Axel de Vernou
As Western countries continue to push for Moscow’s ostracization from global financial markets, the Kremlin will test how long its raw materials can serve as a source of profit and regime stability. In the long run, Russia’s rapprochement with China, which is developing alternative financial systems to the dollar, will enable it to persevere through this year’s sanctions if the West does not pursue more far-reaching methods.
Last month, the London Metal Exchange (LME) attracted international attention when it bucked the trend of intensifying bans on Russian goods. Expecting Russian metals to continue generating strong profits in 2023, the LME has chosen not to prohibit their importation despite the European Union’s ban on Russian semi-finished steel imports in October.
In late September, the European Commission received a joint letter from nine European steel companies warning of the “consequences of a potential import ban,” citing the lack of substitutes for Russia. While the EU pushed forward with the ban nonetheless, it is unlikely that it will last for long because, ironically, European industry once again made its voice heard in late October when Washington proposed additional aluminum bans. In other words, when the EU took a step to minimize Russian imports, the United States could not match its ally because of an alarmed concert of European industrial groups worrying about repercussions for the EU.
The same incoherence regarding natural resources has played out in the opposite direction. To simultaneously advance its climate goals while breaking away from Russian energy sources, the Biden administration included several “Buy American” provisions within this year’s Inflation Reduction Act (IRA) that infuriated Europe. For instance, the act awards extra tax credits to companies that establish wind farms in the United States using American steel. Such provisions discourage businesses from buying Chinese resources and hurt Russia’s war effort. Since February, Moscow has embraced vertiginous price increases in raw material markets such as nickel and vanadium, both of which factor heavily into steel production, since countries are dependent on these Russian exports. The IRA incentivizes companies to avoid these exports and buy American, but Europe is dissatisfied.
French president Emmanuel Macron’s recent visit to the White House emphasized this concern. Following acerbic comments from the Elysée, Macron went so far as to accuse Washington of “fragmenting the West.” Whether Macron succeeded in his quest to alter American minds is yet to be seen because few concrete changes resulted from his visit beyond the creation of a new transatlantic task force on trade.
Nevertheless, the battle over resources is much more complicated than a simple disharmony between the United States and the EU. The EU is increasingly threatened by a dangerous heterogeneity—now bordering on dismemberment—driven by energy. This is all the more fitting for the Kremlin. The Franco-German axis, once heralded as an unwavering source of stability, is at its lowest point in decades.
After German chancellor Olaf Scholz met with Spain’s prime minister in October to discuss the construction of a new gas pipeline that would stretch across the Pyrenees, France firmly opposed the project based on its high cost and inconsistency with European environmental standards. Shortly thereafter, France and Germany canceled a significant cabinet meeting due to energy policy disagreements ostensibly linked to the pipeline dispute. To conclude that tumultuous month, Macron called out Berlin at a European Council summit for not supporting gas price caps amid soaring inflation.
Meanwhile, the Kremlin continues to tighten its hold on key resources to exacerbate divisions between previously coordinated European allies. Ukraine, which accounted for the third-largest share of the EU’s steel imports in 2019, is an obvious target. Russia’s capture of Ukrainian steel mills and the shelling of infrastructure since the start of the war led to a devastating plummet in Ukraine’s steel imports between January and June of 2022—a 62 percent drop compared to the same period last year. Russia has also begun selling discounted steel to Turkey, China, and Taiwan.
If this strategy sounds familiar, it is because Moscow has implemented a similar approach in the energy sector, notably in its generous sales to India and China. However, Western policymakers should not perceive Russia’s short-term substitutes as a sustainable way of escaping the economic pain it has felt since the start of the war.
The West’s primary point of concern should be Russia and China’s recent commitment to de-dollarize their transactions and establish a financial bubble immune to Western sanctions. There is a tendency in the West to discount Russian projects that supply the regime with enough funds to make it to the next month but cannot realistically last for an extended period of time. The problem with this mindset, though, is that Russia has no intention of reverting back to its participation in the U.S.-led international system since it is convinced that China holds the future.
Just as Putin demanded that European companies pay for Russian oil and gas in rubles or gold at the beginning of the year, he has also pressed Chinese energy firms to pay for gas in rubles or yuan. Russian banks have begun issuing checking and savings accounts in Chinese yuan. Since the ruble shot up to unprecedented levels following the invasion of Ukraine, Moscow has had to buy foreign currencies to stabilize its own. In the past, it may have considered the dollar or the euro because they still represent the overwhelming majority of global trade, but this is no longer the case.
“Purchases of currencies of unfriendly countries, primarily dollars and euros, are now impossible,” Finance Minister Anton Siluanov said during an interview in September. “For us, these currencies are toxic.” When asked why Russian assets in dollars and euros are still accumulating abroad if Moscow intends to dissolve all links to these currencies, Siluanov maintained that Russia is in the process of abandoning them before adding a curious line: The only options that remain for Russia are “rubles, a currency that we trust, or imports that are of interest to us.”
In other words, although Russia does not explicitly “plan to switch to barter … but if [its] companies agree on barter transactions … [it] will not interfere with this,” Siluanov explained. This leads to another story less absurd than it appears at first sight.
In August, the Taliban entered talks with Russia about a barter exchange whereby the former would supply raisins, minerals, and herbs in return for the latter’s crude oil that is no longer going to Europe. The deal would provide Afghanistan with 1 million tons of diesel and gas without having to pass through Western financial institutions. Earlier this year, India proposed to exchange tea, medicines, and basmati for Russian fertilizers which have not been banned by Western countries because of the food crisis. Iran has also taken steps to establish a similar barter system with Russia.
All these countries avoid trading in their own currencies because of their volatility. It would not make sense for the Kremlin to force the Taliban to pay for goods in rubles or afghanis while working to de-strengthen the ruble. As some observers point out, though, a barter system complicates taxes and incentivizes both sides to manipulate the value of one’s own goods and services. However, it is unlikely that these parameters will constrain the countries above. Their main objective is to circumvent Western sanctions while gaining access to desirable products. Therefore, it is in their interest to strike mutually agreeable deals to extend the bartering for as long as it takes until China establishes a robust financial system disconnected from Western oversight.
Russia’s economy is also structured to take advantage of the war over energy. When adjusted for purchasing power parity, Russia has the sixth-largest GDP behind Germany. Sectors matter more than size, however. In 2021, Russia’s economy was composed of the following sectors: services (53 percent), agriculture (3.8 percent), industry (33 percent), and manufacturing (14 percent)—the total exceeds 100 percent because there is some overlap.
3.8 percent toward agriculture seems minuscule until it is compared with Russia’s principal allies and adversaries. The United States’ percent of GDP dedicated to agriculture barely exceeds 1 percent, with Germany’s at 0.8 percent and France’s at 1.63 percent. China breaks away from the trend, sitting at 7.26 percent.
These numbers explain Moscow’s weaponization of its natural resources. Russia’s comparative agricultural might reveals why it is at ease with provoking a food shortage and delaying grain exports from Ukrainian ports. Not only will Russian citizens suffer less than their European neighbors, but China is less likely to be affected by its food diplomacy.
Indeed, agriculture was one of Putin’s focal points during the recent Supreme Eurasian Economic Council meeting. Putin celebrated that agricultural production rose 5.4 percent among the members of the Eurasian Economic Union (EAEU) in 2022. This “very good growth,” he said, “is all the more important … amid the growing food crisis in the world.” Putin could not help mentioning that gas prices in EAEU countries are currently “ten times” less than in the EU. Blessed with natural resources that Western countries hesitate to sanction because of their importance to the world economy, such as steel, gold, and diamonds, Russia is betting on sustaining its profits until it can enter a Chinese-led system that insulates it from Western pressure.
Industry was the second central pillar of Putin’s remarks at the EAEU summit. “[T]he member states of the Union continue to successfully develop mutually beneficial industrial cooperation,” Putin said before touting the establishment of a new mechanism within the EAEU that will “grant loans and subsidies to promising joint projects.”
As mentioned above, industry makes up one-third of Russia’s economy. How does that compare to its main adversaries? Industry comprises notably less of the French (16.8 percent), American (18.5 percent), and German (26.6 percent) economies. Russia surprisingly exceeds even Germany in this metric. The winner of this bracket is, once again, China, at 39.5 percent
The use of these statistics is not to argue that Russia is structuring its economy in a superior way to Western countries. It simply underlines a preoccupying trend: Russia’s priorities, financial ambitions, and the organization of its economic sectors increasingly resemble China’s. De-dollarization signifies far more than alternatives to SWIFT—it is a comprehensive transformation that involves profound financial restructuring and the enlistment of key allies. Russia is starting with Central Asian countries by insisting on the EAEU’s efficacy.
Moscow has made its greatest strides toward de-dollarization domestically, however, and this initiative is inextricable from its coercive natural resource diplomacy. For instance, major fuel and oil companies are planning to increase the use of the yuan in their operations. In August 2022, Russians bought a record number of the Chinese currency after Beijing doubled the yuan-ruble trading band in March to provide more flexibility in currency exchanges.
Nevertheless, Russian officials and business executives are well aware that this process is arduous and entails its own risks. “Russia needs dollars since there are many dollar deposits inside the country, and corporations have debts denominated in dollars,” one warned. Last month, even Putin said that Russia “will not give up the dollar,” but will instead dramatically reduce its shares. China still accounts for a smaller proportion of Russian exports than Western countries and the digital yuan is not yet an adequate replacement for the dollar. But time is running out.
The United States must pursue a strategy that diminishes the efficacy of Russian natural resource exports and hampers Moscow’s rapprochement with China while supporting its European allies.
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