Is the West really hurting Putin this time?

Now it must really hurt. Western countries agreed in the first hours after the Russian attack on Ukraine that Russia will have to pay a heavy price for invading its neighbor. Ursula von der Leyen, the president of the European Commission, spoke during an inserted press conference on Thursday morning about “severe sanctions”, which will take a “heavy toll on the Kremlin”. Similar sounds were heard from the United Kingdom, the United States, Japan, Australia and Canada in the hours that followed.

On Thursday evening, the concrete announcements from successively London, Washington and Brussels followed, which were coordinated. Major Russian banks are barred from payments in western currency, while Russian bank deposits are blocked. Trade in Russian government debt on Western stock exchanges is being curbed. There will be restrictions on the export of high-tech goods to Russia. More influential businessmen, politicians and administrators face personal sanctions. EU leaders held hours of talks in Brussels on Thursday evening, with one of the most thorny points: should Russia be kicked out of Swift, the system banks use for cross-border payments? Ultimately, no consensus seemed to have been reached on this. Many details about the measures, especially those of the EU, were still missing on Thursday evening.

The sanctions come on top of the sanctions round earlier this week. In it, a group of prominent spreaders of Kremlin propaganda were subject to travel restrictions and their bank accounts in the EU were frozen. Germany halted the approval procedure for the commissioning of the Nord Stream 2 pipeline.

Financially and economically, the West wants to squeeze Russia even further – in essence, it wants to reduce Russia economically to welfare. The question is whether the West actually dares to do that – sanctions also hurt the sanction-trailer.

1What is and what is not hanging over Russia’s head?

The financial sanctions are limited to individual banks, including Sberbank, Russia’s largest bank, and VTB, the number two.

For the time being, the heaviest sanction that the west can hand out on Thursday remained unused: the complete exclusion of Russia from international payments by denying access to the interbank Swift system. That would mean that no transaction is possible through this system anymore – including European payments for gas and Russian payments for European exports. And that it is almost impossible for western banks to access their Russian assets. It is a sanction that Ukraine insisted on Thursday in no uncertain terms. “I am not going to be diplomatic about this,” wrote Foreign Minister Dmytro Kuleba on Twitter† “Anyone who is now in doubt about whether Russia should be expelled from Swift has the blood of innocent Ukrainian men, women and children on their hands.”

The fact that the ‘mother of all economic sanctions’ failed to materialize on Thursday is particularly painful for the EU in that regard. The US and UK expressed their support for it on Thursday, although the question is whether they were hiding behind the EU, which would probably suffer more from the measure. According to the American president, Europe was in any case a problem. Many countries in Europe are dependent to a greater or lesser extent on Russian gas, including highly influential countries such as Italy and Germany within the EU. According to reports from news agencies from Brussels, Germany, Italy, Hungary and Cyprus have blocked the Swift sanction.

2 How hard will Russia be hit?

The effect of sanctions on the Russian economy is difficult to predict precisely. Western sanctions packages can be expanded in the near future. And the effectiveness of sanctions depends a lot on how strict they are, and on the creativity of Russia – and of Western companies – in devising shortcuts around the sanctions. For example, the German Siemens supplied heat pumps to Crimea via Russia in 2015-2016 – in violation of EU sanctions after the invasion of Crimea (2014).

Russia has been preparing for a financial blow in recent years. The foreign exchange balances now amount to a record amount of USD 631 billion. That is more than 40 percent of the size of the Russian economy, and enough to last for a long time. Dollars themselves have always been the majority, but now make up only 16 percent of those reserves. Euros have gained in importance, but especially renminbi – the Chinese currency that is important for imports from China. If Swift later goes black for the Russians, the question is how hard the blow will really be. Since the invasion of Crimea, Moscow has developed a regional alternative to Swift: SPFS. If this does not suffice, it can use the alternative that China has now set up: CIPS. And as for the closure of Russian access to Western financial markets, Moscow has also prepared for this. Russia’s national debt is only 18 percent of gross domestic product and refinancing should not be a problem. Internationally operating Russian companies, on the other hand, could have a hard time, especially if they use the individual banks that have been hit by the sanctions.

In any case, investors on the Moscow stock exchange seemed to fear this. It lost half its value, after which trading had to be halted. The stock market closed more than 33 percent lower.

European Commission President Ursula von der Leyen said on Thursday that the new round of sanctions would lead to lower economic growth in Russia, higher inflation, more capital flight, and erosion of the country’s industrial base. If these are indeed the consequences, the Russian population and the Russian business community will be particularly affected. The western calculation is probably that the Russians will sooner or later turn against their own president.

3 What are the consequences for Europe itself?

There is no need to doubt that we will react sharply to sanctions. That was the response of the Russian Foreign Ministry to the first US sanctions announced by President Biden this week. Could such a sharp counter-reaction eventually mean turning off the gas tap?

Nobody can rule it out and then not only the Netherlands but especially Europe will have a problem. Many countries in Eastern Europe get more than three quarters of their gas from Russia, Germany has a 55 percent dependency and Italy about 40 percent. For the entire European Union, about a third of gas comes from state-owned Gazprom. In the Netherlands, that percentage is considerably lower at about 15 percent.

But what is this limited dependence worth if major shortages occur in Europe and a logical call for solidarity is heard? Analysts are already sketching an ominous scenario for Europe. Skyrocketing gas and oil prices are fueling high inflation and could be the initiator of a painful recession. The former Russian president, now deputy chairman of Putin’s security council, Dmitry Medvedev, has been unable to suppress his laughter this week. After Germany announced that it would suspend approval of the new Russian pipeline Nord Stream, he tweeted: “Well, welcome to the new world Europe, where you are going to pay 2,000 euros per cubic meter of gas.”

We will not brush away our dependence on Russian gas in a short period of time. The Ministry of Economic Affairs and Climate Policy is currently updating the Protection and Recovery Plan from 2019, which lists the measures taken in the event of a gas crisis. The first measure is a general appeal to households and companies to moderate gas consumption. In eleven steps, from extra levies to shutting down companies, the government can make a decision it will never want to make: cut off entire regions from gas.

In addition to turning off the gas tap, Russia can also take other countermeasures. Following the Western sanctions against Russia in 2014, following the Crimean invasion, the Kremlin banned imports of European food products. For most EU countries, Russia’s importance as an export destination is not particularly great, but the Baltic States, Poland and Finland do export a lot to their large neighbour. The exposure of European banks to Russia is relatively limited. But individual companies and banks that are very active in the Russian market can run into problems.