Discussion of Russia and Sanctions

4/20/19, 3:59 PMRussia Is Winning the Sanctions Game

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Published on The National Interest (https://nationalinterest.org)

Home > Russia Is Winning the Sanctions Game

March 14, 2019 Topic: Security Region: Eurasia Blog Brand: The Skeptics Tags: Sanctions, Russia, Moscow, Economy, Trade

Russia Is Winning the Sanctions Game

 

 

4/20/19, 3:59 PMRussia Is Winning the Sanctions Game

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

by Judy Twigg

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

 

 

4/20/19, 3:59 PMRussia Is Winning the Sanctions Game

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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

 

 

4/20/19, 3:59 PMRussia Is Winning the Sanctions Game

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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

 

 

4/20/19, 3:59 PMRussia Is Winning the Sanctions Game

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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

 

 

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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,

 

php/archive/2335-russias-booming-fish-industry-is-a-great-lesson-in-why-sanctions-dont-work.html” rel=”nofollow”>http://www.vrenergie.com/index.php/archive/2335-russias-booming-fish-industry-is-a-great-lesson-in-why-sanctions-dont-work.html

 

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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.

Import substitution in agrifood has certainly not been challenge-free. Ruble

depreciation has increased prices for imported machinery and technology used in food

production, and the availability of Russian replacements remains limited, hiking

modernization and expansion costs. High interest rates have constrained possibilities

for accelerated investment. Government support schemes routinely disbursed funds

late. The slump in demand for relatively expensive foods has reduced the benefits

accruing from lack of Western competition. Imports still dominate the landscape of

 

 

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high-value products, including beef, fruits, and vegetables. Russian wheat is, on

average, of lower quality than Western counterparts (11.5 percent protein versus 13.5

percent in American wheat). But the impact of all of these factors has diminished since

2016. Last year, for example, Germany and The Netherlands sold $650 million worth

of farm equipment to Russia, and lower Russian wheat prices seem to be working as a

compromise for lesser quality.

Russian consumers adjusted quickly to the new lineup of products on the shelves. Over

time, shoppers have perceived that the quality of domestic alternatives to imported

food is getting better. Two-thirds of consumers polled in August of 2017 indicated that

the quality of food under the import ban had not deteriorated over the previous year.

Against a backdrop of bubbling unrest about Putin’s overall economic policies, most

Russians still blame Western sanctions—rather than Russian countersanctions—for

restrictions on availability and increased prices of imported foods. This attitude appears

to be robust, even as popular concerns about the sanctions overall rose from 28 percent

to 43 percent in 2018. Russian consumers have adopted “food nationalism” in response

to the sanctions environment; 94 percent of urban consumers in 2015, and 90 percent in

2016, reported that they preferred to buy Russian-made food products even when

equally priced imports of comparable quality were available. “Grown in Russia” is a

powerful sentiment.

There’s Just One Lingering Problem

The most visible hitch in matching Western food quality has centered on cheese.

 

 

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Things have become desperate: in August 2017, a Russian man was caught trying to

smuggle one hundred kilograms of cheese from Finland in a compartment of his car

disguised as a fuel tank. Although many small, artisanal Russian manufacturers have

sprung up, none have quite risen to the level of Swiss, Italian, and French cheeses,

many of which take decades to produce. Parmesan is especially challenging: it uses a

lot of milk, as well as access to credit to keep things running while the cheese ages.

Russia produces only about 60% of the raw milk needed to satisfy demand for cheese

and other dairy products; some domestic cheese makers are instead using imported dry

milk, separated dairy proteins, and even palm oil. By mid-2015, about a quarter of

Russian cheese was considered “fake” due to use of palm oil, whose imports increased

by 35.8 percent in the first quarter of 2018 over the previous year, indicating that the

practice continues. Desperate to find acceptable milk sources, one farm outside

Moscow imported one thousand French goats in late 2016 specifically to source cheese.

Despite these challenges, the countersanctions have clearly created a market

opportunity around cheese. The Moscow regional government, for example, is

currently compensating half of the cost of modernization of family dairy farms and up

to 20 percent for cheese-making facilities. At a large cheese festival held outside

Moscow every summer since 2016, farmers have exhibited a prized dairy cow named

“Sanctions,” and one vendor sells “Thanks for Sanctions” t-shirts. And journalists have

had fun with “punny” illustrative headlines: “Sanctions Present Russian Cheesemakers

with Gouda Opportunity”; “War and Cheese”; and “Russians Find Whey around

Sanctions by Copying Cheese.”

 

/2017/09/after-russia-banned-cheese-imports-oleg-sirota-became-a-cheesemaker-video.html” rel=”nofollow”>https://slate.com/human-interest/2017/09/after-russia-banned-cheese-imports-oleg-sirota-became-a-cheesemaker-video.html

 

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Source URL: https://nationalinterest.org/blog/skeptics/russia-winning-sanctions-game-47517

“We’ll Show You”

In July of last year, Putin announced that the countersanctions would remain in place at

least through December 2019. This was no surprise. Why would he backtrack, when his

previously languishing farmers have thrived under these new conditions? The sanctions

created an opportunity to build back a crippled Russian food industry, and Putin

grabbed it. Recent U.S. tariffs have expanded the opening even further to new export

markets. Moving forward, the Trump administration needs to think this through:

unintended consequences are more likely when a clever adversary is actively looking

for ways to create and exploit them. Regardless of whether Trump sees Russia as an

adversary or wants to maintain sanctions at all, it’s hard to imagine the bolstering of a

Russian competitor to U.S. farmers as a desired outcome of the sanctions regime. In

this specific case, Russia remains a few steps ahead in the game.

Judy Twigg is a professor of political science at Virginia Commonwealth University, an

adjunct professor at Georgetown University, and a senior associate (non-resident) at

CSIS. She consults regularly on global health and development issues for the World

Bank, U.S. government, and other agencies.

Image: Reuters

 

 

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