It’s Complicated: The Future of European Trade with Russia

August 08, 2021 | Russia

Executive Summary

New Western Sanctions against Russia are likely despite Limited Room for Maneuver

  1. Washington is readying new sanctions against Russia. Human rights violations pressure the EU to follow. With broad measures already in place, targeting Russian state enterprises and banks remain an option.
     

  2. European companies need to prepare for trade disruptions. Even though the risk of wide-ranging US secondary sanctions is low now, US primary sanctions can bite into EU-Russian financial transactions.
     

  3. Russia will continue to test the limits of how far it can go in alienating the West, leading to miscalculations among businesses and pushing Moscow closer to Beijing.

Watch out for

  • Clues on US sanctions strategy around the anni­versary of Navalny’s poisoning on August 20th.
     

  • Possible interference in German elections in September, triggering new sanctions.
     

  • A ruling in the Tiergarten murder case, with consequences in case of conviction.
     

  • Impact of the US-German deal over Nord Stream 2 on European sanctions policy.

Key Figures

  • 37,3%: EU’s share of Russian total trade in goods, making it the biggest trade partner, but down from 49.4 % in 2013.
     

  • 1.5-2.5% of GDP: The annual damage done by Western sanctions to Russia’s economy.
     

  • 6.5%: The Russian Central Bank’s key interest rate, the highest since 2014.
     

  • 5.7 to 6.2%: The Central Bank’s latest inflation forecast for 2021.

State of Play

In a Complex set of Relations, Improvement is not in Sight

Brussels has had sanctions in place since Russia’s invasion of Crimea in 2014 – but with limited success. In light of the poisoning of Alexei Navalny and the Kremlin’s human rights abuses, the US and Europe will continue to apply restrictive measures. Sanctions target strategic sectors of the Russian economy, particularly finance, defense, and energy. Consequently, Russia’s access to capital markets, military and dual-use goods, and critical technologies for energy projects will be limited. Key driver for Russia’s confrontational policy vis-à-vis the West is its quest for a sphere of influence in the post-Soviet space. Domestic Russian politics with parts of the elite benefitting from the confrontation play a role, too. Addressing the root causes of these tensions requires concessions from both sides. The US administration seeks to prevent further escalation in the conflict with Russia. With Putin’s primary goal to stay in power, the Kremlin, too, is interested in limited de-escalation. Still, sanctions from Brussels and Washington will remain the West’s main tools to push back against Russian activities.

Key Issues

Brussels aims to show some strength…

Expect more sanctions on Russia, even if the EU hesitates. The US and the UK are likely to target individuals linked to the poisoning of Alexei Navalny around the 20th of August. This will send a strong signal, especially to European banks, about the increase of geopolitical risks. The EU does not intend new sanctions for now. But, this will change should Russia interfere in German elections in September. The presumed involvement of the Russian foreign intelligence service in the 2019 murder of a Georgian national, dubbed a “second Skripal”, adds tension. Berlin will all the more show its teeth towards the Kremlin should the Green Party be part of the next government. Both the US and Europe further consider sanctioning Russia for its support of Belarusian dictator Alexander Lukashenko. Berlin and Washington have also vowed to act should Russia threaten Kyiv now that Nord Stream 2 is decreasing Ukraine’s importance as a gas transit country. Whilst new sanctions are not imminent, decision-makers in Brussels can conclude that they have no other choice.

 

Yet, the EU and the US have few options left. New personal sanctions against Putin’s cronies and oligarchs are possible. However, they will not cause defections in the elite unless the US is ready to extend them to a broad range of individuals. An alternative is new US sanctions on Russian state enterprises or big banks. The US Treasury can tighten existing sanctions on Russian entities like the development bank VEB. This effectively takes it off the international financial system and threatens to hit bigger banks like VTB. US President Joe Biden will not, for now, impose secondary sanctions that threaten European companies in their dealings with such entities. But, in this case, companies would be unable to make transactions through American banks or the dollar system. Their European banks can stop financing or clearing for exports, and pull out of contracts to avoid risks. Should Moscow move against Ukraine, it runs risk of losing access to the financial messaging platform SWIFT, curbing most international trade. Also, companies involved in Nord Stream 2 are still at risk of direct US sanctions despite the recently achieved deal. Concretely, Washington can demand Berlin to stop the gas from flowing through the pipeline in an escalation of tensions over Ukraine.

…while Russia is back to Power Play

Even though Western policies cause economic pain to Russia, the economy has largely adapted to the new status quo. Existing sanctions do not constitute a serious challenge for the country’s leadership. Domestically, sanctions empower isolationist forces within the elite. Particularly, the import substitution lobby and law enforcement agencies have increasingly become the regime’s backbone. Moreover, the Western arsenal against Russia without disrupting the global economy – as might a limited oil embargo – is exhausted. Still, the Kremlin does not want to overplay its hand and risk a significant increase in US and EU pressure. Instead, it will seek to use Biden’s declared desire to stabilize relations. At the same time, Russia will continue to sow divisions in the Transatlantic community by directly engaging Germany and France. Moscow correctly believes that the West does not have significant leverage in places like Syria, Belarus, or the Southern Caucasus. Russia is therefore likely to continue its bold policies in those regions while trying not to provoke the West through interference in democratic processes. Vocal support for parties like the AfD through Moscow-controlled echo-chambers on social media is nonetheless possible.

 

At the same time, estrangement from the West and sanctions are pushing Moscow closer to China. Beijing is rapidly increasing its share as Russia’s trading partner and source of advanced technology at the expense of the EU. China’s share in Russian foreign trade grew from 10.5 percent in 2013 to 18.3 percent in 2020, as Europe’s decreased. In 2016, China overtook Germany as the major source of Russian imports of industrial equipment. In 2019 Russia imported nearly three times more worth of industrial tools from China ($30.8 billion) than from Germany ($12.8 billion). The growth of Chinese influence in the post-Soviet space is perceived as an inevitable by-product that Russia lacks the tools to properly address. The increasing Sino-Russian power asymmetry does cause some concerns in Russia. However, its short-term stability paradigm and the emotional investment in a confrontation with the West prevent its leaders from changing course.