Impact of sanctions on Russia fades amid shifting sands of new world order?
With the Russian-Ukraine conflict largely dominating headlines over the past two weeks, it’s hard for us to ignore the limited extent of what Western media outlets claim robust sanctions can achieve. We also take a look into the increasing hesitancy of America’s traditional allies, particularly in the Middle East, to get fully on board with such measures, given the increased economic and political clout of China and Russia and Washington’s limited desire and ability to strong-arm its partners in signing up for the effort.
The much-discussed new and multipolar world order has seen the West’s influence on developing states wane but it would be an overstatement to say it has diminished entirely, many states appear to be paying lip service to the US-led diplomatic push while assessing if they can have the best of both worlds. In the context of market and geopolitical implications, China and Russia’s partners are starting to recognize that breaking away from the fold of western hegemony is not as foolhardy as it once seemed. US sanctions work so long as the counterparty agrees to it. However, how far are the West willing to push sanctions at the cost of critical oil imports from Russia, as well as diplomatic relations with China and other countries more amenable to Russia’s worldview?
In response to the Ukraine crisis, the US and EU ramped up economic pressure by blocking Russian banks from using SWIFT, an international payment system used by thousands of financial institutions. These measures were followed up with sanctions on a major Russian government stockpile, namely the Russian Direct Investment Fund, the country’s sovereign wealth fund. Such intended actions are stoking already surging inflation within Russia and neutralizing the country’s monetary defenses derived from selling foreign currencies, in particular USD and Euros, to stabilize the Ruble (RUB).
However, the unintended consequence is an effective announcement to the world that FX reserves abroad are not safe and subject to seizures or freezes by the US and EU. We think weaponization of money at this scale can only be deployed once; countries looking at this will be contextualizing USD hegemony when dealing with their own internal affairs.
Reaction among Russia’s partners in the Middle East
Initially, Middle Eastern states were hesitant to condemn Russia’s actions in Ukraine. The UAE, which chairs the UN Security Council (“UNSC”), after having joined as a non-permanent member in January 22, abstained from voting on a statement opposing the invasion alongside China and India. However, it appeared that most Middle Eastern states were eventually cajoled by the US and the EU into voting on a similar, albeit non-binding statement in the General Assembly.
Algeria, Iran, Iraq, Sudan, and of course China abstained from the General Assembly vote. Most Arab states voting for the resolution released vaguely-worded statements calling for peace and not mentioning Russia by name. Notably, Syria voted against the resolution as Russia has been a staunch ally to the regime since Moscow intervened tipped the balance of the conflict in Bashar Al-Assad’s favor in 2015. The UAE probably viewed the General Assembly vote as less antagonistic to Russia than any opposition in the UNSC, and will continue to assist Putin and oligarchs loyal to him to bypass sanctions through its notoriously lax banking regulations. The UAE shares a deep security partnership with Russia, notably cooperating closely with Moscow in the Libyan conflict where UAE air assets supported Russian-backed mercenaries on the ground.
However, beneath the surface of the General Assembly vote lies a more nuanced picture. Most major Middle Eastern powers are key security partners of the US, but also recognize a new world order in which Russia (and China) are increasingly important.
Several key US allies (eg. UAE, Saudi, Qatar) in the region are looking on with concern at the situation, after the US gave Ukraine a security guarantee in 1994 (which it has thus far failed to act robustly on), as they themselves have received similar guarantees from Washington in the past. In a rather bold statement this month, Saudi Arabia’s Crown Prince and de facto ruler, Mohammed Bin Salman, has already taken a nonchalant position on America’s views of its track record, and made a rather un-cryptic nod towards China by saying that if Washington misses the boat on Saudi Arabia’s potential, “other people in the East are going to be super happy." The crown prince also pointed out that he has the option of reducing investments in the United States, valued at approximately USD 800 billion. Traditional US allies in the region have already made overtures to Beijing and Moscow to diversify arms supplies but are not seeking a similar Chinese or Russian military hegemony in the region, a theme we have covered extensively in our blog and through our Twitter account @DecipherIntl.
Many Middle Eastern states, already sensitive to food inflation, are among the world’s largest importers of Ukrainian wheat (see above) and are already hoping that Russia can fill a void left by Kyiv’s damaged trade capacity. In OPEC+, Russia collaborates with major players like Saudi Arabia to regulate oil supply, and thereby oil prices. Arab states are also keeping a close eye on China’s handling of sanctions (detailed above in this article), as this will be instructive of their own dealings with Russia. Furthermore, they appear less concerned about Western diplomatic pressure in general and any repercussions this may have on their critical energy exports, for which China is becoming the dominant client.
Sino-Russian economic ties to deepen as Middle Eastern states take note
With that said, in recent years China and Russia have moved ever closer together, particularly in economic terms. Chinese customs data reported a 35.9% jump to a record USD 146.9 billion in total bilateral trade last year, with Russia serving as a major source of oil, gas, coal, and agricultural commodities. It’s noteworthy that Guo Shuqing, Chairman of China’s Banking and Insurance Regulatory Commission said in a news conference that China does not approve of the unilaterally launched Western sanctions, and will continue to maintain normal economic and trade exchanges with its relevant parties.
Meanwhile, 200-300 Russian companies reportedly approached Chinese state-owned banks operating in Moscow to open bank accounts in the past week, including Industrial & Commercial Bank of China (601398.SS), Agricultural Bank of China (601288.SS), Bank of China and China Construction Bank (601939.SS).
In addition, with Russian-issued credit cards using the Visa and Mastercard payment systems are to stop functioning overseas post 9 March, local lenders are looking to substitute with China’s UnionPay system instead. At the consumer level, Russia does have a relatively low credit card penetration. According to the Bank for International Settlements in 2020, Russia’s population (144 million) owned 266.5 million and 39.1 million debit and credit cards, respectively. Among the cards issued in Russia, 74% of payments transactions were conducted through Visa and Mastercard systems. While citizens will be able to transact domestically owing to Russia’s payment system (Mir), they won’t be able to do it abroad aside from the few countries that support Mir, including Armenia, Turkey, and Vietnam. The shift towards the UnionPay system will takes months to set up given a lack of prior agreements, while the cards themselves would need to be designed, certified, and distributed. At the country level, direct connections between the Russian and Chinese central banks mean that SWIFT is of limited relevance given Russia’s approximately USD23 billion swap-line agreement with China, as well as USD 90 billion worth of mainly yuan-denominated deposits held with the latter, which can be used to finance bilateral trade and investments.
With regards to Middle Eastern countries, several Arab states have already learned that buying sophisticated Russian and Chinese weaponry is yet to result in major diplomatic backlash. Looking forward, these countries may have concluded that whatever diplomatic pressure is heaped on China over its support for Russia, as well as other issues such as Taiwan, might not prove to be as much of an impediment to energy deals as previously feared, particularly as Yuan-denominated-energy deals become more common. Many Arab states have already reduced their dollar holdings, as highlighted in a previous post.
We have already seen that onerous Western sanctions on Iran have done little to dampen the Chinese appetite for Iranian energy exports (albeit at a discount), as Chinese imports have exceeded their pre-sanctions peak, according to customs data released in December 21. The Biden's administration has so far decided against enforcing the sanctions against Chinese individuals and companies amid the negotiations on reviving the Iranian nuclear deal.
Brinksmanship and Putin’s energy bluff
While the US and EU have been hesitant to sanction Russian energy, western traders and banks have deployed their own “sanction programs” despite the commodity being sold at deep discounts. There were also disruptions to Russian energy and commodity flows, particularly the Yamal-Europe westbound gas pipeline, which have been painful for both Russia and the West.
As the US and EU started to declare success over sanctions against Russia, global commodity markets responded with massive price gap ups, to which the tone of Western policymakers began to shift. Most notably, the German Economy Minister Robert Habeck spoke against banning Russian oil over concerns of threatening social peace on high energy prices and shortages. It’s worth mentioning that Russian gas accounts for around 40% of European demand.
Should tensions escalate further, the global economy is at risk of moving into recession, starting in Europe before spreading globally. The effects of inflation and supply chain disruptions are already being felt, but plays into Putin’s gambit despite the effects also taking place in Russia. The EU may think twice about such punitive measures due to their potentially limited impact, as China and India can buy up some of the excess Russian capacity (albeit at a discount). In the run-up to the conflict we witnessed significant moves to boost Sino-Russian pipeline infrastructure and Bloomberg has reported that Chinese petroleum and commodities giants are now on the hunt for stakes in major Russian producers. As for Middle Eastern producers stepping in to fill Europe’s void, they have been less than forthcoming, and OPEC has limited capacity to ramp up production in the short term. Only Saudi Arabia and UAE have meaningful spare capacity, and the former has already rebuffed pressures from the US to pump more.
It’s tough to make a call on where things will head geopolitically, but where global markets are concerned, we believe the set up for risk assets are broadly unfavorable after factoring ongoing supply chain and inflationary pressures, and potential financial contagion risks. This has driven a sharp market “risk-off” over the past two weeks, which we think is being underestimated by investors and policymakers.
Until we begin to see geopolitical de-escalation, in any case, in a “risk-off” environment, owning or having exposure to gold and gold miners (neutral asset) should be a priority in investment portfolios, now more than ever.