Russia Is Winning the Sanctions Game16 April 2019
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.
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.
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 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.
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 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. 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.”
“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.