Are the sanctions against Russia working or not?

Six weeks after the United States and the G7 countries armed the global financial system to impose their toughest sanctions on Russia, the cracks are becoming apparent. The ruble regained its pre-war value against the dollar on Thursday, a sign that the capital controls put in place by the country’s central bank were working. As the currency continued its ascent on Friday, Russia’s Central Bank surprised the world by cutting interest rates by 3 percentage points to 17% – still high, but a sign that the country’s defensive stance was too aggressive. European countries continue to buy energy from state-owned giants like Gazprom, flooding Russia with euros and dollars that can then be used by any of the more than 200 banks that are not under sanctions.

Anecdotally, the pressure seems to be diffuse and difficult to pin down: a resident of Moscow whom I have known since well before the war told me on Telegram that the grocery stores were full of food and above all 5 to 10% more expensive; diesel prices were 53.59 rubles a liter, roughly equivalent to $2.70 a gallon – cheaper than anywhere in the United States; and luxury goods retailers on Tretyakovsky Proyezd, Moscow’s equivalent of Rodeo Drive, apparently still sell clothes and handbags to some of their most prized customers, thanks in part to the government blessing the gray market for goods top of the line. Russian President Vladimir Putin has called the sanctions a “declaration of war” – and they may be, but it has also been a propaganda boon for the Kremlin as it escalates its war in Ukraine.

Do not forget that Russia was prepared for this. As one of the largest economies in the world – with a gross domestic product of around $1.8 trillion – Putin has exploited the country’s most important asset, its oil and natural gas reserves, countries like Germany depend on it more than ever. But it’s not just that the rest of the world was caught off guard. According to Columbia University economist Adam Tooze, the Russian budget was designed before the invasion to balance itself out if the price of oil fell to $44 a barrel, meaning it was able to pocket a ton of money. Since 2014, when Putin faced Western sanctions over the annexation of Crimea, more Russian goods have been produced domestically and debts have been restructured to be paid in local currency. In its rush to war, Russia effectively withdrew from the world system where it was spending while further tangling its neighbors who gave it money, and given the size and power of the country, it was difficult for the world to turn back.

It is not that the sanctions have no effect. “The sanctions are having a dramatic impact on the Russian economy. We are most likely going to have the most severe crisis Russia has seen in recent history,” says Elina Ribakova, deputy chief economist at the Washington, DC-based Institute of International Finance. The country’s central bank has been frozen from its own foreign accounts, choking it with hundreds of billions of dollars and euros. Its biggest banks have been kicked out of SWIFT, the financial messaging system, limiting the country’s ability to perform basic financial functions. According to Moody’s, more than 400 international companies have left Russia – including McDonald’s, Starbucks and even a reluctant Goldman Sachs – leading to “massive layoffs that will reduce revenue”. Ribakova notes that many Russians are trying to leave the country, and the brain drain to other countries in Europe and Southeast Asia could have a detrimental effect on the country’s economy for generations. And of course there’s a global hunt for every luxury yacht and apartment owned by Russian oligarchs, along with a host of other trade and travel bans.

But the impression that the sanctions had isolated Putin’s economy from world markets is far from true. “Russia has not been shut out of the financial system,” says Adam M. Smith, a partner at Gibson Dunn who, as a former senior US Treasury adviser, helped craft sanctions against Russia in 2014. So that much of the world’s consumer countries have coalesced against Russia, many of the world’s biggest economies – including China, India, Brazil, Indonesia and Saudi Arabia – have been more dovish, either seeking business with the country or refusing to join the sanctions. “There are more than 250 banks in Russia; the vast majority of them have not been sanctioned. So there is certainly a way to engage in international trade without going through the big banks, without going through SWIFT. I think that’s what the Russians are going to do,” adds Smith.

If you want to see how the West is undermining its own sanctions, look no further than Russia’s oil and gas sales. These agreements, negotiated before the war, are in dollars and euros. While Putin has tried to get ‘unfriendly’ countries to pay for energy in rubles before, that hasn’t really been the case. Ribakova points out that all of these unauthorized banks can still hold foreign currency, thereby acting as a replacement for some of the dollars and euros that the Central Bank of Russia has been frozen from. “It was a blow to the whole kind of fortress Russia principle, central bank sanctions,” she said. “For them, it would be important for financial stability purposes to accumulate foreign exchange reserves.”

As Russia adapted to the sanctions, the United States stepped up its financial sanctions, further isolating the country’s biggest banks and targeting Putin’s daughters. Yet these have not had the general economic effect on the way the country operates. “There are very sophisticated economists running the economy in Russia. These aren’t hacks, are they? They know what they’re doing,” Smith says. Various sanctions that have not yet fully weighed in, such as controls on exports of semiconductors and other computer equipment, should only hurt the Russian economy in the end. “Some of the sanctions aren’t really designed to tighten the screws that tight yet,” Smith says, “but will be soon.”