The Soft-Wars of the 21st Century

Economic Sanctions Imposed on Russia

Analytical Study of

Effectiveness of the economic sanctions imposed and the Soft-war waged by Western Powers

against Russia over the Ukraine

By: Ziad Jaser Durra

11-Jan-2015

Supervision: Dr. Ahmad Hamad

The Soft-Wars of the 21st Century

Economic Sanctions Imposed on Russia

By: Ziad Jaser Durra

Economic sanctions are used to achieve the goal of influencing the targeted country by imposing economic penalties, such as prohibiting trade, stopping financial transactions, or barring economic and military assistance. Economic sanctions can be applied for a variety of reasons, including to punish or weaken the targeted country, to signal disapproval, to persuade a change in policy, or to change the regime.1 They can be imposed to try to avoid war or to pave the way to war.

Economic sanctions by the United States (US) and European Union (EU) have been imposed on Russia since the annexation of Ukraine’s Crimean Peninsula in March, 2014. In July, 2014, economic sanctions were increased in response to the escalating crises in the Ukraine. The Western Powers (EU and US) are accusing Russia of inciting and the supporting the Russian separatists in Eastern Ukraine. The US and EU announced broad targeted economic sanctions against Russia including restrictions on Russian banks’ ability to borrow money, an arms embargo and a ban on technology exports related to the deep sea extraction of oil.2

The sanctions imposed on “Russia’s financial, energy, and defense sectors”3 are tailored

to punish Russia for its action in the Ukraine, violating Ukraine’s territorial integrity and sovereignty. According to the White House, the sanction aims to “increase Russia’s political

1 United States Government Accountability Office (US-GOA), “Economic Sanctions effectiveness as a tool of foreign policy,”

National Security and International Affairs Division, GAO/NSIAD-92-106 Economic Sanctions, (1992), p2, http://www.gao.gov/products/NSIAD-92-106 ,accessed on 11-25-2014 2 European Union External Action, Factsheet EU-Ukraine relations, Brussels: European Union, 140912/01, (12-September-

2014), http://eeas.europa.eu/statements/docs/2014/140514_02_en.pdf 3 The White House “Russia Sanctions, Statement by the President on New Sanctions Related to Russia,” Office of the Press

Secretary, (11-September, 2014), http://www.whitehouse.gov/the-press-office/2014/09/11/statement-president-new-

sanctions-related-russia.

isolation as well as the economic costs to Russia” and turn up the pressure on Russian President Vladimir Putin to abide by International laws.4

In a statement issued by the G7 countries including Canada, France, Germany, Italy,

Japan, the United Kingdom and the United States in July 2014, “We, the leaders of …., join in expressing our grave concern about Russia’s continued actions to undermine Ukraine’s sovereignty, territorial integrity, and independence. We once again condemn Russia’s illegal annexation of Crimea, and actions to de-stabilize eastern Ukraine. Those actions are unacceptable and violate international law.” They added “This week, we have all announced additional coordinated sanctions on Russia, including sanctions on specific companies operating in key sectors of the Russian economy.”5

Soft-wares which involve economic sanctions, diplomatic measures and covert operations are waged to achieve political goals.6 The Soft-war over Ukraine between Russia and Western Powers have been initiated in November 2013, when Ukraine government postponed signing the Association Agreement with EU. After the western powers’ supported demonstrators ousted the pro-Russian president in February 2014, Russia countered the soft attack by softly annexing Crimea. The amount of blood spelled in both attacks were limited in comparison. The Soft-war has been intensified by Western Powers through imposing economic sanctions on Russia. Russia retaliated by increasing support to pro-Russian separatists thus escalating the conflict in southeastern Ukraine. The political stakes are very high for both parties of the conflict. It is very difficult to compel Russia at this level of sanctions to give up its annexation of Crimea and to abundant its interests in southeastern Ukraine. It will require stronger measures and more time for the sanctions to achieve the desired political outcome. Soft-wars like traditional wars are hard to predict their outcome and difficult to end once started. Compromise in the political demands or escalation of the Soft-war are the only options on the table, and hopefully the conflicting parties would not resort to the military option. Study Methodology and Rational: The debate on the effectiveness of economic sanctions imposed on Russia among scholars and politician has increased recently. Some politicians doubt that sanctions will be able to stop Russia’s actions related to the Ukraine. This study have examined the targeted sanctions imposed on Russia by Western Powers in terms of sanctioning policy goals, sanctioned coalition, sanctioned country strength and sanctions duration and impact. This study analyzed the policy of economic sanctions imposed on Russia since 2014 utilizing the hypothesis “Economic Sanctions are unlikely to achieve the desired political goals if the aims are too ambitious, time is short, impact is weak, coalition is fragile, or the sanctioned country is too strong.” Utilizing the deduction method, this study have analyzed whether economic sanctions imposed on Russia are effective in achieving the desired political goals.

4 Ibid

5 The White House, “G-7 Leaders Statement on Ukraine,” Office of the Press Secretary, (30-July-2014),

http://www.whitehouse.gov/the-press-office/2014/07/30/g-7-leaders-statement-ukraine 6 Gary Clyde Hufbauer, Jeffrey J. Schott, Kimberly Ann Elliott, and Barbara Oegg,” Economic Sanctions Reconsidered,” in

Conclusion,” (Washington DC: Institute for International Economics, 3rd edition, 2007).

Literature Review: Enormously influential study on economic sanctions identified 174 cases and 204 episodes of Global use of economic sanctions during the 20th century and up to 2007. The study identified economic and political factors that contributed positively to the achievements of the desired foreign policy goal.7 Sanctions inflect significant human cost on the populations of target states, and there is no reason why economic pressure is employed together with military force.8 Researcher found out that sanctions at least partially successful in 34 percent of the cases. The success rate is depended on the type of policy change sought.9 These studies have become the foundation on the effectiveness of economic sanctions and the authors’ recommendations have guided this research.

1. Economic Sanctions

Economic sanctions as a foreign policy tool are economic measures and penalties, such as prohibiting trade, halting financial transactions, or barring economic and military assistance.10 Since the end of the Cold War, in early 1990s and the globalizations of the world economies, sanctions have been used much more frequently as a tool of foreign policy and international diplomacy.11 Rising from 116 cases of economic sanctions at the end of 1990 to 151 by the end of the 20th century, to 174 cases by 2007.12

1.1. Historical Overview

Economic sanctions have been utilized by countries as a foreign policy tool for centuries. Sanctions were imposed in ancient Greece in 432 B.C. during events leading to the Peloponnesian War between Athens and Sparta.13 The Pericles’s Megarian decree, enacted as response to the kidnapping of three Aspasian women. The sanctions may have contributed to triggering the war between Athens and Sparta.14 In early Islam, Quraysh in about 612 A.D. have utilized economic sanctions against Islamic believers in what is called the Sanction’s Decree (Saheift Al-Mukata) to force them to change their religion.

The United States have applied sanctions against the British and French from 1808 to 1809 to try to coerce them to make concessions on the rights of neutral states. Since the late 195Os, the use of sanctions has been particularly widespread. The most recent cases of sanctions include multilateral sanctions against South Africa imposed in 1985 and 1986 in response to its racial separation policies.15

The US imposed selected economic sanctions on China in 1989 in response to Chine’s suppression of political opposition and human rights violation. The United Nations (UN) have

7 Hufbauer, et al., ”’Economic Sanctions Reconsidered’ in Introduction.”

8 Robert A. Pape, “Why Economic Sanctions Do Not Work,” International Security, Vol. 22, No.2, (1997), pp. 90-136,

http://web.stanford.edu/class/ips216/Readings/pape_97%20%28jstor%29.pdf 9 Hufbauer, et al., ”’Economic Sanctions Reconsidered’ in Introduction,” P6-11.

10 US-GOA, “Economic Sanctions effectiveness as a tool of foreign policy,” p10

11 Richard N. Haass, “Economic Sanctions: Too Much of a Bad Thing,” The Brookings Institution, Policy Brief no. 34, (1998),

http://www.brookings.edu/research/papers/1998/06/sanctions-haass 12

Hufbauer, et al., ” Economic Sanctions Reconsidered,” 13

US-GOA, “Economic Sanctions effectiveness as a tool of foreign policy,” p8 14

Hufbauer, et al., ” Economic Sanctions Reconsidered,” 15

US-GOA, “Economic Sanctions effectiveness as a tool of foreign policy,” p8

imposed comprehensive trade sanctions on Iraq after the invasion of Kuwait in 1990.16 Economic sanctions were imposed on Iran by the United States since the Iranian Islamic revolution in 1979. In 2010 the United States and other countries have imposed unprecedented sanctions against Iran in response to Iran’s nuclear activities.17

1.2. Sanctions Design

To achieve the desired political goals, sanctions can be designed to inflict varying levels of economic hardship on the targeted countries.18

Instrumental sanctions: These are measures designed to prevent the target country from obtaining specific goods or financial capital. Comprehensive trade and financial sanctions imposed by the United Nations in 1990 against Iraq represented an attempt to weaken the country’s commerce and limit its ability to wage war.19

Punitive sanctions: These are measures designed to punish the targeted country economically for intolerable behaviors. These sanctions impose moderate economic pressure and can cause substantial economic costs the target state.20

Symbolic sanctions: These are measures whose economic effects are so slight that sanctioning nations do not expect them to cause great economic harm. They are designed to signal disapproval of the targeted countries behaviors while maintaining commercial relations.21

2. Conflict Background 2.1. The Geopolitical Conflict over the Ukraine

In February 2014, the Ukraine has faced the most deadly demonstration since its independence from the Soviet Union. The protest was against the government dropping plans to form closer trade ties with the European Union. The conflict was a result of more than twenty years of weak governance system, a corrupt economic system dominated by the rolling elites, with strong dependence on Russia. The Ukraine's population are diverse in their language use, religion and ethnical background. The country of forty-five million people has struggled with its identity since the breakup of the Soviet Union in 1991. The country is divided between European-oriented people living in western and central Ukraine and Russian-oriented living in southern and eastern Ukraine.22

Political opponents were repressed in the Ukraine. Successive presidents facilitated increasing control over the economy by few businessmen. Under pressure from Russia, president Yanukovich cancelled plans to sign association agreement with EU in November,

16

Ibid, p8. 17

United States Government Accountability Office “International Sanctions Have Adversely Affected the Iranian Economy,” National Security and International Affairs Division GAO-13-326 Iran, (2013), p4. 18

US-GOA, “Economic Sanctions effectiveness as a tool of foreign policy,” P9 19

Ibid, P9. 20

Ibid. 21

Ibid,. 22

Robert McMahon, “Ukraine in Crisis,” Council on Foreign Relations, (2014), http://www.cfr.org/ukraine/ukraine-crisis/p32540

2013. His decision incited demonstrations in Kiev by protesters seeking to align their future with Europe's and speaking out against government corruption. The bloody demonstrations, with scores of people killed, have resulted in overthrowing the pro-Russian President in February 2014. The overthrow of Yanukovich has increased divisions between the eastern and western parts of the Ukraine.23

In February 2014, Crimea an autonomous republic of Ukraine of two million people with its own parliament and laws, called for a referendum, in which the peninsula's voters voted for unification with Russia. Russia annexed the Crimean peninsula and the port city of Sevastopol and deployed tens of thousands of forces near the border of eastern Ukraine. Conflict erupted between pro-Russian separatists and government forces in April 2014. Pro-Russian separatists in the regions of Luhansk and Donetsk established self-declared "People's Republics." Elections on May 25 brought pro-Western Petro Poroshenko into power. The new president tried to enforce the government control over eastern cities. By September 2014, the fighting between pro-Russian separatists and government forces had killed more than 2,000 person and caused hundreds of thousands to leave their homes.24

2.2. Russia Geopolitical Interests in the Ukraine

Russia strong ties with Ukraine dates back to the ninth century, where Ukraine was part of Russia for centuries. The Crimea peninsula only became part of Ukraine in 1954, when Soviet leader Nikita Krushchev transferred it administrative control. Russians make up an estimated 59 percent of the population of Crimea, 23 percent Ukrainians, and Muslim Tatars about 12 percent.

Militarily, Russia consider Ukraine as a buffer zone between them and Western powers. As part of a bilateral agreement between Russia and Ukraine, Crimea was the base for Russia's Black Sea fleet. Russia has provided security guarantees to Ukraine in exchange for relinquishing its nuclear arsenal. On the other hand, Ukraine plays an important role in Russia's energy trade, where 80 percent of Russia’s natural gas exported to European countries pass through Ukraine.25

Russia considers EU eastward expansion policies to Ukraine a threat, since it opens the door for western organization such as North Atlantic Treaty Organization (NATO) to infiltrate the Ukraine. Russian president Vladimir Putin has described Russia role in Ukraine as to protect ethnic Russians. Putin told the Russian parliament in March 2014, that Russia would protect the rights of Russian all over the world. Russia denied charges of intervention in Ukraine, but has maintained thousands of troops near the Ukrainian border.26

2.3. The US and EU Interests in the Ukraine

23

Ibid 24

Ibid 25

Ibid 26

Ibid

The EU considers Ukraine as a “priority partner country” and have strived to sign an Association Agreement with them. The agreement is considered to be the first agreement that based on political association between the EU and other east European countries. The agreement that include a comprehensive free-trade deal, aims at increasing Ukraine’s political association and economic integration with the EU.

On 21st of November 2013, the Ukraine Cabinet of Ministers decided to suspend preparations to sign the Association Agreement with EU.27 Since the start of the crises in Ukraine in March 2014, the EU had shown support to the “peaceful protest” in Kiev. The demonstration that followed the government's announcement regarding the Association Agreement has resulted in ousting Yanukovich, the pro-Russian President.28 In a statement by EU released on March 6, 2014, the EU Heads of States have applauded the protestors, “We applaud the courage and resilience shown by the Ukrainian people these last months and weeks.”29 The EU have strongly condemned Russia for its “unprovoked violation of Ukrainian sovereignty and territorial integrity” and have requested from Russia to immediately withdraw its armed forces.30 The EU called on Russia to “repudiate lawless acts” in eastern Ukraine and pull back its troops from the Ukrainian border. The EU called on Russia to support the Ukraine peace plan and adopt measures to stop the “flow of illegal fighters, arms and equipment” over the border into Ukraine.31

The United States considers Russia's actions in Crimea and eastern Ukraine as illegal and in breach of international law. The US considers Russia's military support for Ukrainian separatist, a serious challenge to the sovereignty and nonintervention principles of world order. The US accused Russia of arming the Pro-Russian separatists and blamed the rebels in eastern Ukraine, using Russia supplied missiles to be responsible for the shooting down of the Malaysian civilian airliner in July 2014, where 298 persons were killed, mostly Europeans. 32

NATO secretary-general Anders Fogh Rasmussen described the crisis in the Ukraine as the greatest threat to European security since the end of the Cold War. The United States has bolstered NATO's air presence over the Baltic States and deployed about six hundred soldiers in Latvia, Lithuania, Estonia and Poland.33

2.4. Russia Economic Strength

Just as the Soviet Union, Russia is a collection of diverse territories at different stages of development. Russia’s population in 2014 reached about 143.7 millions, at a growth rate of

27

European Union External Action, Factsheet EU-Ukraine relations. 28

Ibid 29

Statement of the Heads of State or Government on Ukraine, Brussels: European Council, (6 March 2014), http://www.consilium.europa.eu/uedocs/cms_Data/docs/pressdata/en/ec/141372.pdf 30

Ibid 31

European Union External Action, Factsheet EU-Ukraine relations. 32

McMahon, “Ukraine in Crisis.” 33

McMahon, “Ukraine in Crisis.”

0.1%. Russia’s annual Gross Domestic Product (GDP) stands at US$2,092 Billion, with GDP average annual growth at 1.1%, and Inflation annual rate stands at 7.7%.34

Russia export revenue has soared since 2000. Merchandise exports totaled over US$520

Billion in 2013, while imports were equivalent to about US$340 Billion. Oil and gas account for around 70% of Russia's exports and metals contributing a further 11%, chemicals 6%, machinery and equipment 4.5%. Russia major markets are the Netherlands which purchase 14.7% of Russia’s exports, Germany 6.7, Italy 6.2 and China 6.8. Machinery and equipment account for 58.1% of Russia imports, Chemicals 14.8, Food and Agriculture products 13.9, metals at 7.1%. China is Russia’s largest supplier with 16.3% of total imports, Germany 12.1%, Ukraine 5.7% and Belarus 4.2%.35

Russia have the world's largest natural gas reserves, with 1,688 trillion cubic feet as of

January 1, 2013. Russia's reserves account for about a quarter of the world's total proven gas reserves. Russia was the third-largest producer of liquid fuels in 2012, following the United States and Saudi Arabia. In 2012 the majority (79%) of Russia's crude oil exports went to European countries. The state-run Gazprom dominates Russia's natural gas production, producing about 74% of Russia's total natural gas output. Russia sells about 76% of its natural gas exports to customers in Western Europe.36 Russia is the third-largest generator of nuclear power in the world and fourth-largest in terms of installed capacity.37

3. Economic Sanctions Imposed on Russia

The EU has utilized economic sanctions as one of the foreign policy tools to promote “peace, democracy and the respect for the rule of law, human rights and international law.” Designed to bring about a change in policy. The sanctions are part of comprehensive policy approach complemented by political dialogue and other political efforts.38

After Russia’s “illegal annexation” of Crimea and Sevastopol and in response to Russia's

continued escalation of tensions through rhetoric and ongoing military maneuvers on Ukraine's eastern border, the EU in April, 2014 have intensified its economic sanctions targeting 15 additional persons with travel ban and asset freeze. In July, 2014 the EU reinforced its sanctions targeting those who are responsible for the “annexation of Crimea” or the destabilization of eastern Ukraine. To bring the number of persons under EU sanctions, in connection with the situation in Ukraine, to 87 while the number of entities to 20.39

34

Economic Intelligence Unit, Fact sheet – Russia, (Nov 2014),

http://country.eiu.com/article.aspx?articleid=1912509775&Country=Russia 35

Economic Intelligence Unit, Fact sheet – Russia. 36

US Energy Information Administration (EIA), “Russia,” (November-2013), http://www.eia.gov/countries/analysisbriefs/Russia/russia.pdf 37

US Energy Information Administration (EIA), “Russia.” 38

Council of the European Union-Press Office, Factsheet - EU restrictive measures, (2014), http://www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/EN/foraff/135804.pdf 39

European Union External Action, Factsheet EU-Ukraine relations.

Following downing of the Malaysian Airlines Flight MH17 in July, 2014 over eastern Ukraine, the EU had significantly increased its sanctions targeting “sectoral cooperation and exchanges” with Russia. The new sanctions limit access to EU capital markets for Russian State-owned financial institutions, impose an arms trade embargo, ban export of dual use equipment and limit access to sensitive technologies in the oil sector.40 In August 2014, The EU further intensified its sanctions to complement those adopted in July. The EU demanded that “ the Russian Federation to immediately withdraw all its military assets and forces from Ukraine.”41 Since March, 2014, the United States, Japan, and Canada have imposed sanctions on a number of Russian and Ukrainian officials. The measures include travel bans and the freezing of assets.42

In July 2014 The United States announced broad economic sanctions against Russia, including restrictions on some state-controlled Russian banks’ ability to borrow money from U.S. The new sanctions imposed an arms embargo and targeted Russian finance, energy, and defense industries “in response to Russia’s continued attempts to destabilize eastern Ukraine and its ongoing occupation of Crimea.”43 The US banned export of deep sea, Arctic and shale deposits extraction technology to Russia. In addition, the U.S imposed restrictions on large Russian companies. By imposing sanctions on companies and banks within Russia’s financial services and energy sectors, the sanctions made it difficult for Russian companies to borrow money from U.S. financial sources. The US have frozen all assets of companies or individuals designated by Executive Orders number 13660 or 13661 and have prohibited any transactions by US individuals or firms with the listed companies.44

The European Union and the United States have threatened to adopt harsher sanctions

targeting the Russian economy. British Foreign Secretary William Hague warned that the EU is prepared to impose more sanctions on Russia if needed.45

3.1. Diplomatic Measures

The Conflicting parties has been engaged in seeking a diplomatic solution to the crisis in Ukraine. A meeting in Geneva between the European Union, the United States, Ukraine and Russia was organized on 17th of April 2014, where all sides agreed on refraining from violence, intimidation or provocative actions. In June 2014, Petro Poreshenko Ukraine’s newly elected president have announced a ceasefire and 15-point plan for the peaceful settlement of the

40

European Council-Press office, Statement by the President of the European Council Herman Van Rompuy and the President

of the European Commission in the name of the European Union on the agreed additional restrictive measures against Russia, Brussels: EUCO 158/14, (29 July 2014), http://www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ec/144158.pdf 41

European Union External Action, Factsheet EU-Ukraine relations. 42

Ben Smith, “Sanctions against Russia over Ukraine,” House of Commons Library, International Affairs and Defense Section, (2014), http://www.parliament.uk/business/publications/research/briefing-papers/SN06951/sanctions-against-russia-over-ukraine. 43

U.S. Department of the Treasury - press release, “Announcement of Treasury Sanctions on Entities Within the Financial Services and Energy Sectors of Russia, Against Arms or Related Materiel Entities, and those Undermining Ukraine's Sovereignty,” (2014), http://www.treasury.gov/press-center/press-peleases/Pages/jl2572.aspx . 44

Ibid. 45

Smith, Ben “Sanctions against Russia over Ukraine.”

conflict. A discussion that focused on peace and security and Ukraine’s territorial integrity and sovereignty was organized in Minsk between Russia and Ukraine and attended by EU. A ceasefire agreement reached in Minsk on the 5th of September, 2014 during Trilateral (Russia, Ukraine, EU) meeting.46

In an effort to isolate Russia from the International stage, the G8 meeting held in Brussels in June 2014, was organized without Russia’s participation. The EU nations suspended negotiations over Russia's joining the Organization for Economic Co-operation and Development (OECD) and the International Energy Agency. The EU-Russia joint summit was cancelled and EU member states decided to cancel regular bilateral meetings with Russia.47

3.2. Impact of Economic Sanctions 3.2.1. Cost on Russia’s Economy

The conflict in Ukraine and international sanctions have weighed heavily on the Russia economy. The Russian economy is close to “near stagnation”, with growth of 0.8 percent in the first half of 2014. Increased geopolitical risks and the uncertainty caused by the threat of sanctions, negatively impacted Russia economic activities in the first half of 2014. Sanction have suppressed business and consumer confidence about future growth prospects which lowered domestic demand for purchasing goods.48

The economic sanctions imposed on Russia and counter sanctions have resulted in reducing needed capital and technology to Russia’s energy sector. Russia have appropriated portions of Russian savers’ pension funds to help the country's companies.49 Manufacturing continued to outperform other industries with 3.6 percent growth, supported by the weak Ruble and a continuing expansion of production in the military complex.50

The economic warfare between Russia and Europe have increased the prices of meat

and vegetable dramatically. Higher than expected prices for food (by 11.4 % in September, 2014) caused by Russia’s import ban on EU food products have also contributed to increased inflation.51 The households purchasing power have fallen, impacted by further climbing inflation and the depreciating Ruble.52

Consumer prices continued to increase in November despite the CBR’s recent rate hike as the Ruble weakened and food prices continued to climb. The capacity of Russian food industry to replace banned food imports appears to be limited. Food prices rose by 12.6

46

European Union External Action, Factsheet EU-Ukraine relations. 47

Ibid 48

World Bank, Russia Overview, (Oct 08, 2014), http://www.worldbank.org/en/country/russia/overview 49

Michael Birnbaum, “Western sanctions for Ukraine conflict hurt Russian economy open up rifts”, Washington Post, (12-October-2014), http://www.washingtonpost.com/world/europe/western-sanctions-for-ukraine-conflict-hurt-russian-economy-open-up-rifts/2014/10/10/4f9db2aa-4e45-11e4-8c24-487e92bc997b_story.html 50

World Bank, “Russian Federation Monthly Economic Developments Report”, (December 10, 2014), http://www.worldbank.org/content/dam/Worldbank/document/eca/russia/Russia-Monthly-Economic-Developments-Dec-2014.pdf. 51 World Bank, Russia Overview.

52 World Bank, “Russian Federation Monthly Economic Developments Report”

percent in November 2014 together with the Ruble depreciation, the twelve-month Consumer Price Index rose to 9.1 percent in November 2014, which is much higher than the CBR targets of 3.5-6.5 percent set at the beginning of 2014.53

3.2.2. Falling Oil Prices and Russia’s Currency Value

Sanction have increased volatility on the exchange rate market and a significant depreciation of the Ruble value. The start of the geopolitical tensions in March, 2014 have resulted in a sharp depreciation of the ruble value. The ruble remained under increased pressure in the first nine months of 2014, triggered by higher and volatile capital outflows from Russia.54 Investors have withdrawn almost UD$75 billion out of Russia in the first six months of 2014 alone.55

The price of oil, the backbone of the Russian economy, has dropped more than 40

percent since July, 2014, the Brent crude fell to $60.47 in mid December 2014.56 Russia is the world's second largest oil exporter, with oil and gas accounting for about 70% of its exports and half of government revenues.57 Battered by low oil prices and the conflict in eastern Ukraine, the ruble has been declining throughout the year, losing about 50% percent of its value since January 2014. In mid December 2014, the Ruble fill from 31 to 62 Rubles for the dollar and 42 to 80 Rubles for 1Euro, which caused Russia to increase its interest rate to 17%.58

Risks to Russia’s financial stability from the large Ruble depreciation and economic volatility have forced the Central Bank of Russia (CBR) to intervene on several occasions.59 The CBR spent about US$40 billion in the first four months of 2014 and hiked its main policy rates up three times. The increased volatility in the Russian economy, required the CBR to spent about US$68.9 billion on interventions to support the Ruble. The CBR’s foreign exchange reserves decreased to US$456.8 billion by August 2014, from US$509.6 billion at the end of 2013.60

3.2.3. Impact on Russia Financial Sector

Sanctions has limited access to international financial markets and cost of borrowing for all sectors of the Russian economy have increased. Debt on Russian banks and companies will amount to US$99.4 Billion in the second half of 2014. EU and US Financial sanctions have targeted selected Russian banks and companies, thus increasing the funding costs for banks. By

53 Ibid.

54 World Bank Group-Russian Federation Partnership, Country Program Snapshot, World Bank, http://www.worldbank.org/content/dam/Worldbank/document/Russia-Snapshot.pdf .

55 Birnbaum, “Western sanctions for Ukraine conflict hurt Russian economy open up rifts.”

56 Nasdaq, Crude Oil Brent, http://www.nasdaq.com/markets/crude-oil-brent.aspx?timeframe=6m , Accessed on 15-

Dec-2014. 57 Voice of Amarica News, Russian Ruble Falls as Oil Prices Tumble Further, Voice of America, (December 01, 2014),

http://www.voanews.com/articleprintview/2540775.html?displayOptions=2

58 Trading Economics, Russian Ruble, http://www.tradingeconomics.com/russia/currency, Accessed on 14-Dec-2014

59 World Bank, “Russian Federation Monthly Economic Developments Report’”.

60 World Bank Group-Russian Federation Partnership, “

Country Program Snapshot.”

July 2014, the rates for interbank lending increased by 0.7–2.2 percentage points relative to end of 2013 levels.61

Russia’s financial sector outlook deteriorated as the depositors’ base continues to erode and refinancing risk increased. The increased refinancing risk is partly reflected in the soaring risk premium on Russia’s corporate debt. Given the deteriorated outlook for the banking sector and the economy, the yields on major Russian Eurobonds held by banks may increase further.62 Markets increase Russia’s economic risk factor and Russia’s 5-year Credit to almost 200 points higher than in January 2014.63

3.2.4. Russia’s Economy Future Outlook

The rising geopolitical tensions in the Ukraine following the takeover of Crimea by Russia, the uncertainties, tightening financial conditions and volatile capital flows put Russia’s economic outlook at a higher risk. Intensification of sanctions and countersanctions could affect trade flows and financial assets.64According to the World Bank there are substantial risks to the medium-term outlook for Russia’s 2014-2016 growth. The heightened geopolitical concerns over the Ukraine and expectations of additional sanctions will lead the Russian economy to slide into a “protracted low-level recession,” contracting by 0.9 percent in 2015 and 0.4 percent in 2016.65

Russia reserves standing at a comfortable US$420 billion at the end of November 2014.66 The CBR’s own reserves at US$205 billion (excluding gold, the Reserve Fund and the National Welfare Fund) are more than sufficient to cover the country’s total external payments due in December 2014 (US$33 billion) and due in 2015 (US$125 billion).67

3.2.5. Political Impact – Russian Support to Putin and his Policies

Despite Russian Government finances under increasing strain because of rising inflation, falling oil prices, lower consumer and business confidence with investment disappearing, Putin still enjoy high approval rating. Polling suggests that Vladimir Putin's popularity remains very high where he still enjoys over 80% approval rating. A state funded opinion research center WCIOM said that nearly two thirds of Russians support President Vladimir Putin’s actions on Ukraine. Forty seven percent believed Putin’s main aim was to achieve peace in Ukraine. 36%, said Putin wanted to keep NATO troops out of Ukraine while 33% believed the president’s mission was to protect the Russian-speaking population in eastern Ukraine.68

61 World Bank Group-Russian Federation Partnership, Country Program Snapshot.

62

World Bank, “Russian Federation Monthly Economic Developments Report 63

Ibid. 64

International Monetary Fund, Chapter 2: COUNTRY AND REGIONAL PERSPECTIVES, (April 2014), p64, http://www.imf.org/external/Pubs/ft/weo/2014/01/pdf/c2.pdf 65

World Bank Group-Russian Federation Partnership, Country Program Snapshot. 66

World Bank, “Russian Federation Monthly Economic Developments Report.” 67

Ibid. 68

Russia New Agency-TASS, “Russians back Putin on Ukraine policy - opinion survey,” (13-Aug-2014), http://itar-tass.com/en/russia/744786 .

There is little evidence that the mounting economic pressures since the March 2014 annexation of Ukraine’s Crimean Peninsula have soften Putin’s policies. Ordinary Russians say they are ready to make sacrifices in a battle with the West.69 The Russian President said “talking to Russia from a position of force is an exercise in futility, even when it was faced with domestic hardships.”70

3.2.6. Economic Costs on Western Powers

It has been challenging to form a united front of EU member states who have varying economic political interests with Russia. There are considerable differences within the EU countries about when and how harshly the sanctions on Russia should be applied.71 Many of the EU countries such Germany, Netherlands, Italy and Untitled Kingdom have close economic ties with Russia. The EU countries import the majority of Russia's crude oil (79%) and about 76% of its natural gas.72 The overall weak EU economic picture made EU countries concerned about the impact of the economic sanctions on their countries and the damage it may cause to EU economies.73

The uncertainty created by a gradually growing sanctions is affecting both the EU and Russian economies, but it may have a more serious effect on the Russian economy.74 Russia’s retaliatory sanctions have affected several EU countries. French government has resisted the call for canceling the sale of two Mistral helicopter assault ships to Russia.75 The French car manufacturer Renault said that its sales to Russia had already fallen by 8%.76 German exports to Russia have declined sharply in the first four months of 2014.77 The EU manufacturing growth stalled in November 2014 as new orders fell at the fastest pace in 19 months, despite heavy price cutting. The final Purchasing Manager Index (PMI) reading for the manufacturing sector in November came in at 50.1, the lowest number since June 2013.78

On the other hand, the U.S. economy remained a bright spot in a troubled global economy, where growth has slowed in China and EU, and Japan has slipped back into recession. U.S. manufacturing output recorded its largest increase in nine months in November 2014 as production expanded across the board, pointing to underlying strength in the US economy.79

69

Birnbaum, “Western sanctions for Ukraine conflict hurt Russian economy open up rifts.” 70

The Kremlin, Presidential Address to the Federal Assembly, (December 4, 2014), http://eng.kremlin.ru/news/23341 71

European Union External Action, Factsheet EU-Ukraine relations. 72

US Energy Information Administration (EIA), “Russia.” 73

Smith, “Sanctions against Russia over Ukraine.” 74

European Union External Action, Factsheet EU-Ukraine relations. 75

Smith, “Sanctions against Russia over Ukraine.” 76

Sarah Gordon and Andrew Bolger “Ukraine crisis threat to European earnings,” Financial Time, (August 3, 2014) http://www.ft.com/intl/cms/s/0/687e16b6-18bc-11e4-a51a-00144feabdc0.html#axzz3M4X6xNRV 77

Smith, “Sanctions against Russia over Ukraine.” 78

BBC News (December 1 2014), http://www.bbc.com/news/business-30276353 79 Lucia Mutikani, “U.S. factory production accelerates in sign of economy's strength,” Routers U.S. Edition, (15-Dec-2014),

http://www.reuters.com/article/2014/12/15/us-usa-economy-idUSKBN0JT1PQ20141215 .

4. Analysis - Economic Sanctions Effectiveness

The sanctions political goals and the type of policy change required play a major determining factor in the outcome of economic sanction. Studies indicated that sanctions are more successful in achieving the less ambitious political goals and they are usually less successful in achieving the most prominently stated goal. Economic sanctions are most effective when they are applied multilaterally and against nations with economic and political ties to the sanctioning country.80 The effectiveness of sanctions is not primarily determined by the economic damage they inflict.81 The success of the sanctions is more closely related to the threatened damage additional measures will cause., than it is to the economic damage of sanctions actually in place. Sanctions aims to create strong opposition within the sanctioned nation to pressure the target nation’s government to comply with the sanctioning nations’ wishes.82

4.1. Sanctions Political Goals

The sanctions imposed on Russia by Western Powers aims to achieve multiple goals. In a statement by the President of the European Council Herman Van Rompuy, he declared that these sanctions “is meant as a strong warning: illegal annexation of territory and deliberate destabilization of a neighboring sovereign country cannot be accepted in 21st century Europe.83The sanctions goals listed based on level of ambition:

1. Punishing Russia for its actions in the Ukraine through exerting cost on Russian government and on individuals pose to benefit from annexing Crimea.

2. Deterring Russia from making similar moves into other former Soviet Republic countries with Russians’ speaking population.

3. Preventing Russia from violating Ukraine’s sovereignty by stopping Russia’s support to the pro-Russian separatists in Ukraine.

4. Forcing Russia to abundant its claim over Crimea.

4.2. Sanctions’ Time and Impact

The sanction that started in March 2014 were gradual and were imposed in phases. Sanctions were intensified overtime, each phase a warning of additional sanctions was made if Russia did not change its policies. The threat of additional sanction have created uncertainty in the Russian financial market. The sanctions combined with falling oil prices have adversely affected the Russian economy.

80

US-GOA, “Economic Sanctions effectiveness as a tool of foreign policy.” 81

Ibid 82

Ibid 83

European Council- Press office, “Statement by the President of the European Council Herman Van Rompuy and the President of the European Commission in the name of the European Union on the agreed additional restrictive measures against Russia,” Brussels: EUCO 158/14, (29 July 2014), http://www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ec/144158.pdf

4.3. Sanctioning Coalition

Economic sanctions are most effective when they are applied multilaterally and against a friendly nation with economic and political ties to the sanctioning alliance. The Multilateral sanctions imposed by the United States and European Union have more political legitimacy and inflicted greater isolation on the sanctioned nation. The higher pre-sanctions degree of warmth between current adversaries, the more likely the sanctions will achieve its goals.84 Overall the EU countries have close economic ties with Russia which will impact positively on achieving the more ambitious political goals.

The different EU member states have diverging economic interests. German companies are reluctant to hamper trade with Russia, the UK financial sector benefits from Russian money, and many Central and Eastern European countries are highly dependent on Russian gas and on Russian spare parts for the Soviet-era weaponry in their armed forces. Sanctions failure rate increase if sanctioning countries have conflicting interests.85 EU countries have conflicting interest with Russia, the fear of further damage to the already weak European economies, may compel some EU countries to be unwilling to increase the level of sanctions or lengthen its duration. This will affect negatively the sanctions sustainability and outcome and will have negative impact on achieving the sanctions political goals.

4.4. Sanctioned Country

Russia the largest country on earth, has one of the 10 top economies in the world with its GDP US$2.1 trillions in 2014. President Putin have a very good grip on power in Russia. His Ukraine policies enjoy support of Russian people. People see him as the person who will bring back Russia national pride and its influence on the International stage. Russia economy undiversified nature made it very vulnerable to falling oil prices. Russia with strong shame and honor code, “saving face” is important and economic hardship have create a backlash. The government remained politically unyielding in the face of external pressure and have benefited by using sanctions to improve its standing among its population.86

Studies have shown that cases involved modest political goals have much higher rate of success. Since the cost on Russian economy was deep, the first two political goals are achievable if not already been achieved, while the third goal will require additional time. The fourth political goal will be very difficult to achieve since Crimea is of significant strategic importance to Russia. President Putin declared in his statement in front the Russian Federal Assembly that Crimea have “invaluable civilisational and even sacral importance for Russia, like the Temple Mount in Jerusalem for the followers of Islam and Judaism.” He added “Crimea is where our people live, and the peninsula is of strategic importance for Russia.”87

84

US-GOA, “Economic Sanctions effectiveness as a tool of foreign policy.” 85

Hufbauer, Jeffrey J. Schott, Kimberly Ann Elliott, and Barbara Oegg, ”’ Economic Sanctions Reconsidered,’ Conclusion,” (Washington DC: Institute for International Economics, 3rd edition, 2007). P160 86

US-GOA, “Economic Sanctions effectiveness as a tool of foreign policy.” 87

The Kremlin, “Presidential Address to the Federal Assembly.”

5. Conclusion

Economic sanctions usually are one weapon among a larger array of political tools utilized against the targeted country.88 The sanctions combined with the falling oil prices have adversely affected the Russian economy. Russia’s future political stability depends on its economic stability. Belonged sanctions and economic hardships will greatly impact Putin support base. Unsatisfied business and middleclass people may rise against Putin’s policies and force a policy change. Considering the importance of Crimea to Russia’s National bride, coercing President Putin to make important policy changes such as changing his policies of annexing Crimea will require intensification of sanctions and allowing more time for them to take effect.

The collapse of oil prices in 1986, have a profound effect on the Soviet Union’s weak and mismanaged economy and it was attributed to great extend to the fall of the Soviet Union. Russia undiversified economy is heavily dependent on oil revenues, with energy and energy-related production amounting to a substantial share of total economic output. The Russian government depends on oil as its main source of foreign currency earnings, and petroleum industries including gas account for about 46 percent of Russian budget revenues. If economic sanctions continued and oil prices remained at current levels of US$60/Barrel, Russia will not be able to afford its social programs or its ambitious ten-year defense spending plan. President Putin may have to curb his military ambitions. To avoid long term damage and to reduce Russia vulnerability through its dependency on oil revenues, Russia needs to diversify its economy and sources of revenue.

It is difficult to predict how Mr. Putin plans to overcome the economic, diplomatic and

covert war (Soft-war) waged against Russia by Western Powers. In the short term, Russia has limited options available to overcome the economic hardship caused by the sanctions and the falling oil prices. Russia may toughen its stand concerning issues such as NATO eastern expansion policy, Iran nuclear negotiation and the Syrian conflict. On the long term, if the conflicting parties did not reach agreement, Russia has a slim chance to survive the economic and political turmoil caused by the Soft-war. On the other hand, if Russia was able to overcome, Russia will come out stronger with a diversified economy and much bigger influence on the world stage.

88

Hufbauer, et al., ”’ Economic Sanctions Reconsidered,’ Conclusion,” P158.