Ukraine and the Limits of Financial Warfare
It is not just on the battlefield where the war is not progressing as hoped. Sanctions have failed to cripple Putin's war machine and risk backfiring on the West
For all the defiant words by western leaders, today’s second anniversary of Russia’s full-scale invasion of Ukraine today is a sombre occasion. With an estimated half a million soldiers on both sides dead or injured, 10,000 civilians killed and 6.5 million displaced, there is no end to the war in sight. Instead there is growing pessimism over Kyiv’s ability to muster the manpower and munitions to resist further Russian advances, let alone recapture lost territory. The recent loss of what’s left of the town of Avdiivka has hit Ukrainian morale, already damaged by the failure of last summer’s counter-offensive. The death of Alexey Navalny while “on a walk” in his Arctic prison a week ago has underscored Vladimir Putin’s ruthlessness and impunity.
But it is not only on the battlefield that the war is not progressing as hoped. From the start, the West set great store by their belief that Russia could be defeated with financial weapons. Russia’s central bank assets were frozen, its banks cut off from the international settlement system, its energy exports embargoed, the price of its oil capped, its import of sensitive technologies banned, and an unprecedented array of sanctions imposed on individuals and businesses connected to the Kremlin’s war machine. The expectation was that this onslaught would crush the economy, cripple Russia’ military-industrial complex and undermine support for the regime.
Of course, it has not turned out that way. The Russian economy grew by 3.6 per cent last year and is forecast to grow by 2.3 per cent this year, well ahead of most G7 countries. As this report from the British Foreign Policy Group noted, the combination of high prices and strong demand from countries such as China and India has meant that energy revenues have remained buoyant. By the end of 2022, Russia was exporting in the value terms as much as in 2014, before the initial invasion of Ukraine. It had generated sufficient surpluses to replenish the reserves frozen by the West by the end of 2022, stabilising the Rouble. Thanks to trade diversion to the many third countries that have refused to join the western campaign, sanctions have proved easy to evade, allowing production of military equipment to soar.
Doubling Down
That has not stopped the West doubling down on economic warfare. Last week, to mark the second anniversary of the war and in response to the death of Navalny, America, the European Union and Britain announced yet another round, the 13th, of sanctions. There are promises of new sanctions on companies outside Russia that may be helping it to evade existing measures. And America is threatening to impose secondary sanctions on foreign banks that do business with sanctioned Russian firms. But as this leader in The Economist notes, the further the West goes down this path of economic warfare, so the risks to its own interests grow:
Alas, in the long term such exercises of power will erode the sway America has over the global financial system, which brings it real benefits. Even America’s staunchest friends in Europe loathe its secondary sanctions, which have in the past led to huge fines for some of its banks. To enforce its penalties America would need to be ready to cause disruption in places such as India, Indonesia and the United Arab Emirates, none of which have any desire to be part of its sanctions effort. If America asserts its power aggressively, it could alienate precisely those emerging powers that it hopes to woo as the world fragments.
Similar concerns apply to another financial weapon that the G7 is contemplating wielding. America is pushing hard for the G7 to expropriate Russia’s frozen central bank assets and hand them to Ukraine to fund its reconstruction. The plan is being backed by Britain, Japan and Canada. The moral case for using Russian funds to pay for the reconstruction of Ukraine is unarguable. Indeed, it was made clear when the funds were frozen at the start of the conflict that they would only be returned if and when Russia had paid reparations for the destruction it has unleashed. According to William Hague, the former British foreign secretary, “we have passed the point at which those assets will ever be returned. They would be better used to support Ukraine and to impose an escalating penalty on Putin.”
Punishing Putin
But the idea that confiscating the assets now would punish Putin is fanciful. The funds are already beyond his reach and Russia has effectively written them off. Nor in the near-term will the money do much to help Ukraine. Its external financing needs have already been met for this year by a €50 billion EU financial assistance package agreed last month and financing from the International Monetary Fund. Using seized Russian assets to defray future Ukrainian funding needs would certainly be politically welcome by reducing the call on western taxpayers, but this needs to be set against the considerable legal and reputational risks of expropriating the assets of a sovereign state, particularly one with which a country is not officially at war.
Those risks loom particularly large for Europe, which is why France, Germany and Italy have been resisting the plan. That is because the bulk of the €300 billion of frozen assets are held in the EU, of which around €190 billion are held at Euroclear, the Belgian-based securities depository. The share of assets held in the other G7 countries is negligible. Nicolas Veron, a scholar at the Petersen Institute for International Economics, set out in a recent paper what is at stake for the EU from seizing the assets without a clear legal basis that would be accepted as much internationally, thereby shielding European governments from accusations of theft.
Confiscation now would set a problematic precedent and incentivise global financial fragmentation. Trust in international monetary arrangements would be undermined to a considerably greater extent by confiscation than by the inherently reversible immobilisation, for which precedents exist . That would disincentivise several central banks from holding their reserve assets in euros. It would also deprive the EU of potential future leverage in some scenarios of negotiations to come, even though no such scenario is probable as long as Vladimir Putin remains in power. Furthermore, it could expose EU countries that perpetrated misdeeds in the past to more pressure from their own claimants. In short, the EU would lose stature and damage global public goods it otherwise cherishes, for the sake of gaining an amount of money that it can do without.
The challenge for the West as it seeks to deepen its financial arsenal is to take care that these weapons do not end up inflicting the greatest damage upon its own interests. At a time when the West stands accused by much of the Global South of double standards over its response to Gaza, it must avoid being seen to disregard the legal order it is seeking to defend in Ukraine. After all the biggest beneficiary of the global public goods of the rules-based system is the West itself. As the BFPG notes, sanctions are already leading to the creation of new geopolitical realities, catalysing the separation of the economic, technological and financial world into ‘Eastern’ and ‘Western’ spheres of influence. To the extent that global financial fragmentation leads to higher borrowing costs, that will only add to the pressures on highly indebted western governments as they seek to boost defence spending.
Displacement Activity
Meanwhile the biggest risk is that the West’s focus on financial weapons has become a displacement activity to divert attention from its failure to deliver the actual weapons Ukraine needs to win the war. That start with the $60 billion of military aid promised by President Joe Biden which is being blocked by Republicans in Congress. Nor is America alone in failing to match words with action. Why has South Korea so far delivered more ammunition to Kyiv than all of Europe and America combined? Why was the EU unable even to meet its own pledge of delivering one million shells by the end of 2023? Why is it that two years into the war, Russia is producing twice as much military equipment as the entire Western defence sector? Where are the F-16s and the long-range missiles that Ukraine has been pleading for?
It ought by now to be clear that Europe cannot hope for lasting security while Putin remains in the Kremlin. That is not just because it is impossible to imagine any peace that Ukraine could agree with Putin that would enable the West to rebuild normal relations with Russia. It is also clear that for the Russian dictator, this is no longer just a war over who will rule Ukraine. This has become a war against the collective West, against a rules-based world order that he thinks is rigged against Russia and against the West’s ideological commitment to liberal democracy and human rights that he regards as a threat to his regime. The war will be won or lost on the battlefield.
I've admired your financial journalism for decades - since you were at MoneyWeek - but there is lots wrong with this article and perhaps you might want to reinvestigate the subject in another article.
The most obvious thing is, forecasts for Russia's growth. I don't know how the IMF comes up with its forecasts.
If you are Goldman Sachs, your job is to interpret data to give good advice to your commercial clients.
The IMF is above all that, it's "independent" in the sense that it's not the IMF's job to make political judgements, like, do the Russians lie through their teeth with their data?
So I suppose it puts the official Russian data into its model, and out comes a forecast. Is that how it works? I'm not sure.
Anyway, Russia stopped publishing many series of economic data last year. Probably none of its numbers can be trusted.
Meanwhile it suits the Russians if Western commentators repeat what is very unlikely untrue - that sanctions don't work. Probably they do work.
But If the GDP story is true, it comes from ramping up military production.at thge expense of the civil economy.
(In so far as it can be ramped up. The Russians are crap at making things. There is a whole rampant corruption story to be told too. They say they produce 100 tanks a month? They probably tell Putin some such number. Is it true, though? New tanks don't seem to appear on the battlefield).
And the civil part of economy is almost certainly in deep trouble. Ordinary Russian do not have happy lives.
The Chinese pay for Russian oil in renminbi. At a price set by the Chinese, quite likely lower than the cost of extraction. In any case there aren't enough pipelines, and they can't be built in time for this war. And India pays in rupees.
What can Russia do with these currencies? Buy joss sticks?
Take a look at where Russia's pipes go, and then another look at which hubs Ukraine is blowing up with drones, often deep into Russia, and then take a rethink.
The Black Sea is now effectively closed to Russian shipping.
Russian assets held in Europe may not be missed by Russia, as you say, because they've got used to not having access to them, But give that $350 bn to Ukraine to spend then suddenly it's a different picture. That's a lot of shells from South Korea, say.
Above my pay grade to check much of what I say above, but reputable people are making these arguments. Revisit the subject is my suggestion!