The United States and the EU also imposed full blocking sanctions and SWIFT bans on six other Russian banks, comprising around 25 percent of Russia’s banking system. These moves, coupled with the sanctions against the central bank, were primarily responsible for the onset of financial pressure.
The United States and the EU retain ample room for escalating sanctions.
But since that first wave of financial sanctions, neither Washington nor Brussels has escalated penalties on Russia’s banks. Their hesitancy has stemmed in part from concerns about obstructing payments for Russian oil and gas, as Russia’s first- and third-largest banks—Sberbank and Gazprombank—play major roles in the energy trade. There have also been concerns about the unintended consequences of targeting Sberbank specifically, as it is the central node of Russia’s financial system. Over half of Russian wages and pensions are paid through the bank, and it holds 45 percent of all Russian household deposits. But the West has enabled Russia’s economy to adapt to sanctions by allowing most Russian banks to retain access to SWIFT and the global financial system. That’s why it makes sense for the United States and the EU to close this loophole, expanding blocking sanctions and SWIFT bans to all major Russian banks.
In parallel, the United States and the EU should expand their sanctions campaign to nonfinancial state-owned companies. Russia’s economy is dominated by government-owned behemoths in energy, defense, shipping, mining, minerals, and telecommunications. The West has banned some of these firms from raising debt on global capital markets, but it has not yet imposed full blocking sanctions on any of them. This turned out to be a major gap in the sanctions campaign when Putin ordered these companies—which generate the lion’s share of Russia’s foreign exchange holdings—to convert 80 percent of their hard currency into rubles. This policy has buoyed the ruble’s value, even as Russia’s central bank has been barred from selling its existing foreign exchange reserves.
In the coming weeks, the West should slap blocking sanctions on many of Russia’s big state-owned companies, focusing on sectors that generate the most export earnings, including the energy sector. Blocking sanctions on Rosneft and Gazprom would greatly complicate these companies’ efforts to sell oil and gas on global markets. The same is true for sanctions on Sovcomflot, Russia’s largest shipping company, which would struggle to insure oil cargoes under sanctions. (The United Kingdom recently imposed unilateral sanctions on Sovcomflot, but the United States and the EU have not yet followed suit.)
The most important step of all, however, is for the West to target Russia’s oil sales directly. Russia exports roughly five million barrels of crude oil and nearly three million barrels of petroleum products per day. In the first weeks of the war, there was a dip in Russia’s seaborne oil sales. But exports have since rebounded and continue at pre-sanctions volumes.
Because Russia exports so much oil, it would be impossible to reduce sales to zero in one fell swoop. Thankfully, there’s a ready playbook for sharply reducing a country’s oil sales: the one that the United States used against Iran since 2011. It consists of three components. First, the West—which accounts for about 55 percent of Russia’s oil sales—would reduce its own purchases substantially. The United States and the United Kingdom have already imposed domestic embargoes, but the EU has refrained from anything beyond vague commitments. To prevent Putin from collecting billions of dollars selling oil, the EU would need to commit to a rapid timeline to bring its own purchases to zero. Thus far, the EU—led by Germany—has been unwilling to bear the economic cost of an oil embargo, promising only to reduce its purchases in the future. (Most estimates suggest that an oil embargo would cost Germany 0.5 to 2.5 percent of GDP this year, whereas the impact on Russia would be far greater.) The Biden administration, meanwhile, has refrained from pressuring Germany or other European countries about their purchases of Russian oil.
The second step is to require all payments for Russian oil to accrue in bank accounts outside of Russia. The West could set this requirement by threatening secondary sanctions on any foreign firm that funnels money to Russia in exchange for oil. For example, when a Chinese company buys Russian oil, it would need to pay Russia in an account held in China. The funds in the Chinese-based account could not be repatriated to Russia; they could only be used for bilateral trade. As China would still receive oil from Russia, there would be no incentive for Beijing to violate the policy and risk Western sanctions. Russia would almost definitely keep shipping oil, because storage capacity in Russia is limited, and the alternative would simply be to stop pumping any oil—causing Russia’s oil industry to collapse and its economy to freeze. The United States executed a similar strategy against Iran, which led to billions of dollars of Iranian oil revenues building up in banks outside of Iran. These funds provided the United States with tremendous leverage in nuclear negotiations, as it could repatriate the funds to Iran at the stroke of a pen.
The final step would be to ask governments around the world to slash their purchases of Russian oil every six months—or risk secondary sanctions. Practically speaking, Washington could make access to General License 8A, a Treasury Department carve-out that provides broad sanctions exemptions for energy-related transactions, contingent on a country’s proven cutbacks in Russian oil purchases over the preceding six months. When the United States levied a similar policy against Iran in 2011, it cut Iran’s oil sales from 2.5 million barrels per day to under one million barrels per day; and when U.S. President Donald Trump reinstated the policy in 2018, Iran’s oil sales plummeted to under 500,000 barrels per day.
These steps would carry costs. They could lead to higher energy prices in the short term that the West would need to address. But inaction also carries costs. Gaps in the sanctions regime help Putin generate billions in hard currency flows every week, letting the Kremlin adapt Russia’s economy to the restrictions already in place.
There is also a real risk that delaying these steps now will make them more difficult to take in the future, since they carry real domestic costs. For now, intense international attention on Putin’s atrocities in Ukraine gives leaders cover to make these hard decisions. But if Putin’s war recedes from the headlines in the months ahead, Western leaders could lose that cover. The window of opportunity to maximize sanctions may not stay open forever.
The Biden administration can and should take all these steps in the coming days—even if the EU is slow to act. In parallel, Congress should immediately enact legislation that mandates sweeping restrictions on Russia’s banks and state-owned enterprises, as well as secondary sanctions on foreign firms that buy Russian oil. Although the Biden administration does not need congressional authorization for the sanctions, a congressional mandate would give the measures teeth and staying power—and, critically, make the threat of secondary sanctions indisputably credible.
These actions would isolate Russia from the global economy and dry up its main source of hard currency—oil sales. Such a strategy might not end Russia’s war against Ukraine. But it would ensure that Putin’s horrific violence carries enduring costs, and it would curb Russia’s ability to fund its military machine in the future.
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