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The West has hit Russia with tough sanctions. They could be tougher still.

If Putin escalates the war in Ukraine, here’s what could be next

- March 2, 2022

When the Biden administration announced its first round of financial sanctions targeting Russia last week for its invasion of Ukraine, it described them as “unprecedented” measures. In the days since the initial announcement, the United States and its allies have substantially increased the pressure on Russia, broadening the scope of the sanctions and bringing in additional partners to intensify the multilateral squeeze.

The speed with which the current suite of measures has been arranged is impressive. They are already inflicting real damage on the Russian economy. Most costly are the sanctions targeting the Russian central bank.

But calling the sanctions unprecedented is an exaggeration. The scope of the initial round, while severe, fell short of sanctions previously imposed on countries like Iran and Venezuela. The United States and its allies could apply still more economic pressure down the line.

The Russia sanctions package is severe

At first, Western sanctions targeted two major Russian financial institutions and a number of oligarchs closely tied to Russian President Vladimir Putin. These banks and individuals were immediately barred from cross-border financial exchanges with any bank that has U.S. or European operations.

While the level of U.S. cooperation with Europe was notable, these measures were otherwise in keeping with past measures targeting banks and oligarchs in Russia.

However, within days, the United States and allies increased the measures’ severity. Within a week, they’d sanctioned Putin himself. Select Russian banks had been cut off from SWIFT, the messaging system by which banks communicate to transfer funds around the world. This week, the United States added the Central Bank of Russia (CBR) to the target list.

Blacklisting CBR is the most significant punishment the West has undertaken yet. The United States rarely sanctions a foreign central bank, although it’s not unprecedented. The U.S. Treasury blacklists, or “designates,” thousands of individuals and entities but only a few are monetary authorities — and those are in a Who’s Who of pariah states: Iran, Libya, North Korea, Syria, Venezuela.

Targeting CBR, therefore, seriously escalates the economic pressure on the Russians. The European Union, Japan, and even historically neutral Switzerland have all joined in isolating CBR, which further intensifies Moscow’s pain.

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Why incapacitating Russia’s central bank matters

Sanctioning the central bank move has two key consequences. First, CBR can’t access its hundreds of billions of dollars in foreign exchange reserves, which it holds in accounts in the United States, Europe and Asia.

Ordinarily if investors were selling Russian assets and exchanging rubles for dollars, CBR could tap its foreign exchange reserves, using the dollars and euros it has saved to buy rubles being dumped by investors. Such a move could prevent a major depreciation of the ruble, which would likely lead to financial panic in Russia.

But the sanctions mean that most of Russia’s reserves are frozen, rendering them useless for currency defense. The Russian ruble lost a third of its value on Monday, absent CBR support.

Second, the central bank sanctions effectively block CBR from transacting business with any entity or individual in the sanctioning countries. Why does this matter? About 20 percent of Russian reserves are held in physical gold, equal to roughly $130 billion. Much of this is believed to be held in Russian vaults. These assets cannot be frozen by sanctions measures.

In normal circumstances, Russia could sell this bullion in global gold markets for hard currency, which it could then turn around and use to support the ruble. Now, Russia will have a much harder time finding buyers for its gold.

More important, any dollars CBR acquires will be useless for foreign exchange intervention since it can’t do business with banks and enterprises in the sanctioning countries. In sum, even assets held on Russian soil cannot be used to defend Russia’s currency.

Check out all TMC’s coverage of the Russia and Ukraine crisis in our new topic guide: Russia and its neighbors.

But the sanctions could go much further

Despite these sanctions’ severity, they fall short of past measures used to target other regimes, in two main ways.

First, so far, the United States has not resorted to “secondary sanctions,” used to great effect against Iran. When enforced, secondary sanctions mean that any bank that wishes to continue doing business in the United States must refrain from conducting business on behalf of sanctioned entities — and must also end all business relationships with third-party financial institutions doing business on behalf of the targeted entity.

Put differently, any bank, anywhere in the world, found to conduct financial business on behalf of targeted Russian oligarchs, banks, and CBR, would immediately find itself blacklisted by the U.S. Treasury as well.

Secondary sanctions would force banks in countries like China, which have not joined the multilateral sanctions effort, to choose between Russia or the United States. Since the U.S. financial system is central to world business, most Chinese banks would likely pull back from providing financial services to Russian partners, as they did with their Iranian partners in the past.

Second, the United States and its partners could end the energy carve-outs in the current sanctions. What does that mean? Right now, most payments for Russian energy are allowed to continue. The world can continue to buy Russian gas and oil, allowing Russia to earn euros and dollars in exchange. While the CBR sanctions mean those earnings cannot be used to support the ruble, they can pay for imports. That’s a vital lifeline for the Russian economy.

Contrast this with how the United States has dealt with Nicolas Maduro’s regime in Venezuela. In 2019, the U.S. sanctioned PDVSA, the state-owned oil company responsible for the majority of the Venezuela’s export earnings.

If they chose, the United States and its partners could add oil payments to their sanctions, treating Russian energy giants like Rosneft and Gazprom as they’ve treated PDVSA. While this would drive up energy prices in Europe and the U.S., it would have an even more devastating impact on the Russian economy.

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In other words, if Putin further escalates in Ukraine, the West could retaliate by significantly escalating sanctions. Should that happen, it would be fair to describe the measures as “unprecedented.”

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Daniel McDowell (@daniel_mcdowell) is an associate professor of political science at the Maxwell School of Citizenship and Public Affairs at Syracuse University.