Jenny Paris

Why Are We Surprised That Sanctions Keep Failing?

Russia’s attack on Ukraine came in the face of stern warnings and escalating economic sanctions from world leaders, including steps to tighten the screws on the country’s debt and access to funding in international markets. While the US and its allies can do more to cut Russia off the global financial system, preventing or waging a war via markets is once again proving a blunt instrument.

Among the measures that President Joe Biden announced days ahead of the attack on Ukraine was a move to sanction Russian sovereign debt. US investors — who were already barred from buying Russian government bonds in the primary market — can no longer trade newly issued securities in the secondary market. Europe followed suit with similar action. As my Bloomberg Opinion colleagues Marcus Ashworth and Brian Chappatta have said, shutting access to secondary bond markets would squeeze Moscow financially far more than any other sanctions attempted in the past. Indeed, about a third of the country’s sovereign debt value has been wiped out, with trading drying up amid a surge in yields and UBS Group AG triggering margin calls by cutting the value of Russian debt held as collateral to zero. More severe action, including kicking Russia out of the SWIFT global financial messaging platform for international payments, would further cripple the country’s economy, exports and standing in global markets.

What these penalties haven’t done, and probably won’t, is avert Russian aggression. Even as Biden announced steps Thursday targeting individual banks, he stopped short of expelling Russia from SWIFT. Bloomberg News reports that two key factors are preventing such a move: Push back from countries like Germany and Italy over energy security and worries it could invigorate rival messaging systems, including one from China or another that Russia started in 2014 after being isolated over the annexation of Crimea. Indeed, the risk of hurting global investors and other innocent bystanders more than the intended target is very real. European banks, companies and countries that rely on SWIFT for fuel transactions would feel the impact along with ordinary Russian citizens. Pushing Russia outside a global checks-and-balances system also risks moving it closer to less controlled corners of finance, such as cryptocurrencies.

Russia had prepared against financial retaliation long before the Ukraine crisis. Ever since the West’s response to the annexation of Crimea in 2014, Russia President Vladimir Putin has been building a war chest of reserves in gold and diversifying currency reserves away from the dollar. Russia has also taken steps to de-dollarize its economy, conducting much of its exports in euros and the Chinese yuan while building a surplus that can allow the government to forego tapping foreign markets for some time. Russia Finance Minister Anton Siluanov said Friday the government will reduce borrowing in 2022 and tap the country’s national wealth fund for cash as needed.

Earlier restrictions barring US investors from buying Russian government bonds in the primary market have also reduced the share of debt held by foreigners. As Bloomberg News reports, Russia’s central bank has slashed its dollar reserves to just 16% of its holdings from 40% just four years ago. As a share of Russian export receipts, the dollar made up a little more than half as of June 2021, down from 69% in 2016, according to a study by UBS economist Anna Zadornova. Over the same period, the euro’s share doubled to 28%. At the very least, these efforts will buy Putin time to continue with the military operation in Ukraine. By the time, the impact on the Russian economy is felt, it may be too late.

History is rife with examples of how economic sanctions have failed to prevent aggression — from Iran to North Korea — no matter how effective they may be in damaging or isolating an economy. Even in times of peace or in purely economic wars, the threat of market-based tools has often failed in forcing the desired effect. Consider that despite being a perennial threat during times of elevated tensions between China and the US, China hasn’t dumped its holdings of US Treasury securities, and avoided doing so even at the height of the trade war under the Trump administration. Likewise, attempts by the US to list China and other governments as currency manipulators have done little to prevent so-called currency wars or force them to loosen their grips on foreign-exchange rates in closely controlled markets.