How Sanctions Work: High-tech industries manage to maintain services and infrastructure, but fail to develop them

Contrary to popular beliefs, the effect of sanctions on the Russian economy appears to be very significant, albeit with some delay. While the sanctions, which are primarily directed against imports, have not triggered a full-fledged macroeconomic crisis, at the level of individual industries their effect has been comparable to that caused by such a crisis. In high-tech industries, such as telecommunications, parallel import chains have helped to maintain production cycles and keep the operation of services running smoothly, but have undermined investment in development. Companies may be able to patch holes, but it is much more difficult to import new sophisticated equipment, particularly because of geolocation controls. As a result, investments become meaningless. At the same time, the Russian authorities' have stated their intention to replace imported equipment with domestic equipment, but this not only appears to be unrealistic, but also substitutes the goals of a rational strategy to counteract sanctions. In fact, it is aimed not at somehow mitigating and compensating for the effect of the technological backwardness associated with sanctions, but at further sovereignty of high-tech industries. In the medium term, such a strategy does not reduce, but intensifies the isolating effect of sanctions.

The claim that Russia has been less sensitive to international sanctions than the architects of such sanctions had hoped has become commonplace. Russian companies and services have been able to quickly establish imports to replace Western supplies, including high-tech components banned for import and needed by the military-industrial complex (→ Re: Russia: The West intends to continue its fight…). Parallel imports through ‘shell' companies in China and other countries have so far seemed invulnerable. However, this optimistic picture is fundamentally incomplete. Parallel imports are much less effective when supplying complex and bulky equipment such as machine tools, drilling rigs or telecom towers. As a result, the Russian telecoms market, for example, may appear good at the moment (telecoms services continue uninterrupted) but has actually stopped developing; companies are mostly busy patching up holes, according to a report by Maria Kolomychenko, a former journalist at Kommersant, RBC and Meduza, prepared by the Deutsche Gesellschaft für Auswärtige Politik (DGAP).

Formally, there is no complete ban on the supply of telecommunications equipment to Russia. For example, the United States does not impede the import of equipment and software necessary for the operation of the Internet. However, the EU has banned companies from doing business with Russian customers that are controlled by the state. This includes Rostelecom, which, together with its Tele2 operator, ranks third in Russia in terms of the number of mobile subscribers. Russia's second largest operator, Megafon, was hit by sanctions in February 2023 (but this has not involved a direct ban on importing equipment from the US). Neither the US nor the EU has imposed sanctions against MTS or Vimpelcom, respectively the first and the fourth largest Russian operators.

However, Western vendors have curtailed co-operation with Russian companies nonetheless. The world's leading telecoms equipment manufacturers Cisco, Nokia and Ericsson have left the Russian market. Moreover, they have not only curtailed their activities, but also destroyed their stocks of equipment in Russian warehouses. They were unable to reclaim this stock as, soon after the war began, the Russian government banned the export of more than 200 types of foreign goods and equipment, including telecommunications equipment, from the country.

Since the mid-1990s, the networks of leading Russian operators have been built primarily using equipment from these companies. International sanctions imposed in response to the annexation of Crimea forced the authorities to think about reducing dependence on Western technologies. In 2015, the Ministry of Industry and Trade presented a large-scale import substitution programme in the IT sector, which envisaged that the share of imported devices (tablets, smartphones and computers) in the Russian market would drop from 90% to 75%. Although Chemezov, head of Rostec, demonstrated several samples of domestic devices at a meeting with Putin, this plan has not yet begun to be implemented. By 2022, the market was in the same state as it had been a decade earlier as complete dependence on Western equipment remained. 

Having lost the ability to buy equipment from long-term partners legally after the war, operators have managed to supply parallel imports in volumes sufficient to maintain their operations uninterrupted, but there is no longer any talk of development. The Skoltech Institute estimates that operators lack about 50,000 base stations to realise their pre-war development plans. In 2022, their fixed capital investment in the industry collapsed by almost a quarter, falling to 350 billion rubles. 60% fewer new base stations were installed than a year earlier. Such a severe dip had only been seen in 2009, when the Russian economy was experiencing a downturn caused by the global financial crisis and falling oil prices. Thus, the notion that the Russian economy has successfully managed to cope with the blow from sanctions is nothing more than a half-truth used to formulate a propaganda narrative. As we can see, the effect of Western sanctions on imports is comparable to the effect of the crisis associated with the critical drop in the scale of Russian exports in 2009, and leads to a comparable failure in investment at the sectoral level.

The issue is, as Kolomychenko explains, that the global telecoms market was originally set up to control deliveries. GPS trackers are built into the equipment, which allow you to track where it ends up. As a result, while supplies of common parts and components via parallel import channels continue without much difficulty, Russian buyers can only get new equipment with some difficulty, even through third parties. One way to get this equipment is to buy it from subsidiaries operating in other countries (MTS, for example, has business in Armenia and Belarus, VEON Group, which used to include Vimpelcom, conducts business in Pakistan and Bangladesh). It is slightly easier with parallel imports of equipment from China's Huawei, which, like its Western competitors, stopped official sales at the end of 2022 to avoid being subject to secondary sanctions as a result of cooperation with the Russian public sector. Operators are also testing equipment from smaller manufacturers from Asia and Israel (Zyxel, TP-Link, D-link and ECI Telecom), but they do not plan to use this in large volumes.

Russian manufacturers have virtually nothing to offer the industry. The Unified Register of Russian Radioelectronic Products, which includes more than 1500 items, has only one base station for fourth-generation networks (LTE) and it is manufactured by one of Rostec's subsidiaries. At the same time, it is only designed to work in the frequency range used by Tele2 and only in a few regions. This is quite surprising, given that, from this year, operators were supposed to start using LTE base stations exclusively made in Russia. This was a condition set by the Ministry of Digital Communications in 2021 when it was extending licences for the use of frequencies. According to the new plan, the transition to Russian base stations is due to take place in 2028. The government will allocate 3.4 billion rubles in subsidies to one of their future manufacturers, KNS Group (IKS Holding). Moreover, the authorities expect operators to spend more than 100 billion rubles on the purchase of domestic equipment from 2025.

Despite the lack of equipment, there continues to be discussion about the construction of fifth-generation (5G) networks, which have already been deployed in the West and Asia and were supposed to be operational in Russian cities with a million inhabitants in 2022. Now the Ministry of Digital Economy hopes that Russia will get 5G connectivity in 2026. But even this deadline is unlikely to be met. Despite years of assurances that the networks will be deployed for domestic equipment, this is still not being manufactured in Russia. At the same time, Kolomychenko's sources in the telecoms market say that the operators themselves are not interested in this. Their subscribers do not particularly need 5G communication (they are more than satisfied with the speed of mobile Internet provided by LTE). The main areas of application of this standard are the Internet of Things and unmanned transport. Before the war, Russian companies, primarily Yandex and Sber, were actively working on the development of drones, but the sanctions have almost negated any efforts in this direction. Thus, the full implementation of 5G in Russia may be postponed indefinitely due to the fact that the entire complex of technological innovations associated with it has become irrelevant in the current circumstances.

As we can see, the telecoms market, as well as a number of others, such as the aviation market (→ Re: Russia: Flying Against Sanctions), has been affected by the sanctions much more severely than it is usually portrayed. The situation in a way looks modelled for high-tech industries. Parallel imports keep the infrastructure in working order, and this creates an impression of economic stability or even the success of its 'structural adjustment', which is actively supported by propaganda. In reality, the epidemic of official optimism is disastrous. The technological gap will grow, as will the obsolescence of sectors. But this real problem has not even been formulated at the level of state strategy. The slogan of 'import substitution' appears entirely implausible, given the experiences of the previous decade. Moreover, this propaganda slogan turns out to be a purely non-market approach to the essence of the problem and substitution of goals in the government's strategies. For example, the recipient of subsidies for the construction of base stations turned out to be a subsidiary of IKS Holding, the largest Russian manufacturer of equipment for SORM. In other words, the aim of the strategy is not to minimise the damage of sanctions on technological development, but to gain sovereignty over the telecommunications industry, expand state control and fixate on issues of security and autonomy. Paradoxically, in the medium term, such an isolationist strategy does not reduce the effect of sanctions, but rather enhances it.