How Will Russian And Asian Trade Develop If The US & EU Put More Sanctions In Place?

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By Chris Devonshire-Ellis 

Moscow has already diversified its supply chains away from the EU

The threat of significant sanctions continues to loom for Russia as the United States appears to almost be willing Moscow to invade Ukraine to enable it to do so – and bring the European Union alongside it in cutting Russia adrift from the West (analysis here).

That will almost certainly mean a full or partial suspension of EU goods marked for Russian consumption – US export trade with Russia being minimal. Talk has also included suspending Russia from the global SWIFT payment system, creating its own – but ultimately recoverable trade problems when dealing with Russia. Moscow has already developed an alternative SPFS system which could be linked with China’s CIPS network and utilize non-US dollar payments that bypass SWIFT entirely. Quite apart from the issue that it would hasten the end of SWIFT as the only global payments network, the rise of sovereign cryptocurrencies, and especially their use in Asia would receive an addition boost. The US dollar would ultimately lose market share from its current position as the leading global currency exchange.

Sanctions at best are hit and miss – times change, products change and tastes change. The West’s sanctions on Russia over Crimea did not reverse the situation, and instead motivated Moscow to look East. Today, seven years on, EU and US trade levels with Russia are back to the same volumes as they were before the annexation of Crimea. What has changed is Russia’s trade with Asia, which has now reached the close to the same export volumes as its trade with the EU.

Since the 2014 Crimea influenced sanctions, Russia’s Eurasian Economic Union (EAEU), a free trade bloc including Armenia, Belarus, Kazakhstan and Kyrgyzstan – a geographic area that fits in between China and the European Union – has signed off additional free trade agreements with Vietnam, Iran, Singapore and Serbia, and has pending FTA to be concluded with BangladeshCambodia, China, India, Pakistan, Indonesia, Mongolia, South Korea, Thailand, Bosnia, Israel, Moldova, Egypt, UAE, Uzbekistan, and is beginning to make steps in South America. The entire ASEAN bloc is also considering an EAEU FTA, while Russia is also targeting the African continent.

In short, the Crimea sanctions have had the effect of motivating Russia to diversify its supply chains, reduce dependence upon Europe, and to develop new markets, especially in Asia. In effect, should the EU place sanctions on Russia, Moscow is collectively developing a more diverse, faster developing and far larger alternative market.

But what would Russia lose if the EU cut ties? There will be initial shortages as well as opportunities. In terms of consumer products, the 2014 sanctions saw EU cheese manufacturers forced out of the Russian market to be replaced, at least initially, by the rather unpleasant Russian version. But what happened next was that EU cheese manufacturers, cut off from a lucrative Russian market then moved to Russia to set up JV’s and make cheese varieties using Russian dairy products. Three years after the 2014 sanctions, good quality Russian-made varieties of Brie, Parmesan, Gorgonzola and so on began to appear back in the shops. It’s not just cheese – before sanctions, Russia imported its preferred European gourmet foods. Now its making its own.

The same applies to wine. The Russian wine industry is rather small, but it is high quality, and a move to reposition Russian wine – from the Black Sea region – as a premium quality product is starting to shift tastes to local consumption. The recent spat over Russia insisting that the word ‘Champagne’ could no longer be used on imported bottles of French Champagne was not an intended slight on Epernay, it was to instill in the Russian psyche that Russian sparkling wines are to the same category, and by definition, standard. With brands such as the Tsarist-era Abrau Durso turning out high quality vintages, they have a point. Russia doesn’t have the European capacity for wine production, but countries such as Armenia and Georgia do, with eastern varietals such as Saperavi (related to Cabernet Sauvignon) already much loved. EU wine makers may need to look elsewhere to partner to sell wines to Russia, and especially in Armenia as it also has an FTA with Russia.

Other supply chain trends are also emerging to replace EU supplies with those from Asia. Italy and the Netherlands are the EU’s largest producers of prawns for example, yet Russia has instead turned its importation of the product increasingly to Vietnam along with other aquaculture.  Vietnam, which via the EAEU has a free trade agreement with Russia, is also becoming a primary exporter of beef and pork to Russia, whereas Russian meat imports used to be sourced exclusively from Germany, Denmark, the Netherlands, Poland and Spain. Russia’s imports of meats from Vietnam reached a record high in the first six months of 2021.

In 2020, the EU’s exports to Russia totaled €79.0 billion. These were led by machinery and transport equipment (€35.0 billion, 44.1%), chemicals (€16.7 billion, 21.1%), and manufactured goods (€7.6 billion, 9.6%) as well as agriculture and raw materials (€6.9 billion, 8.7%). None of these are areas that Russia cannot or would not be able to source elsewhere or manufacture under its own steam.

Russia’s exports to the EU however are dominated by energy, with Russia supplying some 26% of the EU’s oil imports and 40% of the EU’s gas imports – the source of much of the friction created between the United States and Russia, who wish to replace Russia in the EU’s energy supply chains. What impact will that have if the US succeeds in blocking Nordstream2? Negligible – the Russians will simply sell their gas elsewhere and have major clients lined up with China and India among many others.

While politicians talk of ‘serious sanctions’ upon Russia over the Ukraine issue, the reality is that SWIFT disconnection aside – which would create short-term difficulties – can be overcome. Doing so however comes with the US risk of undermining its own global payments system – other countries, and especially China and to some extent India – would be highly concerned by the US taking such measures as they could also be at risk. A Russian SWIFT disconnection would spell the beginning of the end for US dollar dominance.

In the consumer arena though, sanctions will be fairly easily absorbed. Russia is already sourcing increasing quantities from Asia, to the detriment of EU exporters. How far the EU are prepared to go along that route, damage its Russian exports and purchase its energy supplies from the United States while cutting Russia adrift – and the intended ‘punishment’ or lack of to Moscow – is a topic much debated in Brussels. Paris will want to be seen to be leading in this regard, yet the ultimate strategy probably lies with Berlin.

The choice for the EU is between committing full on to buying progressively, and ultimately almost exclusively from the United States – at higher prices, protected by Washington in its willingness to place sanctions of competitors to retain its profit margins, just as it did with the China tariff wars. It is a choice between losing Russia as a US counterweight, or to continue to trade with Russia, in which case security concessions will need to be made concerning Ukraine.

It remains an irony that in contemporary Europe, Paris and Berlin were the only two powers ever to invade Russia – with French and German eyes at the time on controlling Russia’s production capabilities, market potential and influencing and selling to its consumers. If those views have changed in favor of increasing American alignment, further sanctions will materialize. If so, Asian exporters will benefit and EU exporters will need to relocate out of the EU if they wish to continue servicing Russia’s consumers.

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Russia Briefing is written and produced by Dezan Shira & Associates. During these uncertain times and sanctions imposition, our firm assists Russian companies relocate to Asia, and provides financial and sanctions compliance services to foreign companies operating in Russia. We also provide market research and advisory services to foreign exporters interested in Russia as the economy looks to replace Western sourced products. Please contact us at russia@dezshira.com or visit us at www.dezshira.com.