Spillover Effect: Russia’s economy may face a new wave of sanctions stress at the beginning of the year

Russia may face a second wave of sanctions: the changing conditions on the oil market and the newly introduced US Treasury Department authority to impose secondary sanctions against legal entities and individuals for assisting Russian military production will make the Russian economy feel the pressure of previously imposed restrictions. The new measures by the US administration are aimed at ensuring the effectiveness of the ban on supplying Russia with so-called critical goods used in the military-industrial complex. These goods include not only machinery and electronics but also, for example, petrochemical products. While these products are not supposed to be supplied to Russia, controlling such restrictions has proved to be ineffective, and pursuing suppliers has been inefficient. Now, secondary sanctions threaten not only companies supplying banned products, but also all their counterparties, including banks that provide them with certain services. The new control mechanism and the uncertainty over the boundaries of its application have created a 'spillover effect', or side effect. In the initial months of the new rules, Turkish banks drastically limited the processing of any payments from Russia and began closing accounts of Russian companies. Chinese banks also restrict cooperation with clients from Russia, albeit less actively for now. Two years of the war have demonstrated that ways to circumvent sanctions are invariably found. However, each time, this incurs additional costs. In the case of constant monitoring by the US Treasury Department of circumvention schemes, the 'spillover effect' will reoccur repeatedly.

Ukraine's allies are finding it increasingly challenging to reach consensus on new sanctions against Russia, especially as the European Union's economy faces a less-than-ideal situation. For this reason, the current discussion surrounding the 13th package of European sanctions, timed to coincide with the second anniversary of the Russian invasion, is said to have a ‘symbolic character,’ according to sources cited by Politico. At the same time, the notion that the Russian economy has 'digested' the effects of the already imposed sanctions may be premature. On the contrary, there is a possibility that Russia will face a second wave of effects from these sanctions. As Re:Russia has previously reported, changes to the oil market are reestablishing the effectiveness of the ‘price cap’, with buyers demanding bigger discounts on Russian oil. On the other hand, a serious challenge to Russian producers comes from a directive issued by US President Joe Biden at the end of December 2023, which gave the US Treasury Department's Office of Foreign Assets Control (OFAC) the right to impose secondary sanctions against entities and individuals for assisting Russian military production.

The new measure is designed to further restrict supplies to Russia of so-called critical items used in the military and technology sectors. These critical items include, among others, computer numerical control machines, nitrocellulose, precision ball and roller bearings, lubricants for turbines, additives for lubricating oils, internal navigation systems, fibre-optic gyroscopes, etc. Experts from the CEPA analytical centre draw special attention to the mention of petrochemical products in this list. Despite having vast oil reserves, Russia has been unable to establish independent production of turbine lubricants and additives used in servicing heavy military equipment. Before the war, these were mainly purchased from American and European companies, now they come from Chinese and Korean companies. But imports from these countries are insufficient. Accordingly, even partial restrictions will create problems. One of the subsidiaries of ‘Sibur’ is attempting to establish domestic production. However, in order to do this, it needs to purchase equipment and then to establish raw material supplies, which are also subject to sanctions.

However, the issue goes beyond this. In the first month of the new restrictions, their result was more significant than could be expected due to the 'spillover effect'. Thus, since the beginning of 2024, Turkish banks have restricted the processing of any payments from Russia, closed the accounts of some Russian companies and even tightened the requirements for individuals who want to get ordinary bank cards. The powers granted to the Office of Foreign Assets Control (OFAC) are broad, and the application procedure is not entirely clear. It is easier for banks to refuse any potentially dangerous transactions if the cost of the issue is low. The OFAC directive uses language that allows for a very broad interpretation of the basic definitions, explains law firm Gibson Dunn. For instance, the term ‘Russian military-industrial complex’ targeted by sanctions, includes not only defence enterprises and their suppliers but also their counterparts, individuals, and legal entities providing them with any services in ‘significant volumes’. At the same time, the Treasure has not explained what volume it would consider significant. Thus, if one reads the OFAC directive literally, 'the provision of intermediary services [to Russian counterparties] in all transactions, except for food and medicines, is all but prohibited’, a source in the Turkish banking sector complained to TASS. Chinese banks are also imposing restrictions. At the same time, China and Turkey are the largest suppliers of sanctioned products to Russia, according to customs data analysed by Bruegel.

In a recent interview, Central Bank Governor Elvira Nabiullina spoke about 'a certain complication in settlements with many countries'. However, she remains optimistic, stating, 'Where does this lead? In my opinion, it leads to intensified efforts to create alternative payment methods. Businesses in all countries are working on this.’ However, when working on the new restrictions, the US Treasury has taken this into account, Gibson Dunn's lawyers note. The sanctions threaten not only companies that can be directly accused of assisting the Russian military-industrial complex, but also firms using opaque payment mechanisms, removing client data, or other information from payment systems, etc. According to RIA Novosti, Moscow and Ankara are discussing the creation of a special Russian-Turkish bank that could be used for settlements between the countries, but 'there is no concrete information about this issue'. 

Two years of war have demonstrated that ways to bypass sanctions can be found one way or another. However, each time, this creates additional costs. One recent example is the conversion of rupees into rubles, which Indian buyers use to pay for Russian oil. Russian banks have learnt to do this through financial organisations in the UAE, but 'an amount of commission is charged there', explained Andrei Kostin, the head of VTB. At the same time, if the US Treasury constantly monitors the workarounds and schemes, the 'spillover effect' will be quite strong.