Russia bypasses sanctions: is there a remedy?

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  • On the Russian invasion of Ukraine benefited third party countries such as Georgia and Armenia. Georgia’s GDP, which relies on Russian deserters, is estimated to have grown by 10% in 2022.
  • Russia imports goods through countries that are not subject to sanctions. On an annual basis, according to volume data, Kazakhstan exported almost 328 times more smartphones to Russia.
  • Companies within the Russian market that leave usually sell their shares to local Russian entrepreneurs, who continue their operations, changing only the name and logo.
  • Access to capital and to already developed trade chains makes the effective application of sanctions against Russia a very difficult task.
  • A key role in clenching sanctions should be played by the European Union’s diplomatic efforts together with other countries that are involved in re-exports.
  • The scale of Russia’s potential economic catastrophe can be conveyed by the growth of the budget deficit, which has increased as much as 14 times in a year, from 125 billion rubles to 1.776 trillion rubles. In addition, it is worth noting that Russian exports to the European Union fell from €22 billion to €12.8 billion. Sanctions can be effective in the long term, despite their apparent ineffectiveness in the short term.

 

Introduction

At the end of January, the International Monetary Fund (IMF) released a forecast that Russia’s Gross Domestic Product (GDP) will grow by 0.3% in 2023, according to their predictions[1]. This seems irrational, especially in light of the fact that Russia is the country with the highest number of sanctions in the world, surpassing even Venezuela, Iran and North Korea. In the mass media sphere, there are many stories of companies that have abandoned the Russian market, as well as problems in the sale of oil and gas. Mention should also be made of the ongoing war, which has a huge impact on the economy. Despite this, Russia’s inevitable bankruptcy has not happened, with a GDP decline of only 2.5% in 2022[2]. Among some countries, the counting of profits from the war, which has become an economic development opportunity for them, continues. In Poland, however, there is a noticeable division of opinion on whether the sanctions imposed on Russia are effective. The following article will mainly point out how Russia bypasses sanctions and try to find a remedy for this problem.

 

Caucasian ‘el dorado’

Since mobilization was announced in Russia, about 200,000 people have fled their country to Georgia. The main reason for this is the desire to escape forced enlistment in the army and being sent to the front. Endless crowds of Russians can be seen in Georgia’s major cities, and from the airplane windows one can see the line of container ships to the two main ports of Poti and Batumi. Georgian GDP itself, based on Russian deserters alone, is estimated to have grown by 10% in 2022[3]. The situation looks similar in Armenia. The difference is that it recorded economic growth due to the influx of Russian money and citizens as high as about 17%[4]. In Georgia alone, there are about 13,500 Russian companies registered[5]. Usually under changed names, but conducting intensive trade between Russia and Europe, using Georgia as an intermediary country in the transactions. While in the case of Armenia, these tend to be IT companies and it is estimated that since the beginning of the war in Ukraine some 5,000 such entities have been established[6]. This is how Georgia has had an association agreement with the European Union since 2014, which allows for trade facilitation, and the Georgian government itself has no problem working with Europe and Russia at the same time[7].

 

Bypassing sanctions via third party countries

Bypassing sanctions is somewhat of a challenge, but it is feasible. The trade impediments are driving up product prices and require a bit of savvy from Russian companies. The most common scheme to circumvent sanctions is to cooperate with an already existing entity or register a company in a country that engages in trade with the European Union and use it as an intermediary. An example is Turkey, which has increased its exports to Russia by about 198%[8]. This is particularly true for electronic components, sometimes used in the weapon manufacturing industry. It is not possible for Turkey to increase its production capacity in such a short period of time, it only proves that re-exports are taking place there. The Russians themselves are organizing trainings for companies to bypass sanctions by using foreign countries, and one of the hosts of such events is Moscow-based Novelco, where its CEO admitted that it has a renamed subsidiary of his company in Turkey[9]. Another, more sophisticated way is to buy property in this country. After purchasing a property for a minimum of $400,000[10], an individual almost automatically becomes the owner of a Turkish passport. Buying a passport from another country is not difficult if you have significant financial resources.

Not only the countries of the Caucasus and Turkey, but also other former Soviet republics are benefiting from sanctions, as Kacper Ochman, an expert on the Caucasus and Central Asia and owner of the kierunekkaukaz.pl website, points out in an interview with the Warsaw Enterprise Institute: Exports of goods from EU countries to Russia in March-November 2022, i.e. after the start of the war in Ukraine, fell by 47 percent compared to the same period in 2021. (to €36.3 billion), while exports of European goods to Russia’s neighbors (i.e.  Belarus, Armenia, Kazakhstan, Georgia, Uzbekistan and Kyrgyzstan) increased by 48 percent at the same time (to €20.3 billion). Total exports from the EU of sanctioned goods to Belarus, Armenia, Georgia, Kazakhstan, Uzbekistan and Kyrgyzstan in November 2022 amounted to nearly €1.5 billion, while a year earlier the monthly volume was only about €500 million. It can be presumed that a sizable portion of these record exports is going to Russia (especially if one considers the 100-250 percent increase in imports by the former Soviet republics of such goods as laptops, cars, aviation kerosene, turbojet engines, and smartphones). In the first half of 2022, Kazakhstan increased its smartphone exports to Russia. In terms of volume, smartphone exports increased nearly 328 times, from 560 units in the first half of 2021 to 183,600 units in the first half of 2022.

 

Withdrawal of companies from the Russian market and vacuum filling

Many global companies withdrew from the Russian market after the invasion of Ukraine began. Mainly due to image concerns. To understand the whole mechanism of exiting the market and then filling the resulting vacuum, it is necessary to realize that today most well-known companies are established brands. The absence of a standalone logo and branding rights does not necessarily mean the end of a particular company. A prime case in point is, for example McDonald’s which was one of the first to leave Russia. Before the Russian invasion, it counted about 850 units[11]. The entire chain was sold to Russia’s largest franchisee, Alexander Gavor, who owned 25 units before February 24. However, McDonalds forbade the use of its image in Russia, and Gavorov renamed the well-known fast food to “Tasty and Dot.” The restaurants are the same, the procedures remarkably similar. Only the name and logo have changed. However, there are claims that despite the confusingly similar names in the acquired companies, their product range or quality leaves much to be desired and differs from its original. This is indicated, for instance, by reports from Tasty and Dot. McDonalds imitation less resembles its original prototype, although it is lick-alike. After Ikea left the Russian market, it was bought out by a local Russian entrepreneur and renamed “Idea.” This is also the case for other companies leaving Russia. Their shares are sold to local investors (usually at undercut prices), and then the names are changed to illusively similar names, e.g. the OBI home improvement store, is now an OLI chain store.

Significant problems arise in companies that require more advanced technology, such as Renault, which left Russia. The former French company’s factory is beginning to suffer from technological and licensing shortages. The once cutting-edge industrial plant must currently be producing Moskvich cars, a product known back in Soviet times[12]. Of course, these cars are after certain upgrades, but they are far from the standards known in Europe.

 

Is there a way to clench the sanctions?

Unlike countries such as Cuba, Venezuela, and North Korea, which are also facing sanctions, Russia is a very large market with a population of more than 143 million people. After it underwent a political transformation in the early 1990s, many fortunes of local oligarchs with influences throughout Europe were created. Access to capital, as well as to previously developed trade chains, makes effective sanctioning of Russia extremely challenging. Currently, there are 2 900 companies on the list of Russian entities with which trade cooperation is prohibited. It is likely that the number will reach as high as 10 000 companies in the coming months[13].

However, all these measures may prove useless if it is still possible to circumvent sanctions by re-exporting. Countering such activity will be a challenge, as it will be difficult to force countries such as Turkey to disclose all information regarding trade between entities cooperating with Russia, much less prohibit them from doing so. Especially given Turkey’s important role as an intermediary between Russia and the European Union.

Back in June 2022, the number of individuals subject to restrictions included 1175 people[14], and with each successive expansion of sanctions (there are currently 9, with 10th underway) it grows by about 150 people. It is necessary to further expand the list of individuals and companies that are not permitted to trade with the European Union. The biggest problem, however, is enforcement of the ban on re-exports. This requires the cooperation of intermediary countries in such transactions, such as, for example, Turkey, Georgia, Kazakhstan and Armenia, with European Union member states. The lack of such cooperation could lead to a continuing strengthening of Russia’s influence in these countries, and exaggerated interference to a loss of EU attention in this part of the world.

The countries of the Caucasus and Central Asia are not the only ones that have an impact on Russian trade policy. A significant role is played by India, which has increased its oil imports from Russia by 33 times on an annual basis (!)[15]. Although, according to commentators, the New Delhi government itself may comply with the EU sanctions package setting the price of a barrel at $60[16], it will not stop importing the resource. Intensive work is also underway between Iran and Russia to establish a new trade route through Iranian territory and the Caspian Sea[17]. This would significantly shorten maritime transport, which currently takes place through the Suez Canal. Russia itself is expanding its influence within Asia, being more and more isolated from Europe.

There could also be a system to limit re-exports based on verification of shipping bills and the potential final consignee of the goods. This would significantly increase bureaucratic procedures, as well as free up a new branch of the gray area for potential abuse. Registering new business entities for people with different names and citizenships is not a huge problem. Even a thorough tightening of such a system would initiate a hindrance to trade, but there would always be a way to bypass sanctions. Diplomatic activities of the European Union with other countries involved in re-export would have to play a key role in this case. Any new obligation imposed on companies registered in the European Union to clench sanctions would mean an increase in bureaucracy and market regulation, creating obstacles for legitimate enterprises as well.

It may seem that the most advantageous long-term sanction will simply be the time it takes for the results of the enacted sanctions to take effect. Here the influence of the European Union, which has stopped allowing imports of many Russian goods, is noticeable. Production of transportation equipment in Russia fell 51.8 percent y-o-y, and the situation is similar with household equipment. Production of washing machines alone fell 57.9 percent y-o-y[18]. The cessation of trade with the European Union has contributed significantly to the growth of domestic consumption in Russia[19].

The possibility of importing Russian vegetables and fruits into the European Union would also have to be restricted. They are not subject to sanctions and can be found, for example, at wholesale agricultural markets in Poland[20]. Many of the crates or cartons of goods are even labeled with “Russia” as the country of origin, with no attempt to sugarcoat reality or create fiction. Besides, vegetables such as cucumbers and tomatoes are much cheaper than those farmed in Poland. The difference in the case of tomato is as much as PLN 5-7 per kilogram.

Through a limited number of imported goods, domestic manufacturers have gained in importance, but this is still not enough to regain sales performance prior to February 24, 2022. While there is a possibility of finding an alternative market for oil exports (30 percent y-o-y[21]), and among the countries most interested in cooperating with Russia in this regard are China, India and Pakistan. Thus, for goods produced in Russia and then sold in Asia, it is difficult to expect high demand. China, Taiwan, or India have the ability to produce goods at a lower cost compared to Russian companies.

The scale of Russia’s potential economic catastrophe can be conveyed by figures showing the budget deficit, which has grown 14-fold (!) in a year from 125 billion rubles to 1.776 trillion rubles[22]. In addition, it is worth noting that Russian exports to the European Union fell from €22 billion to €12.8 billion[23], and some food products (e.g., mayonnaise, coffee) became as much as 50% more expensive[24], contributing significantly to inflation. Not everything has to happen immediately. Economic processes take time. Venezuela’s collapse and bankruptcy did not last a year, but was made up of years of various bad economic decisions. The ruble’s exchange rate continues to be artificially sustained through restrictions on foreign exchange. The situation is similar with the Russian stock index, where foreigners are prohibited from selling shares[25], including large foreign investment funds.

 

Conclusion

To say that sanctions imposed on Russia are not effective is a significant exaggeration and misrepresentation of the truth. They are hampering the country and contributing directly to a potential economic disaster that has only been postponed. Despite popular opinion, the first restrictions did not have the spectacular effect that was expected, after the Russian invasion of Ukraine. This did not happen in a short period of time. Currently, the state of the Russian economy can be compared to a colossus on clay legs that is kept on a drip, with a chance of recovery or death.

To identify areas where sanctions need to be tightened, the main one is the European Union’s control of re-exports of goods to Russia. A more important role would have to be played by diplomatic action against the intermediary countries, but this is an extremely difficult task.

It is necessary to further expand the list of sanctioned individuals and companies. Despite the existence of re-exports and the possible circumvention of sanctions, in the long term this could be burdensome for Russian entities. The increasing expense in money and time in attempting to circumvent restrictions could have a significant impact on further increases in the price of imported goods in Russia.

Another important element is the slow sanctioning of trade in food products between Russia and the European Union. This cannot be done immediately, given the persistently high inflation in Europe, but it can be done in stages.

Russia’s isolation in Europe is increasingly becoming a reality, but this does not necessarily mean the end of it. It is increasingly turning to Asia, having more and more in common with countries such as India, China, and Pakistan. Sustaining sanctions on Russian raw materials in Europe must be upheld. Instead, there is a concern that in the long term, Asian markets are large enough to perhaps be the place where Russian oil will flow permanently, and Europe will cease to be necessary for Russia.

 

Footnotes:

[1] https://dorzeczy.pl/ekonomia/398899/mfw-poprawia-prognoze-dla-rosji-wzrost-zamiast-spadku.html

[2]https://www.rp.pl/polityka/art37791171-putin-chwali-sie-spadkem-pkb-rosji

[3] https://www.money.pl/gospodarka/putin-zastawil-na-gruzje-grozna-pulapke-z-czegos-musimy-zyc-6851281547881312a.html

[4] https://forsal.pl/swiat/rosja/artykuly/8634103,kraje-poludniowego-kaukazu-i-azji-centralnej-zyskaly-gospodarczo-na-emigracji-z-rosji.html

[5] https://studium.uw.edu.pl/badanie-rosnie-zaleznosc-gospodarcza-gruzji-od-rosji/

[6] https://wiadomosci.onet.pl/swiat/setki-tysiecy-rosjan-uciekly-z-kraju-te-panstwa-najbardziej-na-tym-skorzystaly/lsk7g52

[7] https://www.osw.waw.pl/pl/publikacje/komentarze-osw/2022-06-07/zjesc-ciastko-i-miec-ciastko-gruzja-wobec-wojny-na-ukrainie-i

[8] https://www.rmf24.pl/raporty/raport-wojna-z-rosja/gospodarka/news-sankcje-wobec-rosji-sa-nieskuteczne-wartosc-eksportu-wzrosla,nId,6385313#crp_state=1

[9] https://wgospodarce.pl/informacje/120787-reuters-rosja-omija-sankcje-ma-podzespoly-przez-turcje

[10] https://trimarium.pl/projekt/turcja-pomaga-rosji-w-obchodzeniu-sankcji/

[11] https://www.wirtualnemedia.pl/artykul/koniec-mcdonald-s-rosja-govor-vkusno-tochka-logo-smacznie-i-kropka

[12] https://www.bbc.com/news/business-63735943

[13] https://www.money.pl/gospodarka/sankcje-dociskaja-rosyjskie-firmy-w-rok-liczba-firm-na-czarnej-liscie-sie-podwoila-6861801339124320a.html

[14] https://www.ey.com/pl_pl/law/szosty-pakiet-sankcji-ue

[15] https://biznesalert.pl/indie-import-ropy-rosja-2022-wzrost/

[16] https://www.money.pl/gospodarka/indie-zaskocza-rosje-ws-limitu-cen-ropy-new-delhi-moze-obnazyc-grozby-putina-6854397773282208a.html

[17] https://biznesalert.pl/rosja-iran-sankcje-transport-europa-indie-azja/

[18] https://obserwatorgospodarczy.pl/2022/11/03/rosyjski-przemysl-ciagnie-cala-gospodarke-w-dol/

[19] https://businessinsider.com.pl/gospodarka/pmi-przemysl-rosji-w-najlepszej-kondycji-od-siedmiu-miesiecy-jest-cos-co-nadrabia/q04prnq

[20] https://www.sadyogrody.pl/handel_i_dystrybucja/106/import_warzyw_z_rosji_zimowa_produkcja_w_polsce_nie_bedzie_sie_oplacac,33799.html

[21] https://serwisy.gazetaprawna.pl/energetyka/artykuly/8653712,limit-cen-ropy-spowodowal-spadek-rosyjskich-przychodow-o-30-proc.html

[22] https://businessinsider.com.pl/finanse/budzet-rosji-w-zapasci-zalamanie-dochodow-z-ropy-i-gazu/g3whds4

[23] https://biznes.interia.pl/gospodarka/news-wiekszosc-krajow-ue-zwiekszyla-import-z-rosji-pomimo-sankcji,nId,6523374

[24] https://pricing.day/

[25] https://www.money.pl/gielda/gielda-w-rosji-wznowila-dzialalnosc-ale-jest-w-tym-pewien-haczyk-6750682797480864a.html

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