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Why the U.S. Will Keep Russian Sanctions on Simmer, Not Boil

8 MINS READAug 27, 2018 | 10:00 GMT
U.S. Senate Majority Leader Mitch McConnell, left, and an aide walk toward the Senate chamber in the U.S. Capitol on Feb. 12, 2018.
(ALEX WONG/Getty Images)

U.S. Senate Majority Leader Mitch McConnell, left, and an aide walk toward the Senate chamber in the U.S. Capitol on Feb. 12, 2018. A bipartisan group of senators is planning to ramp up the sanctions against Russia, but Washington is unlikely to go to extremes in pressuring Moscow.

Highlights
  • The United States will almost certainly impose more sanctions against Russia in the coming months, but the extent of the measures will be a product of deliberation and compromise between the U.S. Congress and the Trump administration.
  • Russia's efforts to strengthen financial stability and diversify its economic ties as part of its strategy to insulate itself from sanctions will enable Moscow to avoid any major economic disruptions — at least in the near term.
  • Despite the increase in sanctions, the United States and Russia will nevertheless continue to conduct negotiations on issues of contention, including arms control and Syria.

The standoff between the United States and Russia shows no signs of abating, and nowhere is the discord more apparent than in Washington's use of sanctions against Moscow. Washington expanded its sanctions against Moscow on Aug. 27 by banning the export to Russia of sensitive national security-related goods, including calibration equipment and gas turbine engines, after the poisoning of former Russian spy Sergei Skripal in the United Kingdom in March. The present export ban is just the first installment of the sanctions measures, as a second round could enter force in 90 days if the Kremlin does not provide "reliable assurances" that it will stop using chemical weapons and permit the United Nations to conduct relevant inspections in Russia. If Moscow does not comply with the demands, the U.S. government could consider a raft of measures against the Kremlin, including a suspension of Aeroflot flights to the United States, a restriction of U.S. bank loans to Russian companies or a downgrade of diplomatic relations.

But hot on the heels of the present sanctions is a proposed bill that could challenge Russia. On Aug. 2, a bipartisan group of U.S. senators introduced the Defending American Security From Kremlin Aggression Act, under which Russia could face sanctions that affect its sovereign debt and energy projects because of its alleged interference in U.S. elections. The senators, however, might not succeed in passing their bill to the fullest extent, as some of their congressional colleagues have expressed concern that the new sanctions could go too far in punishing the Russian economy — and even affect the wider world. But regardless of the ultimate degree of U.S. actions, Washington is unlikely to forego sanctions as a weapon in its relations with the Kremlin.

The Big Picture

In its 2018 Annual Forecast, Stratfor noted that tensions were likely to rise this year between Russia and the United States and that Washington had signaled its intentions to increase pressure on Russia through a variety of means, including a heavier sanctions regime. The forecast has proven correct, as U.S. sanctions against Russia continue to expand.

How We Got Here

The United States has steadily ramped up its sanctions against Russia since 2014, the year Moscow annexed Crimea and lent support to a pro-Russian uprising in eastern Ukraine following the euromaidan revolution. Congress has been critical in gradually expanding the sanctions, especially through motions such as the Countering America's Adversaries Through Sanctions Act, which passed in August 2017. The legislation not only expanded sanctions against Russia but prohibited U.S. President Donald Trump from lifting any existing sanctions against Moscow in the absence of congressional approval of a detailed report of Russia's concessions on the matter. In essence, the changes have ensured that Congress, and not the president, wields the power to adjust sanctions against Russia.

Following the act's passage, the U.S. Treasury submitted a "Kremlin Report" that led to the implementation of harsh sanctions in April against a number of Russian oligarchs, their companies, government officials, a bank and others. The measures, however, particularly hurt the world's second-largest aluminum company, Rusal, and its owner, Oleg Deripaska.

In total, the Treasury Department's Office of Foreign Assets Control has targeted nearly 500 Russian individuals and entities with sanctions, depriving the affected firms of a quarter of their average revenue and costing the overall Russian economy tens of billions of dollars. And because of its dependence on the U.S. market, Rusal has suffered even greater losses, shedding more than 50 percent of its stock market value. The measures also forced Rusal's aluminum smelter in Nadvoitsky, in the Karelia region, to close as its operations are geared toward the United States. Elsewhere in Russia, Rusal plants have been compelled to stockpile aluminum supplies.

A graphic outlining two key pieces of U.S. legislation expanding sanctions on Russia.

Russia Crafts a Response

In response, the Kremlin has employed a longer-term strategy to insulate itself from sanctions, allowing Russia to weather the storm and avoid major economic disruption. Russia has revamped its fiscal and monetary policy and instituted an enhanced tax collection system under which it can balance its budget at a lower price of oil ($61 per barrel, instead of the previous $67) — though the steady rise in the price of oil since its crash in 2014 has also helped the country balance its budget and reduce its reliance on new issues of eurobonds. As a result, Moscow has raised its foreign currency reserves to over $450 billion and channeled more than $77 billion into its National Wealth Fund.

In the meantime, Russia's central bank has divested itself of most of its U.S. Treasury holdings while accumulating more gold, suggesting that Moscow is preparing for more serious sanctions to come. A higher value-added tax that will enter force next year will lower the price of oil that Russia needs to balance its budget even further to around $50, the lowest since 2008, while planned pension reforms — though politically unpopular — will aim to improve Russia's fiscal position over the longer term starting next year. Major Russian companies, including Norilsk Nickel and Alrosa, are experimenting with mechanisms to use rubles, instead of dollars, in settling payments to foreign customers in countries like China and India.

Ultimately, the U.S. goal in implementing sanctions against Moscow — as with other adversaries like Iran, Syria or North Korea — is to alter Russian behavior that clashes with the interests of Washington and its allies, particularly in regard to its involvement in the Ukrainian and Syrian conflicts, as well as its interference in elections in the United States and Europe. And, as a potential side bonus to Washington, the sanctions could even create rifts in the Kremlin, or between key oligarchs and the Russian government.

Time to Ramp Up the Pressure?

The impact of more sanctions will ultimately depend on the degree to which the United States implements the measures — a decision contingent on the result of deliberations among various branches of the U.S. government. After all, it is Congress that introduces most sanctions legislation against Russia, while it is up to the Treasury and the president to impose such measures.

If the United States takes the extreme step of implementing sanctions on Russian sovereign debt and banning Russia's biggest state banks, Moscow would face such staggeringly high borrowing costs that the country's central bank would need to step in to prop up the banking system. The full implementation of the Defending American Security From Kremlin Aggression Act would limit Russia's ability to contain the ruble's volatility, resulting in a rise in inflation. In the longer term, Russia would attract less investment and enjoy less access to Western technology and markets.

A graphic showing Russia's macroeconomic fundamentals

Unsurprisingly, Russia has warned of significant retaliation if the United States passes the act, with Russian Prime Minister Dmitri Medvedev dubbing such a move a "declaration of economic war." Until now, Russia has typically engaged in tit-for-tat retaliation to sanctions while also providing an asymmetrical response by playing the spoiler role in areas of strategic interest to the United States, including Syria, Ukraine and North Korea. The harsher the sanctions, the more damaging Moscow's reaction will likely be.

The Trump administration, however, opposes such a stark course of action. The Treasury Department has repeatedly warned that targeting Russian sovereign debt and banks could spread contagion and damage global financial markets because Russia holds over a third of its sovereign bonds outside the country. Several U.S. senators have also objected to the severity of such measures given the potential for a spillover — as already evidenced by the impact of the Rusal sanctions on global aluminum prices and exports. Accordingly, the Defending American Security From Kremlin Aggression Act is unlikely to be implemented in full.

Compromise in the Offing

More likely is a compromise between Congress and Trump in which Washington increases the economic pressure against Moscow, but not to the extent that it targets Russia's sovereign debt or imposes bank restrictions. But despite previous disagreements between Trump and Congress, as well as delays in implementing sanctions, the end result has always been greater sanctions, with Trump acquiescing — albeit reluctantly — to demands to increase economic pressure on Russia. Nevertheless, the Trump administration has indicated that it could ease or reverse sanctions under certain conditions, as indicated by the president's willingness to offer Russia concessions on Ukraine and Syria in exchange for sanctions relief or his attempts to persuade Deripaska to decrease his stakes in Rusal to free himself from Washington's sanctions.

Regardless, a measured increase in sanctions will not completely scuttle the broader negotiation process between the United States and Russia. Moscow and Washington will continue to hold talks on a range of contentious issues that could produce progress on issues such as arms control and Syria. (Indeed, U.S. national security adviser John Bolton sat down with his Russian counterpart, Nikolai Patrushev, in Geneva on Aug. 23.) But while the United States is unlikely to go to extremes in sanctioning Russia, it will continue to use the prospect of such measures as a means of shaping the countries' relationship in Washington's favor.

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