Explained | How exactly does the West plan to cripple Russia economically through sanctions?

Representative Image of the ongoing Russian invasion of Ukraine (Image: Reuters)

More than a week after Ukraine was invaded by Russia, the country has been hit with a deluge of economic sanctions, trade measures and punitive banking restrictions by the US, European Union and other Western allies such as Japan, Canada and the UK.

The US has announced a long list of economic and trade sanctions against Russian President Vladimir Putin, senior cabinet ministers, Russian government officials and members of parliament, prominent oligarchs and even banks and companies. Even as Putin shows no signs of toning down his military assault, the sanctions hope to hit Russia financially and effectively shut down its economy.

Similar sanctions have been used earlier by the US against the regimes in Iran and North Korea, which effectively excluded them from global financial flows and removed all possibility of them interacting with the global economy independently.

What makes the sanctions effective is that while they are a series of policy measures and financial guidance aimed at US citizens and entities, non-US persons, companies and even other nations also stand the risk of being hit with secondary sanctions in case they violate these. Moneycontrol takes a deep dive into the plethora of sanctions, and how exactly they aim to hit Russia.

Ban from SWIFT

The Society for Worldwide Interbank Financial Telecommunication, or SWIFT, is the world’s leading provider of services related to the execution of financial transactions and payments between banks worldwide. The key global interbank system facilitates transactions between banks from 200 countries.

The system has now been closed to seven major Russian banks, which means they can’t initiate transactions involving lenders or entities on the list. Since most international trade transactions are done in US dollars and involve US banks, excluding Russia from the SWIFT network means cutting off its ability to transact with almost all other countries.

These banks would be disconnected from the system on March 12, before which they have initiated a massive rush to sell their foreign monetary holdings and led to the Russian currency plummeting in value. However, SWIFT has also put accompanying restrictions that cut down on the ability of these banks to sell most assets.

Banking restrictions

The Office of Foreign Assets Control (OFAC), a financial intelligence and enforcement agency of the US treasury department, on February 24 announced independent banking restrictions beyond the SWIFT move.
Aiming to stop Putin from accessing his war chest, it has cut off three key Russian institutions, namely the Central Bank of the Russian Federation, National Wealth Fund of the Russian Federation, and Russia finance ministry from accessing all US dollar-denominated bonds, foreign exchange and other financial instruments.

It asked all US financial institutions to close within 30 days all correspondent or payable-through accounts, and to reject any future transactions with two of Russia’s largest banks, Sberbank and VTB Bank, and their subsidiaries. It has prohibited American citizens and businesses from doing any business with the banks.

VTB Bank is Russia’s second-largest bank and the total sanctions are expected to hit about 80 percent of the banking sector in Russia. On a daily basis, Russian financial institutions conduct about $46 billion worth of foreign exchange transactions globally, 80 percent of which are in US dollars. The vast majority of those transactions will now be disrupted. The US has also put sanctions against a long list of Russian oligarchs and their businesses.

According to OFAC, activities subject to secondary sanctions risk include trading through the sanctioned Russian banks, and trading with or providing support in the form of finances, material or technology to sanctioned Russian businesses and sanctioned individuals.

Export controls

One of the most significant measures instituted by the US has been a series of major export controls against Russia. The Bureau of Industry and Security (BIS) under the US department of commerce on February 24 issued new rules significantly limiting exports of sophisticated goods, software and technology to Russia.

This mandates new licences needed for the export, re-export or transfer of high-tech exports to Russia such as software and technology. This would cover microelectronics, telecommunications items, sensors, navigation equipment, avionics, marine equipment and aircraft components.

However, the rule provides for certain limited exceptions, which will be reviewed on a case-by-case basis. Also, the US has specified eight general licences that authorise certain transactions as well as trade in agricultural commodities, pharma and petroleum products.

BIS also significantly restricted the availability of licence exceptions for Russian exports, re-exports and transfers that had till now been in place. These had allowed US exports to flow to Russia despite sanctions and restrictions till now. Also, foreign-made products that are produced with or incorporate US technology or software will now require a US export licence to ship to Russia.

Finally, the export controls reiterate a near-total embargo on the export of defence items to Russia. In a stringent move, this will cover all defence equipment manufactured in the US, by US companies globally, or items produced elsewhere and worked upon in the US. BIS also added a number of Russian aviation, shipbuilding and other industrial base entities to its restricted list. BIS estimates that these new controls will result in an additional 350 licence applications being submitted to BIS annually.

The restrictions on Russia’s imports of key technology, including semiconductors, would squeeze its "access to finance and technology for strategic areas of its economy and degrade its industrial capacity for years to come," according to US President Joe Biden. All the export controls are designed to hamper Russia’s ability to develop its aerospace and defence sectors, and its global competiveness.

The latest controls will also have a direct impact on aviation with many yet-to-be-answered questions on flying US-origin aircraft out of and back to Russia, supplying repair parts and air safety matters.

Western allies

The European Union (EU) has also undertaken a series of sanctions such as freezing Putin’s and Russian foreign minister Sergei Lavrov’s European assets, sanctioning 351 members of the Russian parliament, and putting restrictions on Russia’s financial, energy and transport sectors.

Apart from closing its airspace to Russian aircraft and banning Russian media outlets, the EU has also announced plans to institute an export financing ban. Significantly, Germany has halted certification of the Nord Stream 2 pipeline which was to carry natural gas from Russia to Germany and other European nations.

Meanwhile, other Western allies have announced their own measures. The UK has sanctioned all of Russia’s major banks, and more than 100 individuals, entities and subsidiaries from accessing the UK market and suspended all dual-use export licences to Russia.

Australia announced sanctions that will target more than 300 Russian government officials and barred several top Russian banks from transacting with Australian financial institutions. Canada cancelled all export permits to Russia, banned new transactions in Russian sovereign debt and sanctioned more than 400 Russian entities and individuals. Japan has prohibited the issuance of Russian bonds and frozen several Russian individuals’ assets.

Interestingly, at least two of China’s biggest state-owned banks announced that they will not support transactions with Russia, while three others have said they would scrutinise transactions more.