Re-Blogged From Stratfor
- Washington will increase pressure on Moscow in 2018 through a series of expanded sanctions aimed at Russia’s financial stability, elites, reputation and defense industry.
- Russia will weather the increased pressure by further insulating its economy, oligarchs and companies, placing additional responsibility for the country’s stability on the Kremlin.
- The Russian government can maintain its position next year, though its resources are growing slim and the Kremlin faces a pivotal series of elections.
(MARK KOLBE/Getty Images)
Heading into the new year, tensions between Moscow and Washington show no sign of abating. The United States is continuing its investigations of Russian interference in the 2016 U.S. presidential election; both sides have accused each other of arms treaty violations; and both countries are continuing to build up their positions across the globe as they prepare for a long-term struggle. In addition, the United States has specified four areas — each with varying effects and degrees of political fallout — for further sanctions against Russia. The added pressure on the Kremlin comes as President Vladimir Putin faces re-election and Russia grows increasingly fragile.
Sanctions in Place
Since the Soviet period, the United States has targeted Russia with numerous sanctions. The primary ones currently in effect were instituted over human rights violations and the conflict in Ukraine. In late 2012, the United States expanded its Soviet-era sanctions over human rights and approved the Magnitsky Act to punish those deemed responsible for the death of Russian tax accountant Sergei Magnitsky, a whistleblower who investigated Kremlin abuses and a tax-fraud scheme. The act penalizes dozens of people believed to be involved in the case, but the measure has evolved into a platform for the United States and its allies to punish- Russia for a much wider scope of human rights abuses.
The Ukraine sanctions imposed by the United States (and, to a lesser extent, by the European Union, Canada, Australia and Japan) stem from Russian involvement in the conflict there and includes the conflict in eastern Ukraine, Russian support of the previous government, the downing of Malaysia Airlines Flight 17 and the annexation of Crimea. Those penalties include:
- Limits on debt issuance to Russia’s six largest banks, four primary state oil firms and four state defense firms.
- Sanctions on Russia’s energy industry, prohibiting U.S. firms from providing, exporting or re-exporting goods and technology related to deep-water, Arctic offshore and shale oil and natural gas projects in Russia.
- Bans on subjects receiving dual-use goods by Russia’s primary state defense companies.
- Sanctions (travel and asset freezes) against hundreds of Russian entities and individuals.
But the effects of these sanctions on Russia are open to debate, because low oil prices plunged the country into a recession in the same year that some of the penalties were implemented. And Russia insulated much of its economy as ties soured with the West. It has curbed Western imports by building up its domestic capabilities (including in food, credit services and online infrastructure) and by looking to the Asia-Pacific and the Middle East for investment partners and some level of trade. The sanctions did bite into some key energy projects, such as the giant oil deal with Exxon Mobil Corp., and they will have a long-term effect on Russia’s oil production. But much to Washington’s chagrin, Moscow has, for the most part, weathered the penalties.
During the past year, Washington has drafted a string of sanction options; some were extreme, such as cutting off Russia from Western-based financial and credit systems. But four key subjects — sovereign debt, oligarchs, human rights and defense — are moving into range as targets of expanded sanctions. In July, the U.S. Congress wrested the power to directly withdraw the Russian sanctions away from the presidency, and lawmakers now require that changes to the sanctions regime go through them first. President Donald Trump signed the Countering America’s Adversaries Through Sanctions Act in August, and it included provisions for expanding penalties in the coming years.
Beginning in February, the U.S. Treasury Department will submit the details on possible expanded sanctions, though their general targets — sovereign debt and oligarchs — are already known. These penalties are connected mostly to the U.S. investigation into Russian interference during the 2016 presidential election, which has sent U.S. perceptions of Russia plummeting — particularly in Congress.
The Sovereign Debt Squeeze
In its February report, the Treasury Department will detail the effects on Russia and the global market of possible sanctions on U.S. citizens who buy new Russian domestic government debt. Current sanctions prevent certain Russian companies (such as its largest bank, Sberbank, and oil giant Rosneft) from issuing bonds to Western investors, but they don’t prevent the government from issuing the debt. So the Kremlin has been taking on sovereign debt and reportedly transferring it to its sanctioned firms. In 2017, foreign investment in Russian government debt rose from 5 percent to 30 percent of the total $25 billion in bonds issued. Among many Western financial firms, Russian government bonds have been considered some of the best performing in emerging markets this year.
In 2018, the Russian government expects to borrow an additional $18 billion to supplement its federal budget, which is already slim for the year. While the country is pulling out of a recession, it is also settling into a prolonged period of economic stagnation. Moreover, the Russian people and many of the country’s strategic firms and banks are facing even more difficulties, forcing the Kremlin to take on increased financial burdens to ensure the economic system doesn’t destabilize and to mitigate popular backlash. The Kremlin will likely draw on much of its reserve funds to stay afloat, while borrowing more heavily internationally.
If the United States implements sanctions on Russian sovereign debt, Western investors (beyond American) could be spooked away from buying it. The Russian Finance Ministry said in mid-December that the government would not try to issue bonds ahead of the February report; it was confident Moscow had enough non-Western connections to purchase its future debt. Russia has spent much of its energy in recent years strengthening its relationships in the Asia-Pacific and the Middle East to mitigate pressure from the West. So expanded sanctions on Russian sovereign debt would be a hindrance, but not a burden heavy enough to change Russian behavior.
Pinching the Oligarchs
Another sanctions option that has caught the Kremlin’s attention will be part of a second U.S. Treasury Department report to be released in February. It will outline the most significant Kremlin-tied oligarchs, the silovarchs, their net worth, evidence of corruption, their business ties abroad, their assets abroad and their sources of income. Their families (wives, children, parents and siblings) and associates will be subject to sanctions, as will their assets. In addition, their children could even be prevented from studying abroad. The scope of this option is starkly different from the current sanctions on Russian personalities. Those Kremlin-tied oligarchs mostly keep their assets and lives inside Russia, and they are also directly tied to Russian foreign policy — mostly to the conflict in Ukraine. Expanding the list to the oligarchs and silovarchs who are Putin’s personal cronies comes closer to directly targeting the president.
And among members of the general oligarchy, concern has spread that they may get roped into sanctions under this investigation. These elites are holdovers from the chaotic 1990s and are not necessarily loyal to Putin. They typically hold vast sums of money, assets and business interests abroad, and most of them are tied to the Kremlin because they need Putin’s support. Names floated among the media are mostly the surviving oligarchs of the metals and energy industries: Oleg Deripaska, Roman Abramovich, Mikhail Fridman, Alisher Usmanov and Mikhail Prokhorov. According to The Moscow Times and RBC media group, Russian oligarchs have flooded Washington with lobbyists and lawyers, who have reportedly suggested that the oligarchs divorce their wives and put their assets in the names of their now ex-wives to protect them. On a side note, the oligarchs have also reportedly threatened Forbes Russia to not publish its annual list of Russian billionaires. In early December, Russian media reported that Forbes would pull back on the list, though it didn’t confirm or deny that it was acquiescing to the oligarchs.
After Putin’s crackdown on the oligarchs during his first decade in power, the remaining handful of businessmen running major non-state firms are powerful. The Kremlin relies on these oligarchs to maintain non-state businesses, to shore up the country’s financial sector and to supply the livelihoods for the many regions and cities dependent on a single industry. Should they come under U.S. attack for a foreign policy they are not responsible for, then they may turn on Putin and his administration, destabilizing the already tense system of elites.
Unnamed sources in Washington told the newspaper Izvestia that the list of oligarchs and businessmen drawn up by the U.S. Treasury Department won’t be released publicly. The move is probably intended to prevent those people from moving their funds and shifting their business ties to duck sanctions. In addition, the Izvestia report claimed that the list would be shared with the United States’ European partners to attempt to persuade them to not do business with those on the list. That move is likely just a recommendation, because most Europeans are not fully behind expanded sanctions, which could harm their economies and businesses. And concern about the U.S. use of this sanction option sparked increased capital flight from Russia by foreign investors during November and December.
On Dec. 21 Putin called a large bunch of the oligarchs to the Kremlin; such a call typically means the government is going to demand that the billionaires flush cash into the Russian system to keep it stable. Such a demand was issued last month, but the most recent sit-down was starkly different. The Kremlin offered to help the oligarchs move their money safely from abroad by using Eurobonds to protect it from U.S. targeting. The Russian Central Bank and Finance Ministry assured the businessmen that the infrastructure to move foreign currency investments in bulk back to Russia had been put in place. Unofficial reports claim the Russian government will float $3 billion in Eurobonds, but not through the typical security accounts, such as Euroclear or Clearstream — which are required to notify the U.S. Treasury Department. Instead, the float would be available to anonymous Russian investors directly, though it is unclear what system Moscow will use instead.
Magnitsky and Human Rights
Though the Europeans are not necessarily on board with either of the aforementioned measures, they could agree to sanctions over human rights. The United States has expanded the Magnitsky Act over the years, turning it from a vehicle for sanctions on people responsible for the Russian accountant’s death to one targeting global human right offenses. The original act was adopted by a handful of Western allies, including Canada, the United Kingdom, Estonia and Lithuania. The only high-ranking individual on the sanctions list until recently was Alexander Bastrykin, head of Russia’s Investigative Committee.
However, on Dec. 20, the Treasury Department expanded the list to include one of Russia’s most powerful and controversial figures: Chechen leader Ramzan Kadyrov. He is accused of being involved in a purge of homosexual men in his region this year. Dozens of gay or bisexual men have fled Chechnya, though Kadyrov denies the accusations. He responded in his usual way: with a rant on Instagram. He blasted the sanctions, then mocked their impact because he says he has no assets in the United States and doesn’t want to travel there.
This fall, Canada introduced its own version of the Magnitsky Act and sanctioned 52 people tied to the case. Ottawa is also using the act as blanket legislation to target global human rights offenses, though it is primarily aimed at Russia. The United Kingdom, as well, is considering expanding its Magnitsky-style bill in February. And France, South Africa and Ukraine are all considering introducing similar measures against Russia next year.
The Magnitsky Act and related bills do not directly hit the Kremlin or Russia. However, Putin has repeatedly noted that he takes personal offense to the measures. For an autocratic leader who has aggressively consolidated power and has not shied away from conflicts abroad, this sentiment may seem peculiar. But this issue is reportedly one of the primary demands Russia has repeatedly raised in larger negotiations. Putin seems to believe that the act undermines his reputation at home and abroad. Now that the act is expanding to his closest loyalists, the issue is likely rising in the Russian leader’s priorities.
Targeting the Defense Industry
Next year the United States is likely to impose sanctions on Russian defense companies that provide technology or development that violates the Intermediate-Range Nuclear Forces Treaty (INF Treaty). The United States and Russia have repeatedly accused each other of violating the 1987 arms-control pact, which bans a buildup of intermediate-range nuclear missiles in Europe. In November, U.S. Defense Secretary James Mattis presented NATO allies with an ultimatum to join U.S. punitive measures on Russia over the INF Treaty. The U.S. Commerce Department is preparing a list of companies believed to be involved in developing weapons that violate the treaty.
The Cold War arms treaties have long been a bone of contention between Moscow and Washington, and they have grown obsolete as both sides have been developing missiles that could violate the treaty and as arms programs have proliferated to many other powers who are not bound by the pact’s restrictions. Putin said in his recent televised news conference that the treaty was all but dead. The United States is already planning to increase force deployments in Europe and expand missile defense programs — both against Russia’s wishes.
Despite the INF Treaty technically still being in place, Russia is already responding to U.S. sanctions over the agreement. Putin ordered 77 defense firms to ensure that they can develop equipment and parts currently imported from the West. The Russian government has also decreed that all purchases made by its Defense Ministry and various security services should be made in secret. All documentation of contracts, registrations, purchases and permits by these agencies and their contractors will be issued in closed tenders and classified as state secrets. Banks and financial institutions will also mark such transactions as classified.
With increased financial allocations for the defense industry, Russia is also preparing for the eventuality of a break in the treaties. However, Putin has said Russia will challenge the United States if there is a renewed arms race, but he would not bankrupt the country to do so, reflecting a lesson the longtime Russian leader learned from the mistakes of the Soviet Union.
So for the United States and Russia, 2018 is shaping up to be another contentious year. While Washington is laying out the tools it can use against Moscow, Russia is getting ready for even tougher relations by insulating its economy and building bridges to the Asia-Pacific and the Middle East.