FEBRUARY2023

BearingtheBrunt

TheImpactoftheSanctionsonRussia’sEconomyandLessonsfortheUseofSanctionsonChina

AUTHORS

GerardDiPippo

AndreaLeonardPalazzi

AReportoftheCSISEconomicsProgram

FEBRUARY2023

BearingtheBrunt

TheImpactoftheSanctionsonRussia’sEconomyandLessonsfortheUseofSanctionsonChina

AUTHORS

GerardDiPippo

AndreaLeonardPalazzi

AReportoftheCSISEconomicsProgram

II|BearingtheBrunt

AboutCSIS

TheCenterforStrategicandInternationalStudies(CSIS)isabipartisan,nonprofitpolicyresearchorganizationdedicatedtoadvancingpracticalideastoaddresstheworld’sgreatestchallenges.

ThomasJ.PritzkerwasnamedchairmanoftheCSISBoardofTrusteesin2015,succeedingformerU.S.senatorSamNunn(D-GA).Foundedin1962,CSISisledbyJohnJ.Hamre,whohasservedaspresidentandchiefexecutiveofficersince2000.

CSIS’spurposeistodefinethefutureofnationalsecurity.Weareguidedbyadistinctsetofvalues—nonpartisanship,independentthought,innovativethinking,cross-disciplinaryscholarship,integrityandprofessionalism,andtalentdevelopment.CSIS’svaluesworkinconcerttowardthegoalofmakingreal-worldimpact.

CSISscholarsbringtheirpolicyexpertise,judgment,androbustnetworkstotheirresearch,analysis,andrecommendations.Weorganizeconferences,publish,lecture,andmakemediaappearancesthataimtoincreasetheknowledge,awareness,andsalienceofpolicyissueswithrelevantstakeholdersandtheinterestedpublic.

CSIShasimpactwhenourresearchhelpstoinformthedecisionmakingofkeypolicymakersandthethinkingofkeyinfluencers.Weworktowardavisionofasaferandmoreprosperousworld.

CSISdoesnottakespecificpolicypositions;accordingly,allviewsexpressedhereinshouldbeunderstoodtobesolelythoseoftheauthor(s).

?2023bytheCenterforStrategicandInternationalStudies.Allrightsreserved.

CenterforStrategic&InternationalStudies

1616RhodeIslandAvenue,NW

Washington,DC20036

202-887-0200|

III|GerardDiPippoandAndreaLeonardPalazzi

Acknowledgments

ThisreportwasimprovedsignificantlybythecommentsandsuggestionsofexpertsincludingMaxBergmann,JudeBlanchette,BenCahill,MattFerchen,YakovFeygin,MichaelHirson,IikkaKorhonen,JanisKluge,DouglasRediker,andMariaSnegovaya.

Theviewsexpressedinthereportarethoseoftheauthorsandnotoftheexpertswithwhomweconsultedortheiraffiliatedinstitutions.

ThisreportwasmadepossiblebythegeneroussupportoftheSmithRichardsonFoundation.

IV|BearingtheBrunt

Contents

ExecutiveSummary1

1|Introduction3

The2014SanctionsonRussia3

TheCurrentSanctionsandExportControlsonRussia4

2|TheEconomicImpactsonRussia6

FinancialShockandRecovery7

SustainedTradeSurplus8

FiscalImpactMitigatedbyEnergyExports10

DisruptedProduction,HigherPrices,andLowerLivingStandards12

ADismalEconomicOutlook15

3|TheGoalsandEffectivenessoftheEconomicMeasuresonRussia17

AnEconomicTheoryofVictory?18

4|ComparingRussiaandChinaasEconomicTargets20

5|LessonsforthePotentialUseofSanctionsagainstChina23

AbouttheAuthors26

Endnotes27

1|GerardDiPippoandAndreaLeonardPalazzi

ExecutiveSummary

T

hisreportassessestheeffectsandeffectivenessoftheinternationalsanctionsandexportcontrolsaimedatRussiasinceitsfull-scaleinvasionofUkraineinFebruary2022.ItisthefirstofthreereportsassessingthefeasibilityandimplicationsoftheUnitedStatesusingeconomicmeasurestodeterChinainacrisisoverTaiwan.SubsequentreportswillanalyzetheeconomicinterdependenciesandvulnerabilitiesoftheChineseandU.S.economiesandevaluatehoweconomicmeasuresmightbedeployedduringvariousTaiwancontingencies.

ThisreportfindsthatwhiletheeconomicmeasuresareslowlybleedingtheRussianeconomy,theyareunlikelytodeliveraknockoutblow.Earlypredictionsoftheirimpactwereoverstated.Russia’sfinancialsectorteeteredintheweeksaftertheinvasionbuthassincestabilized.Russia’simportsdroppedinthefirstfewmonthsafterthemeasuresbutbytheendof2022hadnearlyrecoveredtotheirprewarlevelsbyshiftingawayfromEuropetowardChina,Turkey,andafewothereconomies.Moscowpostedonlyamodestfiscaldeficitin2022largelybecauseofoilandgasexports.However,Russia’sindustrialsectorprobablyhasweakened,inflationhasworsened,andrealwageshavefallen.

Goingforward,Russia’sabilitytocontinuecollectingrevenueforoilandgasexportswillbeakeydeterminantofMoscow’sabilitytoavoiddrainingitssovereignwealthfundorborrowingdomesticallytofunditswareffort.Iftheeconomicmeasuresremaininplace,Russia’seconomicoutlookwillbebleak,withRussianhouseholdslookingforwardtostagnationatbest.Russiaislikelytoincreasinglysubstitutelower-qualitydomesticgoodsforforeigngoodsandrelyonChinaasitstopsourceofimportedgoods.

Westerngovernments’goalsforsanctionsandexportcontrolshaveshiftedoverthepastyear.Initially,thethreatoftheirusewasintendedtodeterMoscowfromattackingUkraine.ThatgoalfailedinlargepartbecauseRussianpresidentVladimirPutinbelievedhiswarofaggressionwouldquicklysucceed.Briefhopesof

2|BearingtheBrunt

destabilizingRussiaweredashedafterRussia’sbankingsectorandexchangeraterecovered.TheprimarygoalisnowtodegradeRussia’sabilitytosustainitswarthrougheconomicattrition.Themeasuresaredoingthattosomedegree,buttheyareunlikelytobeasdecisiveasbattlefieldoutcomes.

TheuseofsuchmeasuresagainstRussiahasspurredspeculationabouttheirpotentialuseagainstChina,particularlyinacrisisoverTaiwan.EnactingcomparablesanctionsandexportcontrolsonChinawouldbefarmoredifficultanddisruptivetotheglobaleconomy.ThebiggestdifferencesbetweentheeconomiesofChinaandRussiainthiscontextaretheirsize,importancetointernationalfirmsandinvestors,anddegreeofintegrationintoglobalsupplychains.Thatsaid,theuseofsuchmeasuresisstillpossibleinacrisiswhereeconomiclogicissupersededbystrategic,political,andmilitarypriorities.

TheeconomicmeasuresaimedatRussiasofardemonstratesomelessonswithimplicationsforpotentialsanctionsorexportcontrolsagainstChina.Theseincludethefollowing:

?Economicintegrationandinterdependencearenotaguaranteeagainstconflict.However,Russia’sinvasionofUkraineisasamplesizeofone,andChineseleaders’calculus,includingregardingTaiwanandtheirprioritizationofeconomicdevelopment,couldbequitedifferent.

?Ifeconomicsanctionsaretobeusedasadeterrent,theUnitedStatesanditsalliesshouldcrediblysignaltheirwillingnesstoimposesuchmeasures.

?Economicmeasuresarefarmoreeffectivewhenimposedincoordinationwithallies.OrganizinganeconomicallianceagainstChinawouldbemoredifficultthanithasbeenforsanctioningRussia.

?Inflictingmaximumeconomicpainonatargeteconomyrequirescuttingoffitsexternalsourcesofrevenue,whichhasnotoccurredwithRussia.Thismightrequireincreasingtheeconomicresiliencyof

statesimposingsuchmeasures.

?Theeffectivenessofmeasurescanwaneaswork-aroundsarediscovered,andsustaineduseofsuchmeasurescanspurnetworkstoevadethem.

?Theeffectivenessofsanctionsislimitedbythewillingnessofleadersincountriesimposingthemtopaycoststhemselves.

?Economicdeterrenceshouldbeconsideredasupplementto,butnotasubstitutefor,militarydeterrence.

3|GerardDiPippoandAndreaLeonardPalazzi

1

Introduction

T

heinternationalsanctionsandexportcontrolsimposedonRussiainresponsetoitsfull-scaleinvasionofUkraineinFebruary2022offerauniquetestcaseofthepowerandlimitsofsuchmeasures.Thesanctionsarethemostsubstantialandrapidaimedatamajoreconomy—previouslythe11thlargestintheworld,withagrossdomesticproduct(GDP)of$1.78trillionin

2021

1—sinceWorldWarII.ThecurrentmeasuresbuildonthoseimposedonRussiain2014.Russiaisnowtheworld’smostsanctionedcountryintermsofthenumberofmeasuresimposedonit,butthemeasuresarelesscomprehensivethanthosetheUnitedStateshasimposedonIranbecauseRussiaremainsallowedtoexportcommodities.

2

Still,thesanctionsandexportcontrolsarehurtingRussia’seconomy.Thisstudyevaluatestheireffectsandeffectivenessanddrawslessonsforfutureuse,includingagainstChina.

The2014SanctionsonRussia

In2014,theUnitedStates,EuropeanUnion,andotheralliesrespondedtoRussia’sinvasionofCrimeawiththreetypesofsanctionsandexportcontrols:(1)assetfreezesandtravelbansaimedatindividualsandcompanieslinkedtoCrimea’soccupationandRussia’sincursionintotheDonbas;

3

(2)financialsanctions,includingprohibitionsonEUandU.S.entitiesbuyingorsellingnewbondsorequityissuedbyRussia’slargeststate-ownedbanks;

4

and(3)exportrestrictionsonoil-relatedequipmentaswellasdual-useandmilitaryitems

.5

The2014sanctionshitRussia’senergysector,finances,andmilitarybutdidnotincludeembargoesonRussianenergyproductsormeasurestobarRussianbanksfromtheSocietyforWorldwideInterbankFinancialTelecommunication(SWIFT)network

.6

Theseactionstriggeredlargecapitaloutflows,substantialdepreciationoftheruble,inflation,andcontractionsinGDPandfiscalrevenues

.7

Overall,theestimatedlossofpotentialforeigninvestmentsinRussiaamountedtonearly$500billion

.8

4|BearingtheBrunt

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

2020

2021

2022

TheKremlin’s“FortressRussia”strategyaroseinresponsetothesesanctions.ItsgoalwastorenderRussiaaself-relianteconomywitha“fortress”balancesheetdesignedtoprotectthecountryfromfuturebalance-of-paymentsshocksandfurthersanctions.Moscowachievedthisgoalinfourways.

First,theCentralBankoftheRussianFederation(CBR)carriedoutasubstantialde-dollarizationofitsassets

becauseitbelievedU.S.assetswouldbethemostatriskoffuturesanctions.Beginningin2018,theCBR

reallocateditsreservesawayfromU.S.dollarassets,withtheeuroaccountingfor32percentofCBRreserve

assetsbymid-2021andtheremainderingold(22percent),U.S.dollars(16percent),renminbi(13percent),and

othercurrencies(17percent)

.9

Second,Moscowreinforceditsconservativefiscalposture,includingbyassuminglowoilprices

.10

Russia’spublic

debt—about75percentofwhichisdomestic—wasfairlystableafter2014andjumpedto$290billion,or16percentof

GDP,in2021onlybecauseoftheCovid-19pandemic

.11

Russia’spublicandprivatesectorsreducedforeigncurrency-

denominatedexternaldebtforallsectorsfrom$539billioninearly2014to$350billionbytheendof2021.

12

Third,theCBRbuiltupforeignreservesbyinterveningtolimitrubleappreciation.Asaresult,Russia’sforeign

reservesnearlydoubledfrom2015to2022,from$356billiontoover$630billion(Figure1)

.13

Finally,Moscowattemptedtospurself-sufficiencyinagriculturalandindustrialgoodswithsubsidiesand

embargoesonWesternfoodimports

.14

Intheindustrialsector,self-sufficiencylargelyfailed:Russia’smachine

toolsandelectronics,forexample,haveremainedreliantonforeigninputs

.15

Figure1:Russia’sOfficialReserveAssets,2005–2022

USD,billions(leftaxis);percent(rightaxis)

externaldebt(rightaxis)goodsimports(right

Oicialreserves(leraxis)RelativetoforeigncurrencyRelativetoannualaxis)

700350%

600

500

400

300

200

100

0

300%

250%

200%

150%

100%

50%

0%

Source:CSIS’scalculationsbasedon“BankofRussia,OfficialReserveAssets,”CEIC,/en.

TheCurrentSanctionsandExportControlsonRussia

TheWesternsanctionsinresponsetoRussia’s2022invasionofUkrainehaverequiredamuchgreaterlevelofcoordination.Sincetheinvasion,Washington,Brussels,andthegovernmentsofothermajoradvancedeconomieshaveimposedaseriesofcoordinatedmeasuresonMoscow,includingthefollowing:

5|GerardDiPippoandAndreaLeonardPalazzi

?Financialsanctions,whichbannedsomeRussianbanksfromtheSWIFTnetwork,barredforeignbanksfromtransactingwithdesignatedRussianfirmsandbanks,andfrozemostoftheoverseasassetsheldbytheCBR.Closetotwo-thirdsofRussia’sbankingsystemhaslostaccesstoU.S.orEuropeanfinancialsystems

.16

?ExportcontrolsoncommoditiesortechnologiesdeemedrelevantforRussia’sdefense,aerospace,ormaritimesectors,includingsemiconductors,lasers,andsensors

.17

?Importrestrictions,includingenergyembargoesonRussia’scrudeoilandrefinedpetroleumproductsbytheUnitedStates,Canada,andAustraliasoonaftertheinvasionandbytheEuropeanUnionandtheUnitedKingdominDecember2022.

18

TheEuropeanUnionimplementeditsembargoonrefinedpetroleumproductsinFebruary2023.

19

?AG7-ledcaponthepriceofseaborneRussianoil,setat$60perbarrelsinceDecember2022.ThirdpartiesmustdemonstratecompliancewiththeoilcaptoreceiveWesternmaritimeshippinginsuranceandservices.

20

InFebruary2023,theG7,theEuropeanUnion,andAustraliaimplementedpricecapsonRussianrefinedpetroleumproducts.

21

?Sanctionsonindividualsandentitiesinvolvedwiththewar,includingdefensesectorfirms.MeasuresincludedassetfreezesandtravelbansonRussiangovernmentofficials,aswellasRussianoligarchsandpropagandists

.22

Overall,anestimated$100billioninprivateRussianassetshasbeenfrozen

.23

?Indirectsanctions,or“self-sanctioning,”byforeignfirmsexitingtheRussianmarketorsuspendingoperationsbecauseofpressuresfromcustomersorcommercialconstraintsimposedbythesanctions.

6|BearingtheBrunt

2

TheEconomicImpactsonRussia

T

hesanctionsaimedatRussiainresponsetoitsFebruary2022invasionofUkrainenearlytriggeredacrisisattheonset.However,afterafewmonths,Russia’sbankingsectorandexchangeratehadlargelyrecovered.TheeconomiceffectivenessoftheWesternmeasureshasbeenlimitedbyMoscow’sFortressRussiapreparations;adeptpolicyresponses,especiallyfromtheCBR;andRussia’scontinuedabilitytoexportkeycommodities,particularlyoilandnaturalgas.

Atahighlevel,theeconomicshocktoRussiafromWesterneconomicmeasureswaslessthanmanyexpectedintheweeksfollowingMoscow’sinvasion.EarlyforecastssuggestedRussia’srealGDPwouldfallby10to15percentin2022.

24

However,Russia’srealGDPcontractedonly2.1percentin2022,accordingtopreliminarydatafromRosstat.

25

Forperspective,thecontractioninRussia’seconomyin2022wasgreaterthanthatcausedbythe2014sanctionsbutlesssharpthantheCovid-19shockin2020andevenlesssothantheaftermathoftheglobalfinancialcrisisin2008orthesovereigndebtcrisisofthelate1990s(Figure2).

ItcanbedifficulttoparsethecausalimpactsfromWesternmeasures,voluntaryactionsfromforeignfirms,Russianretaliatoryactions,orthewarmoregenerally.Westernmeasures—especiallytheexportcontrolsandeffortstoreduceRussia’senergyrevenues—areharmingRussia’seconomy,asisthegeneralchillingeffectofthosemeasuresandpoliticalpressuresonforeignfirmstoexittheRussianmarket.Internationally,RussianofficialsliketoblameWesternsanctionsfornegativespilloverstoothercountries,includinghigherpricesandgrainshortages.

26

However,Russia’sactions,disruptionstoBlackSeatrade,andincreasedriskpremiumsaremorelikelycauses,atleastaftertheinitialshockfromfinancialsanctions.

TheRussianeconomyhasnot,andprobablywillnot,sustainanythinglikeaknockoutblow,butitislimpingalongandslowlybleeding.Goingforward,thequantityandpriceofRussia’senergyexportswillbeakeydeterminantoffiscalandinflationarypressuresfeltbyMoscowandRussianhouseholds.

7|GerardDiPippoandAndreaLeonardPalazzi

Figure2:Russia’sRealGDPafterCrises

Index,100=GDPatquarterwhencrisisbegan

1998global?nancialcrisis2008global?nancialcrisis2014Crimea

2020Covid-192022Ukraine

104

102

100

98

96

94

92

90

0123456

QuartersarertheCrisis

Source:CSIS’scalculationsbasedon“FederalStateStatisticsService,GrossDomesticProduct,”CEIC,

/en

.

FinancialShockandRecovery

Duringthetwotothreemonthsfollowingtheirimposition,WesternfinancialsanctionshadasubstantialimpactonRussia’sexchangerateandbankingsector.CoordinatedsanctionstofreezetheCBR’sforeignexchangereserveswereprobablythemostunexpectedanddramaticearlyeconomicactionafterthewarbegan.

27

Thesanctionsrenderedroughly$300billionoftheCBR’s$630billionassetsmostlyuseless,exceptforthoseinChineserenminbiorgold,constrainingtheCBR’sabilitytointerveneinforeignexchangemarkets.Theruble’svaluefellfrom75rublesperU.S.dollarbeforetheFebruaryinvasiontoalowofaround120rublesperU.S.dollarinmid-March.

28

TheCBRimposedstrongcapitalcontrolsandraisedinterestratesfrom9.5percentto20percenttostemoutflowsandmitigateexchangeratepressures.

29

Meanwhile,worriedRussiansrushedtowithdrawtheirbankdeposits,contributingtofinancialdistressandaseverelackofbankingsectorliquidityinMarch2022.

30

Buttheperiodofacutefinancialstresspassed.Bymid-April,theruble’sexchangeratehadrecoveredtoitsprewarlevel,thoughthisissomewhatmisleadingbecausetherubleisnolongerafullyconvertiblecurrency(Figure3).BankingsectorliquidityreturnedtosurplusinApril.TheCBRbeganloweringitsbenchmarkinterestrateinAprilandsubsequentlyreturnedtoitsprewarrateinJune.MostRussianstemporarilylostaccesstotheirforeigncurrencydeposits,whichhadbeenforcefullyconvertedtorubles,butcapitalcontrolseasedinMaytoweakentherublebecauseitwasthreateningthecompetitivenessofRussianexportsandruble-denominatedbudgetrevenues.

31

8|BearingtheBrunt

Figure3:ExchangeRateofRussianRuble,January2021–February2023

RUB/USD

130

120

110

100

90

80

70

60

50

40

01/202104/202107/202110/202101/202204/202207/202210/202201/2023

Note:DataasofFebruary14,2023

Source:“BankofRussia,ForeignExchangeRate:BankofRussia:USDollar,”CEIC,

/en

.

SustainedTradeSurplus

Russia’senergyexportsonlypartiallymitigatedtheimpactofsanctionsandexportcontrolsin2022.Russia’scurrentaccountsurplus,whichincludesitstradebalanceingoodsandservicesplusincome,increasedaftermid-2021becauseofhigherenergyprices.InOctober2022,itreachedanall-timehighof$245billiononanannualizedbasis,equaltoroughly10percentofRussia’sGDP.TheCBR’sreportedreserveassets,whichcountfrozenforeignaccounts,fellfromapeakof$643billioninFebruaryto$540billioninSeptemberbeforerecoveringtoabout$600billioninearlyFebruary2023.

32

Russiamaintainedasubstantialtradesurplus,allowingthecentralbanktostabilizetheexchangerateandgivingthebankingsectoraccesstoforeignexchange.

Russia’sexportsincreasedmorethanitsimportsdeclinedin2022.TheRussiangovernmentstoppedpublishingtradedatainearly2022,butitispossibletoestimatethevalueofRussia’simportsandexportsbyusingstatisticsfromothercountries.Basedondatafrom51othercountries,theauthorsestimatethatin2022,Russia’sexportsincreased$104billionyearoveryearwhileitsimportsfell$70billion.AnOctober2022studyfromBruegelestimatesthatfromJanuarytoSeptember2022Russiagenerated$120billioninextraexportrevenuebecauseofhigherprices,especiallyfornaturalgas.

33

Russia’simportsdroppedsubstantiallyafterthewarbeganbutpartiallyrecoveredduringthesummerof2022.Basedonmirrortradestatistics,Russia’sgoodsimportslikelydecreased50percentfromMarchtoMay2022comparedtothepreviousthree-monthperiod.Russia’stotalimportsin2022fellto$223billionfrom$294billionin2021(Figure4).

34

9|GerardDiPippoandAndreaLeonardPalazzi

60

50

40

30

20

10

12

10

8

6

4

2

Figure4:Russia’sForeignTrade,January2013–December2022

USD,billions

Exports(oicial)Imports(oicial)Exports(estimated)Imports(estimated)

0

2013201420152016201720182019202020212022

Note:Estimatesbasedon51countries’reportedtradewithRussia.

Source:CSIS’scalculationsbasedon“Nationalsources,ImportsandExports:Russia,”CEIC,

/en

.

Russia’simportshaveshiftedawayfromadvancedeconomiesinfavorofafewemergingmarketeconomies,especiallyChinaandTurkey.In2022,EUandU.S.exportstoRussiafellfellby40percent($43billion)and73percent($4.7billion),respectively,comparedto2021.Meanwhile,exportsfromChinaandTurkeytoRussiaincreasedby13percent($8.7billion)and62percent($3.6billion),respectively,thoughdatafromTurkeyprobablycapturetransshipmentsreroutedfromothercountries.

35

ChinahasovertakentheEuropeanUnionasRussia’stopsourceofimports,withRussia’simportsfromChinaincreasingasashareofitstotalimportsfrom25percentin2021toanestimated34percentin2022(Figure5).

36

Figure5:China’sGoodsTradewithRussia,January2019–December2022USD,billions

ExportstoRussiaImportsfromRussia

0

01/201907/201901/202007/202001/202107/202101/202207/2022

Source:CSIS’scalculationsbasedon“GeneralAdministrationofCustoms,China:ImportsandExports:Russia,”CEIC,

https://www

.

/en

.

10|BearingtheBrunt

However,EUexportsofmachineryandothermanufacturedgoodstoCommonwealthofIndependentStates(CIS)countrieswereabnormallyhighattheendof2022,suggestingtransshipmenttoRussiaisoccurring.

37

Russia’ssemiconductorimportshaveshiftedawayfromtheUnitedStatesandGermanyastopproviderstowardChinaandHongKong,withWesternchipsprobablyreachingRussiathroughintermediaries.

38

ToreduceexposuretoWesternsanctions,RussianentitieshavepivotedtotheChineserenminbiforsomeinternationaltransactions.InternationalrenminbitransactionscanbeprocessedviaChina’sCross-BorderInterbankBankPaymentSystem(CIPS),whichprimarilyusesSWIFTformessagingbutalsohasitsownmessagingsystem.

39

CIPSdoesnotreportitsvolumesbycountry,butoverallCIPStransactionsincreasedfromRMB374billion($59billion)perdayinthefirstquarterof2022toRMB421billion($59billion)inthefourthquarter,whichmightreflectgreaterrenminbi-basedChina-Russiat