Analytics

What will be the impact of the pandemic on the EU and Russia?
Part 2: Economic relations and sanctions

The COVID-19 pandemic has changed our lives beyond recognition. It has disrupted relations within and between states and societies throughout the world, including between the EU and Russia. Moreover, the virus fully absorbs peoples' minds and leaves little space for the reflection about the post-pandemic future.

The EU-Russia Expert Network is in a unique place to start such a reflection process. Over the coming weeks our members will discuss here how the pandemic impacts on the EU and Russia. How will it change the fabric of their political, economic and societal relations? How will it affect their common and contested neighbourhood and their international context? What can and should both sides do to control the damage and prepare for a future that is likely to be quite different from what we imagined just a few weeks ago?

EUREN Members Answer

8 May 2020

The COVID-19 pandemic has generated enormous pressure on economies in the EU and Russia. In EU member states it has exposed businesses of all size, as well as welfare and healthcare systems. The role of the state in the economy is changing drastically (if only temporarily). Global supply chains are being disrupted and increasingly questioned in the light of the crisis. The oil price slump in recent weeks has posed an additional challenge for the Russian economy. How will the pandemic transform economic systems in the EU and Russia? Will it fundamentally alter the fabric of their economic relations? Or will they return to the "old normal" after the COVID-19 crisis ends?

OKSANA ANTONENKO | Control Risks Group, Cambridge :

COVID-19 disruption will have a profound and lasting impact on the global economy. By the end of 2020, it is projected to contract by over 3%, compared with the previous IMF projection of over 3% growth. How the pandemic affects EU-Russia economic relations will depend on four critical uncertainties.

How deep will the Eurozone and Russian economies contract and how fast will they recover? According to the IMF, the Eurozone economies are expected to contract by 7.5% and the Russian economy by 5.5%. For the EU, this will be the deepest recession since WWII. For Russia, the depth of the economic contraction – similar to 2009 or 2015 recession – is likely to be combined with a slow pace of recovery not seen since early 1990s.

Depending on the trajectory of COVID cases, economic growth may not resume on both sides before 2021. Moreover, both the Eurozone and Russian economies are likely to experience economic stagnation for several years, unless major structural reforms are implemented. This task is particularly difficult for Russia, which has not been successful in its reform efforts and continues to rely on commodity exports as its main source of revenues.

Will their respective recovery strategies lead to economic convergence or divergence? The extent of the EU-Russia trade rebound will be contingent on their respective economic recovery strategies. If Russia comes out of the crisis with an even greater share of state dominance over the economy, the volume of EU trade and investment into Russia will remain lower. Similarly, if the EU prioritises green economic recovery, then the existing economic inter-dependency between the EU and Russia will diminish. On the other hand, if Russia decides to promote private-sector-led recovery, the EU may look at Russia as a potential destination for its supply chain diversification strategy. Such an approach would benefit from a gradual lifting of the sanctions, which would, therefore, depend on the Russian conflict resolution efforts in the Donbas.

How will the crisis impact on EU demand for Russian oil and gas? Oil prices have collapsed to a 20-year low following both a 30% drop in global demand and an unprecedented global oil glut. Oil price is forecast to remain at $30-35 per barrel for several years. In these circumstances, Russia will be fighting hard to preserve its share of the EU market. However, the crisis is likely to accelerate the EU's transition away from fossil fuel dependency. One area where EU and Russia can cooperate in the future is the development of clean energy sources – such as hydrogen.

How will the crisis reshape the fundamentals of the global economy? The COVID-19 experience is likely to compel the EU to enhance its economic resilience by insulating strategic industries. This is likely to include even greater scrutiny of foreign investment and ownership in strategic sectors, critical information, cyber and bio-medical technologies. In Russia, these trends have been in place even before the crisis. Technological cooperation between companies in Russia and the EU may become even more problematic.

JANIS KLUGE | German Institute for International and Security Affairs, Berlin :

While the economies of Russia and the EU are both suffering enormous damage because of the COVID-19 crisis, the effects are asymmetric. Both Russia and EU countries have implemented strict social distancing rules, but the support provided to the economies is very different. Germany, among the EU countries, is spending the most to keep its economy alive. Berlin is planning additional expenditure of 6.9% of GDP and has authorized over 50% of GDP for tax deferrals, loans and guarantees. Other EU governments and Brussels have also set up sizeable rescue packages, which will lead to a complete support package of 3.3 trillion Euros, or 23.7% of EU27 GDP.

Currently (April 2020), the Russian businesses and population are expected to bear the brunt of the lockdown. The Russian leadership is reluctant to spend. It has allocated only around 0.7% of GDP for additional direct spending and 2.1% of GDP for tax deferrals, loans and guarantees. This has created a high risk of a severe, protracted economic downturn. Moscow could do more. While tax revenues shrink because of the low oil price, Russia's public debt is very small (15% of GDP) and the country's reserves are sizeable.

Russia's main exports to the EU are particularly affected by the crisis, as international energy markets are in turmoil. While some recovery of oil and gas prices is likely, Russia's economy and the state budget are currently going through a decarbonization shock. COVID-19 has demonstrated yet another pitfall of oil and gas dependency. At the same time, the pandemic showcases what a less carbon-intensive future could mean for economic ties between the EU and Russia. If trade and investment evolved around the energy transition and green technologies, economic relations could be made more stable and sustainable, with less reliance on hydrocarbons.

While trade and investment are being hindered at a physical level by the pandemic, COVID-19 has accelerated the advent of the digital economy. This could reduce the costs of doing business between Russia and the EU in the future, not least because it alleviates costly barriers, such as visa requirements. Faster digitalization is also an opportunity for Russian IT exports that could replace some of the oil and gas revenue. EU companies have, at the same time, the expertise to support the automatization of production in Russia, which would help to reduce the risk of infection in the workplace. These opportunities can only be seized, however, if no new digital borders are raised through the nationalization of the internet and digital technologies.

SERGEY KULIK | Institute of Contemporary Development, Moscow :

The COVID-19 pandemic has put Russia's economic muscles under enormous stress. It has introduced a combination of painful challenges for Moscow, three of which should be emphasized.

First, the pandemic has reduced the global demand for energy exports and stimulated a slump in oil prices. It has also intensified competition with other international suppliers on the European markets vital for Russia. The EU's Green New Deal would transform European energy consumption substantially, further aggravating the implications for traditional Russian exports. At the same time, Russia is facing growing difficulties in the Chinese market. Pressure on Moscow is also aggravated by the controversial terms of Russia's recent energy contracts with Beijing, including covering Chinese loans. The blow to Russia's national reserves will be severe if these problems persist for another year or two. These challenges, among others, make it much more important for Moscow to keep its position on the EU energy market and fight for increasing oil prices (to at least 40$ per barrel) in 2020.

Secondly, there will be a drastic loss in GDP, possibly around 10%, if the quarantine lasts into the second half of 2020, and Russia's need for financial resources will become desperate. Before 2014, the EU was Russia's key source of foreign direct investment and bank credits. Today, however, EU and US sanctions have barred the country from international financial markets and deterred even their close partners, like China, from providing loans. With Russia's internal capabilities shrinking, finding a way to undo this "credit knot" will become one of the most pressing challenges that the Russian leadership and economy face.

Thirdly, domestic demand in Russia, which has staggered a little since 2014, is likely to embark on a prolonged downward curve. Even without sanctions, this will not encourage foreign investors and exporters, including those from the EU, to become more deeply involved in the Russian market.

In this new reality, Russia needs to find innovative ways to achieve its economic recovery. Among other things, this should include wider integration into global supply chains (GSC), which could re-emerge after the pandemic, as well as identifying new niches in the international market. The country's involvement in GSCs was underdeveloped even before the sanctions and counter-sanctions, particularly in comparison to many EU countries. Moreover, as a supplier of commodity sub-products, Russia has been limited to the lower levels of the existing GSC. After 2014, the gaps have become even bigger. High oil prices have so far assuaged the ruling elite's appetite and have not offered the impetus that is required to strive for the innovation and integration that will lead to more profitable and technology-intensive GSCs. Today, Moscow has to think urgently and strategically about a future that moves beyond international commodity markets, along with much needed reforms. The EU is the better partner for both.

The UN Secretary-General, Antonio Gutierrez, and UN High Commissioner for Human Rights, Michelle Bachelet, have called for an easing of the sanctions that have undermined access to food, essential health supplies and COVID-19 medical support in the countries concerned. Both have referred to Iran, Yemen, Cuba, North Korea, and Zimbabwe. Some people (not only) in Russia have suggested there should be an expansion of such a pandemic-induced waiver to sanctions in general, including Western sanctions against Russia. Do you agree with such an approach? Should the sanctions that the EU and Russia imposed on each other from 2014 be reconsidered in the light of the COVID-19 pandemic?

NICOLAS DE PEDRO | The Institute for Statecraft, Barcelona :

Should Russia need medical support or humanitarian relief to deal with the COVID-19 pandemic, the EU must be ready to react rapidly and help as much as possible. Donbass-related sanctions, however, must be maintained. The war goes on and neither has Russia proved a clear commitment to the full implementation of Minsk protocol terms nor has shown any will to reconsider its long-term objective of exerting strategic control over Ukraine. What is at stake here is the right of Ukraine to exist as an independent and fully sovereign nation, and this must always be borne in mind. Despite what some prominent commentators have suggested in the last few days, the sanctions have proved to be an effective tool for preventing further Russian military escalation in Eastern Ukraine.

In fact, three elements seem to have prevented a full out war over Ukraine. Firstly, the lack of significant local support in Southern and Eastern Ukraine for the Kremlin's covert operation in spring 2014, beyond certain areas in Donbass. Secondly, the potential military and political cost for Russia vis-à-vis the determination and effective performance shown by the reconstructed Ukrainian Armed Forces. And thirdly, the prospect of tighter economic sanctions and international isolation in case of further escalation. Hence, lifting the sanctions will deprive the EU of its most effective, and perhaps only, tool to persuade Russia to accept a peaceful settlement that needs to be agreeable for Kyiv as well.

Furthermore, lifting the sanctions without any meaningful improvements on the ground could result in the Ukrainian issue relegated, if not forgotten, in the EU-Russia bilateral agenda. It seems extremely unlikely that such a move would contribute to a sustainable peaceful settlement of the war in Ukraine. What is the incentive then for the EU to open the debate about lifting the sanctions? Not to mention that there seems to be no clear correlation between lifting these very targeted sanctions and the Kremlin's capability to deal with the COVID-19 pandemic.

STANISLAV SECRIERU | European Union Institute for Security Studies, Paris :

The cross-border nature of the COVID-19 pandemic and the lack of a medical cure so far, calls for more international cooperation, not less. This applies to both the EU and Russia who share a border, strong trade links and a wide web of people-to-people contacts. To effectively combat СOVID-19 and its consequences requires the removal of the barriers that have put human life in danger by limiting or impeding concerted efforts against the virus.

That said, the EU sanctions on Russia limit neither food exports nor the delivery of humanitarian aid. Similarly, they do not prohibit the supply of drugs, medical equipment or cooperation in the domain of medical research. The EU and Russia have been conducting joint research projects on infectious diseases such as HIV, TB and others for a number of years already. In early 2020, Brussels encouraged Russia to participate in EU and multilateral scientific efforts to address the COVID-19 pandemic - for now without an active response from Moscow. If some EU member states are not in a position to deliver medical equipment that Russia needs today (e.g. respirators), it is not because of the sanctions, but because they cannot satisfy both domestic and external demand simultaneously.

The opposite is true of the restrictive measures that Russia enacted. The partial food embargo against the EU, coupled with the import substitution programs in the field of medical drugs and equipment, left Russian citizens worse off than before. Whereas the former contributed to food price inflation, and in some cases (highlighted by the Russian watchdog Rosselkhoznadzor), the decline of product quality, the latter has disrupted old supply chains, resulting in drug shortages for patients with critical illnesses. Thus, in the context of COVID-19, a waiver (even if it were temporary) on the food embargo against the EU, and a relaxation of the rules on importing certain foreign-produced drugs could help alleviate the situation for millions of Russian citizens who are affected by the pandemic in multiple ways.

The EU sanctions were introduced in response to Russia's continued violation of Ukraine's sovereignty and territorial integrity since 2014. The COVID-19 pandemic offers an opportunity for the EU and Russia to work together in a joint effort to prevent the spread of the virus in the conflict area. Russia could ensure there was a proper ceasefire and facilitate unrestricted access for international organizations to evaluate needs and organize the urgent supply of food and medical equipment – which the EU could then finance. This would save lives and could help to build confidence, without which a peaceful resolution of the conflict and the lifting of EU sanctions will stand little chance.

TATIANA ROMANOVA | St. Petersburg State University, Saint Petersburg :

Do Western "sanctions" (or restrictive measures, to use Moscow's vocabulary) have to be revised because of the COVID-19 pandemic?

At present, Western sanctions are not preventing Russia from effectively fighting COVID-19. Moscow faces universal problems (a shortage of hospital capacities, individual protection and lung ventilation equipment). Sanctions do not inhibit the transnational sharing of these scarce capacities. Nor do they prevent the exchange of scientific information, vital for curing the infected and the development of a vaccine. However, sanctions will slow down Russia's economic recovery, which will be complicated anyway by the collapse in oil prices. Western measures have limited Russia's access to the financial markets, as well as to certain technologies. Moreover, Russian consumers are footing the bill for Moscow's agricultural counter-sanctions. Finally, Russia is investing scarce resources into import substitution.

Western sanctions were meant to be smart (that is, affect those who were involved in the 2014 events in Crimea and the Eastern Ukrainian conflict). Yet most Russians are experiencing the consequences of these sanctions (in particular through limited access to financial markets). Uncertainties of doing business with Russia, which stem from the Western sanctions (particularly those imposed by the US), and the unpredictability of their future development, negatively affect transnational economic cooperation. Nor do anti-Russian sectoral sanctions seem to be effective in resolving the problem of Eastern Ukraine. No progress seems to be the preferred solution of the present Ukrainian leadership because the modalities of the settlement are so contentious for that country. As a result, Kyiv pockets the benefits of a no-deal, while Russia bears the costs and is entrenched in its belief that no constructive cooperation with the West is possible.

Given all of the above, Russia could relax its own counter-sanctions first, to ease the burden for its population and set an example of sanctions' relief. In addition, Russia could keep on the table discussions of the Normandy Four (in the form of a videoconference for the coming months) with a view to achieving further progress and implementing the decisions that have already been agreed. The West, for its part, could link the lifting of sectoral sanctions to incremental progress on the implementation of the Minsk agreements. Ideally, that decision would involve both the EU and the US, as the latter neutralises any EU steps by using secondary sanctions. Due attention should be paid to steps taken by both Moscow and Kyiv to encourage progress on the part of the latter.

IVAN TIMOFEEV | Russian International Affairs Council, Moscow :

Since the global outbreak of COVID-19, there have been calls to soften existing sanctions. This could let target-states focus their scarce resources on fighting the pandemic or getting access to humanitarian supplies. Those who have joined the calls include the UN's top officials, a number of leaders, including Vladimir Putin, and EU officials. There have been some practical steps as well. The U.S. Treasury has published a factsheet highlighting legal opportunities for humanitarian transactions with Iran, Syria, Cuba, DPRK, Venezuela and Russia (regarding the Region of Crimea). The EU has started using INSTEX for humanitarian deals with Iran, while the Swiss Humanitarian Trade Arrangement – another mechanism of humanitarian operations with Iran – has started operations. However, all these options are quite limited and will not fundamentally change the existing sanctions of the U.S. and the EU. Business is still careful about the risk of secondary sanctions and it may abstain even from the permitted humanitarian channels.

Russia's chances of the sanctions being lifted are especially low. A group of EU Parliament members has asked the European Commission to rebuff such a possibility and the Russia critical segment of the press has voiced their fears that Russia's medical aid to Italy would harm the consensus on sanctions against Moscow. However, the key reason is that Russia is capable enough of addressing the COVID-19 threat itself without any humanitarian aid or exceptions from the West. The situation is alarming, but the medical authorities, industry and science seem to be dealing with the issue. Crimea is the most vulnerable due to the Western blockade, but Russia is able to cover the necessary demands. In the worst-case scenario, it may rely on Chinese help if local supplies are not enough. More importantly, all the political contradictions in Russia-West relations that led to the sanctions and counter-sanctions are still there. There are few political reasons why either side should lift the sanctions.

COVID-19 may result in U.S. sanctions against China, which might aggravate tensions between the two powers and have long-term consequences, including for the relationship between Russia and the EU. Such a deterioration could be harmful to international security.