Situation Report: A closer look at the impact of E.U. and U.S. sanctions on foreign businesses in Russia

Western sanctions against Russia are backfiring. Four years on, they have strengthened Russia’s domestic production while creating compliance and reputational risks for Western multinationals. That Western countries are now effectively placing sanctions on each other makes the anti-Russian response even less tenable.

Background 

On 29 June, the E.U. agreed to extend economic sanctions against Russia for six months over the conflict in Ukraine. The extension comes amid deteriorating relations between Brussels and Moscow, following claims that Russia was responsible for the poisoning of a former Russian spy in Britain in March.

The current set of economic sanctions, due to expire on 31 July, were originally introduced in 2014 in response to Russia’s annexation of Ukraine’s Crimean peninsula that year, and Moscow’s continued support of pro-Russian separatists in eastern Ukraine. Even though some E.U. member states, including Greece and Italy, have called for a lifting of the restrictive measures, the bloc’s foreign policy chief, Federica Mogherini, said on 25 June that there was no indication that Russia was respecting the 2015 Minsk peace agreement that sought to end the conflict. There have been repeated ceasefire violations on both sides.

Earlier in June, the E.U. announced that it would extend a separate set of sanctions prohibiting E.U. nationals and companies from doing business in Crimea. These will apply until June 2019. For instance, the sanctions prohibit real estate companies from acquiring assets in Crimea, and ban the export of goods to the disputed region that could be used in the transport and telecommunications sectors.

In addition to the economic sanctions, the E.U. imposed travel bans and asset freezes, enabling law enforcement authorities to seize property as well as funds in bank accounts, on 155 individuals and 38 entities. Those on the list include government and military officials as well as armed separatist groups in eastern Ukraine.

The U.S. imposed similar sanctions against Russia in March 2014 and in September that year it extended earlier measures to ban U.S.-based companies from selling equipment that could be used for oil and gas exploration by Russian state-owned energy companies, such as Gazprom and Rosneft.

Impact on the Russian economy and local businesses

The E.U. and U.S. sanctions have had little overall effect on the Russian economy. This is partly due to the rising price of oil, Russia’s major export, which has offset the impact of the sanctions. Oil and natural gas products account for about 50 per cent of Russia’s exports, and the price could rise further. The World Bank projects oil prices to average USD65 per barrel in 2018 and 2019, up from an average of USD60 last year, with prices expected to rise to USD66 per barrel in 2020.

Russia’s unemployment rate is well below that of many E.U. member states. In April, unemployment fell to 4.9 per cent, a decrease from a 5 per cent rate in the previous month and the lowest since August 2017. The country’s central bank also expects GDP to grow between 1.5 and 2 per cent this year. Russia is also experiencing a decline in population, and the United Nations predicts that the country’s population could fall to 119 million by 2050, a considerable decrease from its current population of 144 million. As part of the economic sanctions the E.U. has imposed a ban on trading weapons with Russia, as well as limiting its access to E.U. capital markets for five majority state-owned Russian financial institutions and their subsidiaries. European Union nationals and entities are prohibited from providing loans to Russian financial institutions for more than 30 days.

The most effective set of measures against Russia have been those imposed by the U.S. government in April, over allegations Moscow interfered in the 2016 U.S. presidential election. The sanctions list includes 24 senior figures, such as Russian businessmen Oleg Deripaska, who previously served as the president of Moscow-based aluminium manufacturing company Rusal and still holds a stake in the company, and Viktor Vekselberg, the founder of Renova Group, a Russian investment company with interests in the metals and energy sectors. Rusal was also sanctioned as part of the measures, causing the company’s stock price to fall by about 40 per cent.

In April, the U.S. government indicated that it would ease sanctions against Rusal if Deripaska divested from the company. The sanctions against Rusal, which employs more than 52,000 workers, have heightened Russian concerns about job security, particularly in towns and cities whose economies rely on a single industry – known as ‘monogorods’ – heightening the risk of social unrest in the country.

Impact of U.S. and E.U. sanctions on foreign businesses in Russia

One significant impact of the sanctions has been an outflow of capital from Russia. According to figures by the Higher School of Economics (HSE), a Moscow-based research institute, capital outflow is likely to rise to about USD49 billion this year due to the sanctions. This is in line with A2 Global’s forecast in August 2017 that foreign direct investment (FDI) was unlikely to increase over the one-year outlook. E.U. sanctions have significantly curtailed FDI and loans from the E.U. to Russia; the E.U. accounted for about 75 per cent of all FDI and lending to Russia before 2014.

However, it is important to note that this outflow is not necessarily negative for Russia itself, at least in the short term. This is especially the case if European investors are selling off their assets cheaply to their Russian competitors. If anything, the sanctions have had a worse impact on Western companies than their Russian counterparts.

Companies caught violating the sanctions have been prosecuted. In May 2018, authorities in the Netherlands launched a probe into seven Dutch companies over allegations that they had supplied equipment used for the construction of the Kerch Strait bridge, which links Russia with Crimea. The construction companies, which include Bijlard Hydrauliek and Dematec Equipment, face fines of up to EUR820,000 if found guilty, but have denied knowingly supplying equipment for the construction of the bridge.

Moreover, Ukrainian authorities confirmed in January that they have been investigating several multinationals, including German sports brands Adidas and Puma, over allegations that the companies continue to operate in Crimea. While Adidas denied claims that it was supplying retailers in Crimea – which would be a violation of E.U. sanctions – it nevertheless faced a backlash in Ukraine after the country’s deputy defence minister, Oksana Markarov, openly supported a boycott initiated by social media users against Adidas in May. The boycott targeted Adidas after a local subsidiary of the company released a collection of sportswear which included symbols of the former USSR national football team ahead of the Fifa football World Cup.

The sanctions on Russia have also had an indirect impact on foreign businesses in the country. Following the imposition of E.U. and U.S. sanctions in 2014, authorities responded by carrying out nationwide sanitary inspections of restaurants owned by U.S.-based fast-food chain McDonald’s, leading to the temporary closure of three branches in Moscow, including one in the central Pushkin square. In April, McDonald’s announced that the fries served at its restaurants across the country would be made with Russian-grown potatoes because the U.S. sanctions had caused a depreciation in the rouble, making imports of raw potatoes more expensive. This again shows how sanctions can sometimes redound to the benefit of the target country.

Further weakening the sanctions is a growing divide between Europe and America. France and Germany had opposed the U.S. sanctions against Rusal because their industries sourced aluminium from the company. Now, the U.S. and E.U. are imposing trade sanctions on each other. On 22 June, the E.U. imposed retaliatory tariffs on a range of U.S. products after Washington introduced duties on steel and aluminium imports from the bloc earlier in June.

Energy supplies are another point of difference. As we pointed out in our August 2017 Monthly Insight, low levels of natural gas production in Europe are likely to increase the continent’s dependence on imports from Russia over the next few years, and Germany is expected to import 50 per cent of its natural gas supplies from Russia by 2025. In recent months the U.S. government has warned that it would impose sanctions on Nord Stream 2, the second phase of a major pipeline project which would transport natural gas from Russia to Germany through the Baltic Sea. The U.S. has consistently opposed Nord Stream 2, which is under-construction and will cost approximately USD11 billion. The project relies on financing from several E.U.-based companies including French energy utility Engie and Anglo-Dutch oil and gas major Royal Dutch Shell.

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