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«I. Introduction This policy memo examines the effectiveness of the sanctions regime that has been adopted and consequently prolonged by the European ...»

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Policy memo

Are sanctions an efficient tool for countering Russian activities in Ukraine?

To: Federica Mogherini

From: Klára Balounová, Sabina Nováková, Barbora Obračajová

Date: December 1, 2015

Re: Policy Recommendation for the Strengthening of Sanctions against the Russian

Federation

___________________________________________________________________________

I. Introduction

This policy memo examines the effectiveness of the sanctions regime that has been adopted and consequently prolonged by the European Council in order to use non-military countermeasures against Russian actions that undermine or threaten the territorial integrity, sovereignty and independence of Ukraine. The application of such measures as a long-term non-violent solution shall remain a priority of the European Union. With this objective, we suggest that the sanctions are further tightened until Russia withdraws its military presence and ceases to support the so-called “separatists” in Ukraine. Secondary measures of implementation shall be the continuing efforts to diminish European reliance on Russian energy sector and pursuit of relations with Eastern partners in general and Ukraine in particular. We also claim that the effect on European economies has not been as damaging as to undermine the overall efficacy of the adopted strategy.

II. Background The Ukrainian crisis was triggered by the sudden refusal of Ukrainian President Viktor Yanukovych to sign an Association agreement with the EU on November 21, 2013. Street protests known as “Euromaidan” erupted soon afterwards. The protesters demonstrated not merely in favor of the EU Association agreement, but also against Yanukovych’s corrupt regime in general. The protesters were ultimately bloodily suppressed in February 2014, leaving over a hundred people dead. Ukrainian government was subsequently removed and many high government officials, including Yanukovych himself, fled the country.

Pro-Russian and anti-Euromaidan protests erupted across Ukraine, particularly in Crimea and the Donbass region, with Moscow’s direct support. Members of Russian armed forces without insignia began to operate in Crimea and finally seized the buildings of the regional parliament and local government. Similar scenario has been later repeated in Eastern Ukraine, the main difference being that unlike in Crimea, the so-called Donetsk and Luhansk People’s Republics (DNR and LNR) have not officially become subjects of the Russian Federation. With respect to the continued fighting in Donbass, the EU fully endorses the ceasefire deal agreed in Belarus in February 2015 known as the Minsk II agreement.

So-called referendum on the status of Crimea was held in the autonomous republic and in Sevastopol on March 16, 2014. As a result, Crimea declared independence from Ukraine and requested to join the Russian Federation. This was an unprecedented action against international law. The vote was in violation of the Ukrainian constitution, lacked Kiev’s authorization and was held already under occupation by Russian armed forces. Independence, sovereignty and territorial integrity of Ukraine were violated despite the assurances given by Russia earlier. This mock referendum is considered illegitimate and invalid by the European Union. Yet, its result has immediately been recognized by the Russian Federation. In response to the illegal annexation of Crimea by Russia and deliberate destabilization of a neighboring sovereign country, the EU, the U.S. and other countries initiated the first round of sanctions against Russian individuals and businesses.

EU imposed its restrictive measures in three waves of sanctions with differing aims and validity. This was its own initiative within the Common Foreign and Security Policy framework. There is a fundamental linkage in between the sanctions regime and the Minsk II agreement, whereas the former shall not be lifted until the latter is implemented.

Firstly, there are the economic sanctions, whose status has been extended until January 31,

2016. European banks are barred from giving long-term loans to financial institutions registered in the Russian Federation. Five major Russian majority state-owned financial institutions as well as their majority-owned subsidiaries established outside of the EU have limited access to EU capital markets as a result of the current economic sanctions. An export and import ban on trade in arms and an export ban on dual-use goods for military use or military end users in Russia have also been imposed against Russia. Moreover, the economic sanctions limit Russia’s access to certain sensitive technologies and services used for oil production and exploration.

Secondly, an EU-wide assets freeze and travel ban to the EU, currently affecting 149 individuals and 37 legal entities deemed responsible for actions undermining or threatening independence, sovereignty and territorial integrity of Ukraine, has been put in place. This measure has been extended until March 15, 2016.

Lastly, the EU has adopted a package of measures against Crimea. This includes targeted sanctions against prominent officials or general visa denials to all individuals applying for an EU entry visa with a Russian passport illegally issued in Crimea by the Russian authorities.

Investment in annexed Crimea is considered illegal. It is outlawed to the EU member states’ citizens and EU-based companies to buy real estate or legal entities located in Crimea, to finance Crimean companies or to export certain goods and technology for use in Crimea or to Crimean companies. There is also a ban on all imports coming from Crimea without certificates of origin and documentation issued by the Ukrainian authorities. These restrictions have been prolonged until June 23, 2016.





Russia immediately enforced its own “counter-sanctions” as a response to the Western sanctions. Moscow banned import of basic food products including fresh vegetable, fruits and dairy products, as well as other consumer goods coming from the EU, the U.S., Canada, Australia and Norway. This embargo negatively affected European food producers and Russian population as well. Russian consumers miss not only luxurious European goods, but also a wide range of ordinary products in grocery shops. Domestic food and goods supply do not sufficiently satisfy the demand. The quality of products available in the Russian market significantly decreased due to the lack of foreign competition. Moreover, the cost of goods and food available locally in Russia sharply increased, further raising the inflation.

The impact of sanctions cannot be measured separately from other developments. It was not only the Western economic sanctions, but also falling oil prices that contributed to the sharp decline in Russian economy. In June 2014, the oil prices started to fall dramatically from $100 per barrel. The oil prices have continued to further decrease until today, and as of the end of November 2015, the oil price was $45 per barrel. Russian balanced state budget for 2015, on the contrary, calculated with oil price of $100 per barrel. Lower oil prices have generally been compensated for through currency devaluation. On November 10, 2014, the Russian Central bank decided to stabilize the national currency through a fully floating exchange rate. It thereby limited its regular interventions (with the exception of threats to financial stability).

Nevertheless, the Central bank had to intervene against the declining exchange rate of the Ruble by selling its foreign-exchange reserves merely some three weeks after this decision.

The exchange rate of the Ruble decreased from average 37.20 RUB/USD in September 2014 to average 64.37 RUB/USD in September 2015. Russian external debt has become even more difficult to repay due to the unfavorable exchange rate of the Ruble to the U.S. Dollar and due to restrictions placed on Russia’s access to foreign capital markets. Higher inflation rate affects real wages that contracted about 8.5 % only in the first half of 2015, and the poverty rate increased by 2 % in the first half of 2015. Current financial and currency crisis in Russia might not be at its end. According to some economists, Russian economy is currently threatened by the deflationary trap.

The purpose of sanctions has not been to weaken Russian economy per se, but to create political pressure on Russia to change its policy towards Ukraine. The EU shall further decide on changes to or prolongation of the sanctions regime, whereas it must have clear strategy mirroring its long-term objectives.

III. Options There are three possible options available to the EU – to abandon the sanctions regime altogether, to maintain the current sanctions mechanisms, or to further strengthen them.

Initiatives to abandon the EU sanctions against the Russian Federation are mainly supported by entrepreneurs with vested interests in the Russian market and by business lobby protesting against any limitations of international trade in general. In comparison with other countries which have also imposed sanctions against Russia, European economies have been suffering more under the sanctions regime. This is not only because of oil and gas imports, but because Russia is one of the most important trading partners for some EU countries, most notably Germany. Yet, other countries are indirectly affected, mainly due to a decrease in exports to countries trading with Russia. Withdrawal of the sanctions as a responsive gesture towards Russia might trigger a series of positive Russian actions in Ukraine. On the other hand, the EU might be merely regarded as a weak organization with no actual power to influence Russian actions in Ukraine after the eventual withdrawal of the sanctions. Another question which needs to be taken into account is that political and even business confidence is difficult to regain once it is lost.

Second option is to maintain sanctions at their current level of operation. In this regard, efficiency of the sanctions regime must be thoughtfully weighed. The Russian economy has certainly undergone hardships in the past two years, when multiple negative economic developments stroke. This was both due to geopolitical tensions caused by the crisis in Ukraine and due to decreasing oil and gas prices as well as other economic variables. While the damage the sanctions caused to the EU countries is certainly significant, the European economies have been most hit at the very beginning of the sanctions regime, whereas the damaging effect has lowered with time as European economies adjusted to the new situation.

The sanctions have been fulfilling their long-term objective, which is to put the adversary under pressure to review the unfavorable strategies adopted. On the other hand, they are not completely destructive. The main advantage of this approach is the possibility to continue with the strategy while having other options, that is to toughen or weaken the sanctions based on current developments, open.

The third option at hand is to re-evaluate and strengthen the EU sanctions against the Russian Federation that are already in place. Given that the current sanctions have been in force for a long time (some since March 2014), Moscow became more or less accustomed to them. If we strengthen the sanctions regime, it will have a larger and quicker impact on Russia than if we keep the current sanctions in place without any significant changes.

IV. Recommendations

It is the long-term objective of the EU that Russia withdraws its forces from Eastern Ukraine and illegally annexed Crimea and stops all its actions targeted against independence, sovereignty and territorial integrity of Ukraine. The EU strictly adheres to non-military means in its policy in order to achieve these goals. The main purpose of EU sanctions against the Russian Federation is not to destroy Russian economy and society or the Putin regime, but to pressure Moscow to change its policies, in particular its foreign policy course. Russia has to withdraw its support for so-called “separatists” in the occupied Ukrainian territories and stop intervening on their side against the Ukrainian forces.

Some opponents of the current EU sanctions regime argue that whatever the EU does only hurts the Union, because Russia is never going to admit it has a military presence in Ukraine.

As a matter of fact, Moscow does not have to acknowledge anything – in spite of its public statements, there is already ample evidence of its direct involvement in the conflict. It is undeniable that since their implementation, the EU sanctions have become an important factor Moscow has to take into consideration when planning its next steps in the conflict. If we strengthen them, their effect will further increase. While the EU sanctions affected Russia deeply, Moscow’s counter-sanctions against the EU have been rather toothless due to Russian economy’s structural deficiencies. At the same time, the sanctions being an efficient tool is mirrored in Moscow’s use of its own sanctions intended to pressure, coerce or punish other states (most recently Turkey) for their actions.

There is a wide range of policy options available to the EU in this regard. First of all, we can tighten the economic sanctions and restrictive measures and put a ban on short-term loans as well. This would further curb Russia’s access to European capital. Consequently, Russian financial institutions would not be able to borrow money in the EU, making the costs of borrowing money even higher. Furthermore, we can cut off Russia from the SWIFT banking transaction system, thus effectively separating Russian businesses from the rest of the world.

All this would put increased domestic pressure on the Russian government to alter its policies.

It is equally important to continue working on expanding the scope of EU sanctions, most notably the EU-wide assets freeze and entry ban. Additional persons and entities to be added on the existing list should include all members of the Federation Council of the Russian Federation who authorized the use of armed forces in Ukraine on March 1, 2014, and all members of the State Duma of the Russian Federation who actively voted in favor of the annexation of Crimea on March 20, 2014. As a next step, the entry ban and property freeze could be extended on family members and business partners of those already on the list, pending necessary amendments to EU legislation.



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