Despite the imposition of sanctions by the U.S. and EU since March, Russia had not retaliated economically until imposing the August 7 import ban on meat, fish, vegetables and dairy products from the U.S., EU, Canada, Australia and Norway. That move, coupled with an intensification in military posture, signaled a new aggressiveness by Russia. While it is unclear whether that shift occurred because Moscow was feeling the effects of Western sanctions, the ripple effects on Western markets are beginning to show.
Some U.S. and EU food producers have been insulated from the Russian food ban, but that is mostly due to prior Russian import prohibitions. For example, Russia’s February 2013 ban on U.S. beef imports has meant that U.S. cattle producers were already locked out of the Russian market. Similarly, Russia banned pork imports from the EU in January this year due to concerns about swine flu, so the new ban has had no effect on the status quo for EU pork producers.
However, the ban has been a shock to a number of other industries that relied on Russia as a core export market. Exports of poultry and nuts from the U.S. to Russia each exceeded $100 million in 2013, and exports of fish and prepared foods were each in the tens of millions of U.S. Dollars. U.S. exports of fruit to Russia also exceeded $230 million last year. With Russian markets off limits for at least the next 12 months, U.S. food and agriculture producers in these industries are expecting to see their revenues slide.
In the EU, the situation is even more extreme due to closer economic ties with Russia. Russian-bound exports of fruits and vegetables exceeded $1 billion in 2013, as did exports of cheese. EU exports of milk products, butter, eggs and beef to Russia each exceeded $100 million. EU member states such as Latvia, Lithuania, Poland, Spain and Finland have had strong trade relationships with Russia and are likely to be the hardest hit.
EU Takes Countermeasures
EU officials have sought to offset the Russian food ban’s effects, including setting aside €125 million to compensate EU producers of perishable fruit and vegetable products. With fruit and vegetable exports to Russia exceeding $2.7 billion last year, EU producers began feeling the pinch almost immediately. In some cases, prices for those products have already fallen by 50 percent or more in Europe, and many of those products will be destroyed or simply left to rot in order to stave off oversupply. The Russian sanctions hit Europe at a bad time — many crops were ready to harvest and economic growth had already been lagging.
Although the Russian Government lifted a ban on imports of certain food products on August 20, it has had a varied impact on U.S. and EU producers. For instance, even though lactose-free milk and dairy products were removed from the list of banned items, several EU countries have already experienced losses in the dairy market. EU Agriculture & Rural Development Commissioner Dacian Ciolos said: “In a number of Member States export earnings are being lost and new outlets need to be found”, adding that the dairy sector needed “time and help to adapt” to the restrictions.
Given the sheer volume of EU dairy exports to Russia last year (€2.3 billion, including exports of cheese worth €1.0 billion), the European Commission agreed to help pay the storage costs for butter, skim milk powder and certain cheeses in order to mitigate the effect of the Russian sanctions. On August 28, the Commission announced that it would cover daily costs of storing these specific products for three to seven months. The Commission has not yet specified the amount it is prepared to provide to prop up the dairy industry, but any proposed aid would first have to be approved by the EU member states.
The European Farmers Union, Copa-Cogeca, welcomed the initiative of the EU Commission but claimed that “the move does not go far enough”. Copa-Cogeca has asked the EU for additional support in order to balance the market and help farmers in specific sectors and regions.
Russian Citizens Suffering with Food Prices
In Russia, food prices have increased by 10 percent in cities like St. Petersburg and even more significantly in remote areas. As many Western analysts predicted, Russian citizens are the other unintended sufferers of the import ban. Russia took steps to offset the domestic effects of the ban by signing a new agricultural trade deal with Egypt in July, and it is exploring new relationships with Brazil, Argentina, China and even New Zealand. However, the partial revocation of the food ban indicates that these measures, in tandem with Russia’s domestic production, might not be enough to completely supplant U.S. and European imports.
Intensification of EU sanctions
The conflict escalated this week when Russian troops crossed the Ukrainian border to fight alongside pro-Russian separatists. Following a meeting of the European Council on August 30, the EU announced that it is preparing potential new sanctions that may be unveiled in the coming days.
The details of the new EU sanctions are unclear, but they are expected to target the defense, dual use goods and financial services sectors of the Russian economy. In the finance industry, the UK is lobbying the EU to cut off Russian financial institutions from the SWIFT banking system. A ban from SWIFT would disrupt trade flows with Russia on a major scale, as most international payments are made using SWIFT. There are also indications that the new financial sanctions would prohibit Europeans from purchasing Russian government bonds. This appears to be another attempt to continue the choke-hold on Moscow’s access to foreign funds. On the trade side, the EU may impose broader prohibitions on European exports to Russia of dual use goods, rather than just those specifically intended for the defense industry. Depending on the ultimate definition of “dual use”, this could impact a wide swath of European exporters that have so far remained immune from the effects of the sanctions.
New U.S. Sanctions being Contemplated
As part of a coordinated effort with Europe, the White House has also indicated that the U.S. is preparing a new round of sanctions on Russia. Like the EU, the U.S. sanctions have so far taken a targeted approach, and it appears that the new sanctions would likely not deviate from that model. It is expected that new U.S. sanctions would focus on the Russian energy sector and could include an export ban on products and technologies that could be used in Arctic oil and gas exploration.
Guidance
Russian sanctions are becoming the new normal for U.S. and EU companies, but with the political situation gradually worsening, the compliance landscape may drastically change without warning. The food ban and troop movements show a new aggressiveness by Russia, and heavy-handed sanctions by the U.S. and EU appear imminent. Although today’s cease-fire between Ukraine and pro-Russian rebels is encouraging, Russia will need to change course politically in order to unwind the damage done to trade relations. The constant ups and downs in Russo-Western relations since March indicate that this is a long-term issue without a quick fix.
For U.S. and EU companies, this is discouraging news. The size of Russia’s economy and its close ties with Europe in particular make the trade war almost as damaging to Western interests as to Russian. The U.S. and EU approach of targeting the sanctions to specific Russian actors and industries is a recognition of Russia’s importance to the global economy. However, without a clear sign of intent by Russia to deescalate tensions, Western companies could soon face the type of full-scale embargoes currently imposed on countries like Iran and Syria. Today’s food ban could become tomorrow’s investment ban, and Western companies like McDonald’s are already seeing retaliation by the Russian authorities. U.S. and EU companies with boots on the ground in Russia or with significant Russian trade relationships should pay close attention to political and legal developments. Instability is the word of the day, and as anyone with investment experience in a developing economy knows, instability is bad for business. Western companies should consider putting new projects in Russia on hold or even scaling back current operations until the situation settles. That could be months from now, but the cost of unwinding new investments may far outweigh the lost opportunity costs of being patient.
