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Russia Is Winning the Sanctions Game

March 14, 2019 Topic: Security Region: Eurasia Blog Brand: The Skeptics Tags: SanctionsRussiaMoscowEconomyTrade

Russia Is Winning the Sanctions Game

These sanctions were supposed to punish Moscow's elite, but instead they've spurred economic development and patriotism.

The current conversation about Russia sanctions centers around targeting and scope. Are we punishing the people whose behavior we most want to change? Is there pain, well inflicted, on those individuals responsible for creating chaos in Ukraine and Crimea, for reckless attacks on Sergei Skripal and others, and for wanton interference in Western elections? Can we hurt Russian elites in a way that Putin will notice? Have we done enough?

In at least one sector, though, the sanctions are a textbook case of unintended consequences: they’ve put Russian farmers in the best shape they’ve ever been. Countersanctions aimed at imported Western food products—put into effect just days after the initial sanctions in the summer of 2014—initially sent Russian consumers into a tailspin, hungry from a lack of immediate alternatives to tasty European cheeses and processed foods. But palates adjusted quickly, and the import substitution effects boosted Russia, by 2016, to the position of top wheat exporter in the world. As the United States hemorrhages global agro-market share courtesy of Trump-era tariffs and trade wars, Russia is actively and aggressively filling the gap.

The Sanctions

In early 2014, following Russia’s illegal annexation of Crimea and continued involvement in separatist uprisings in eastern Ukraine, the United States, European Union, and several other Western countries imposed sanctions. Throughout 2014, these measures progressed from the diplomatic (limits on previously scheduled meetings and talks), to curbs on specific individuals and organizations (targeted visa bans and asset freezes), and finally, in July and September, to restrictions on Russia’s financial, defense, and energy sectors. The latter limited access to capital markets and low-interest loans, imposed an arms embargo and ban on exports of dual-use items to military clients, and prohibited export of innovative extractive technology (with special approval required for all other energy-related exports). Since 2014, the sanctions have been sustained and augmented, but they have remained within these categories.

In August of 2014, Russia initiated countersanctions to ban specific food commodities imported from the United States and EU. Affected foods included beef, poultry, fish/seafood, fruits/vegetables, nuts, milk and dairy, cheese, and a wide range of processed and prepared foods. The ban was broad, covering both staples and luxury items. It hit many foods on which Russia was most import-dependent, and its wide geographic scope (the range of countries it covers) has made it difficult to compensate fully for shortages by increasing imports from non-sanctioned countries.

The Impact

Russia felt the whole spectrum of sanctions in three immediate ways: increased volatility on foreign exchange markets, leading to significant depreciation of the ruble and resulting inflationary pressures; restricted access to financial markets; and depressed consumption and investment. Imports sank in the third quarter of 2014. The steep drop in world oil prices in the fourth quarter of 2014 likely had even more profound effects on the Russian economy than the sanctions and countersanctions. In late 2014 and early 2015, oil prices fell so far (from $100 per barrel in Q2 2014, to under $60 by the end of 2014, and even further by the second half of 2015) that Russia’s export revenues were cut by a third. And the financial sanctions meant that Russia could not mitigate the oil price plunge by borrowing money.

Right off the bat, the countersanctions impacted $9.5 billion worth of food annually, covering almost a tenth of total food consumption in Russia and a quarter of food imports. Before the countersanctions, domestic production covered less than 40 percent of Russia’s intake of fruit, 80 percent of milk/dairy, and 90 percent of vegetables; Russia was already a net exporter of cereals, potatoes, and oil plants. The countersanctions banned 60 percent of incoming meat and fish, and half of imported dairy, fruits, and vegetables. Overall, the share of imports in total food consumption decreased from over a third in 2014 to just over 20 percent in the second quarter of 2017.

Prices immediately increased. By February of 2015, food inflation (year-on-year) was over 23 percent. Households shifted food buying and eating habits away from pricier, formerly imported foods (fruit, milk/dairy, beef) toward less expensive, domestically-sourced goods (potatoes, bread, chicken), and have adopted “smart shopping” strategies to value acceptable quality at lower prices (including a diminished appetite for prestige brands in favor of trusted store brands). Before too long, the consumer environment had largely adjusted and recovered. By 2018, food price increases were much lower than overall inflation.

 

Some banned food products from the EU have made their way to Russia as re-exports from other countries. In the final quarter of 2014, for example, EU dairy exports to Belarus increased tenfold compared to the previous year, and exports of fruit and fish doubled—not likely a surge in the domestic Belarussian market. While not a large percentage of Russia’s overall food trade, these secondary import substitutions have exacerbated trade tensions between Russia and Belarus, leading to a reinstatement of customs controls between the two countries in December 2014, as well as the threat of restrictions on imports of milk products from Belarus as recently as spring 2018. Probably rightly, Russia accuses Belarus of being a willing conduit for banned, counterfeit, and low-quality or mislabeled foods.

The Industry

 

The countersanctions were a gift to the Russian agrifood industry. They legitimized and catalyzed an import substitution strategy whose broad objective had been in place since the late 2000s: to become self-sufficient in food. In other words, the sanctions paved the way for Putin to overcome a long-standing embarrassment dating back to the collapse of the sector in the 1990s. The timing of the countersanctions—announced just a couple of days after the sanctions—led many observers to wonder whether the lists of banned products had been planned beforehand, specifically as a measure intended ultimately to boost domestic production.

Russia’s food industry has seized this opportunity. Many investors who had not previously bothered with agriculture suddenly became interested in farming. High-end oligarchs also got the message, with the agriculture sector becoming a point of national pride and patriotism for some. Viktor Vekselberg, for example, has started investing in the construction of urban greenhouses. The government has earmarked 242 billion rubles (just under $4 billion USD) in agricultural support for 2018–2020, focused on rail transportation, subsidized loans, block grants to regions, partial compensation for capital investments, and targeted support for dairy farmers. A new legal requirement for public procurement gives preferences to domestic products—not just for food, but across the board, including key industries like software. This government purchasing boost, in combination with the countersanctions, has been of comparatively less benefit to domestic sectors that don’t produce quality alternatives to imports, but the food industry has benefited significantly. Even sub-sectors not covered by the countersanctions have asked to get in on the game. In June 2015, Russian candy manufacturers asked for countersanctions to extend to European chocolate, hoping to capture the market niche from Belgium, France and Germany. The Minister of Agriculture, Alexander Tkachev, summed it up neatly in 2015: “We are thankful to our European and American partners, who made us look at agriculture from a new angle, and helped us find new reserves and potential.”

Agrifood was one of the few bright spots in the country’s otherwise bleak economy from 2014–2016, boasting 3.2 percent average growth. In the words of Andrey Guriev, the chief executive of PhosAgro, a Russian phosphate fertilizer producer: “In one day, the Russian agricultural sector became profitable as hell.” And the growth continues. Russia now produces almost twice as much grain as it consumes, and it’s nearly self-sufficient in sugar and meat products. Domestic production has completely displaced imports of pork and chicken. By 2016, Russia had become the world’s largest exporter of grains, which had overtaken arms sales to become Russia’s second-largest export commodity (after oil/gas) to the tune of almost $21 billion. The Black Earth region of central and southern Russia, close to Black Sea ports, is well positioned to supply large wheat importers like Turkey and Egypt, and there has been huge investment in storage facilities and export terminals. This food market turbulence has attracted a new superpower; China is rapidly creating a market for Russian soybeans and sunflower seeds, replacing U.S. products hit by Trump-era tariffs. And it doesn’t stop there. Russia has about 50 million still-unused acres of potentially productive land, on top of the seventy-nine million where wheat was grown in 2017, and its crop rotation schemes—including winter wheat, corn, barley—hedge well against bad weather and unpredictable markets. Putin’s “May decrees” last year included a goal to double 2018’s $25 billion in food exports by 2024.