Western supplies of military kit to Ukraine – including last week’s decision by the U.S. and German governments to send tanks – have been the real game-changer in the country’s defence against Russia’s invasion.
Export controls on military-useful equipment, including dual-use technologies such as semiconductors, have also degraded Putin’s war machine. Now loopholes are starting to appear, such as supplies of chips from China, according to a report by the Silverado think tank. Western governments should tighten up these controls.
Economic sanctions have played a smaller role in curbing Putin’s power. The decision by the United States, Europe and others to freeze about $300 billion in Russian central bank reserves has been useful in cutting the size of the piggy-bank Putin has to bribe his way around export controls.
By contrast, sanctions on Moscow’s exports of oil and gas have so far done more harm than good. They haven’t crippled Russia’s economy and haven’t forced Putin to withdraw.
In the initial aftermath of the invasion, Western allies mostly issued threats to stop buying Russian oil and gas. That still helped push up energy prices, giving Putin a bonanza. Russia’s current account surplus doubled to $227 billion last year.
Global inflation shot up. European consumers had to pay through the nose to secure alternative sources of energy and governments racked up large fiscal deficits to cushion the impact on businesses and households. This led to tensions between those countries which could afford to do so, such as Germany, and those which couldn’t.
Meanwhile, emerging economies led by China got a big discount on the oil they bought from Russia. It is hardly in Western interests for the People’s Republic, its biggest geopolitical and economic rival, to benefit from cheaper energy.
CASE FOR TIGHTER SANCTIONS
This has not stopped some from arguing that the Western allies should double down on sanctions against Russian hydrocarbons. A recent report from the Kyiv School of Economics argues that the G7 leading economies should lower their price cap on Russian oil from $60 a barrel to $50, and then perhaps to $30-35. Europe should also ban all remaining imports of Russian gas, except that which goes through Ukraine.
The KSE report argues that times have changed. Whereas Europe was vulnerable to a sudden loss of Russian energy imports last year, now Putin has his back to the wall. Europe has done a remarkable job building up alternative energy sources, so it no longer depends on Russian gas. Prices have fallen back to pre-war levels.
Meanwhile, global oil prices have fallen sharply from their peak, while the Kremlin has to offer a discount of about $30 a barrel compared to the global benchmark to shift its oil. The government is running a budget deficit which could reach about 6% of national income this year, says Tim Ash, a strategist at BlueBay Asset Management. The current account surplus has shrunk and it has suffered massive capital flight.
Russia’s revenue from exporting hydrocarbons is already set to halve to about $180 billion this year, says Jacob Nell, one of the authors of the KSE report. Further restrictions would knock a further $40 billion off that figure, with two-thirds coming from lower oil revenues and a third from gas.
Nell says this could push the Russian economy over the edge. The rouble could collapse and inflation soar, leading to bank runs and further capital flight. The government would have to jack up interest rates and cut back spending.
The Kremlin could respond with drastic measures such as stringent capital controls or printing money. But these would make the government unpopular, undermining Putin’s government and increasing the pressure to pull back from Ukraine.
THE CASE AGAINST…
But things might not play out that way. Russia could cushion any blow from lower energy exports by selling some of the central bank reserves that aren’t frozen. And it might not even need much of that cash. After all, the Kremlin wouldn’t just accept a unilateral cut in the price of oil it sells to $30.
Russia could push up the global price by carrying out threats to reduce its oil exports. It would presumably have to offer customers such as China an even bigger discount, as buyers wouldn’t have access to Western shipping and insurance. But if the global price rose enough, Russia might still earn similar amounts at lower volumes.
A similar dynamic could play out with gas. True, Russia can’t easily redirect the gas it pipes through Turkey. But the global gas price would rise, and Russia could direct the liquefied natural gas it currently sells to Europe to other regions.
What’s more, even if tighter sanctions further damage the Russian economy, that might not unseat Putin or end the war. The lesson from countries like Iran and North Korea is that regimes don’t bend even if their people suffer hardship.
But the real worry is that sanctions might backfire on Western countries which are just getting their breath back after last year’s shock. The consensus in financial markets is that any recession will be short and shallow, and that many countries will avoid a downturn altogether.
A sharp increase in oil and gas prices would change that calculus. Fears over recession, inflation, interest rates and budget deficits would be back, and with them concerns over the political consequences.
Nationalist politicians who are sympathetic to Putin would find new supporters on both sides of the Atlantic. The biggest risk would be that America elects an isolationist president next year and the flow of arms to Ukraine stops. With Kyiv benefiting from military support and the gains from tighter sanctions uncertain, trying to bankrupt Russia is not worth the risk.