By Lukasz Rachel and Moritz Schularick
PRINCETON/PARIS – Russia’s brutal shelling of Ukrainian cities continues. Thousands are dying, millions are suffering. Yet the West remains paralyzed about further action on what matters most: sanctions on Russian energy exports. Absent an immediate and full boycott of Russian gas and oil by Western countries, the best way forward is to commit to a ladder of sanctions that they will climb in a preannounced fashion over the coming weeks.
The initial response of the West to the Russian invasion was swift, strong, and impressively unified. But it is becoming glaringly obvious that it is also insufficient. The effects of the initial sanctions shock on the Russian economy are fading. In recent days, the ruble’s exchange rate first stabilized and then appreciated sharply, while government bond yields have fallen back. The consensus forecast for Russia GDP growth in 2022 stands at -8% – a sharp contraction, but hardly a collapse.
It is not hard to understand why the Russian economy and President Vladimir Putin’s regime have been able to withstand the sanctions so far. Energy exports – a crucial source of income for the Russian state – remain excluded from the sanctions list. In fact, surging energy prices have brought massive windfall gains to the Kremlin. In February, as Russia prepared and launched its invasion, the country’s current account posted its highest monthly surplus in 15 years.
With higher prices and increased flows, the European contribution to Putin’s war chest has increased significantly since the war started. Huge sums – on the order of €700 million ($769 million) – are transferred to Russian accounts every day. This money pays for mercenaries, missiles, and aircraft spare parts from countries that sell only for hard currency. More broadly, about 40% of Russia’s total government budget revenue comes from oil and gas. Without this income, Putin would struggle to pay for his war machine.
Unfortunately, the debate on an expanded energy embargo seems stuck. Although academic studies suggest that the economic consequences for energy-importing countries would be manageable, a few key governments remain hesitant. In Germany, for example, the domestic industrial lobby firmly opposes action and, despite generally supportive public opinion, has the government’s ear. This is highly problematic for at least three reasons.
First, by shying away from economically costly sanctions, European politicians are signaling to Putin that he wields power over Europe, which will only embolden him to test Europe’s resolve even more. It also risks delaying the inevitable adjustment of European industry and consumers to the reality that Russian energy was never as cheap as it seemed. Lastly, the continued flow of blood-soaked energy money allows Putin to press ahead, dramatically increasing the long-term costs for Europe of containing a revisionist Russia.
At the same time, there is no denying political reality. However shortsighted their rationale may be, important countries are unwilling to go cold turkey on Russian gas.
To break the deadlock, a preannounced embargo schedule could be implemented over a period of, say, six weeks. For example, the EU could immediately ban imports of Russian refined oil products, other than diesel, and at the same time announce that the ban will be expanded every week to a new group of products: coal imports next, then diesel, then seaborne crude oil, then pipeline oil. Finally, about six weeks from now, payment for gas imports would be made into escrow accounts from which withdrawals are frozen for the duration of the war.
Committing to a future path for sanctions that ratchets up the restrictions according to a preannounced schedule would renew pressure on Putin and strengthen incentives to seek diplomatic solutions. An immediate end to the targeting of civilians and a withdrawal of Russian forces would halt the sanction schedule.
Moreover, “forward guidance” on sanctions would provide European consumers of Russian energy with clarity on the necessary adjustment they will need to make, and its speed. This would spur efforts to adjust consumption, instead of lobbying politicians in Berlin and other capitals to delay the inevitable. By forcing industry to make these adjustments, forward guidance on sanctions would also dramatically reduce the vulnerability of the European economy to political extortion by Putin come the fall.
The effectiveness of this policy depends on adhering to certain key design principles. Most important, such sanctions will need to have an indefinite duration, to avoid the usual EU political gridlock that otherwise may plague efforts to extend them. If unanimity was needed to abort the tightening of sanctions, the policy would become more credible and defection-proof. And companies should be able to import Russian energy products only at the current run rate until the full embargo hits. They would not be allowed to increase imports to front-run the embargo.
The precise ordering of the steps and their detailed breakdown can be decided on the basis of expert analysis of refinery operations, with the aim of minimizing short-run logistical costs for Europe. The task now is to agree to a graduated schedule of sanctions on Russian energy exports.
Time is not on Europe’s side. It has been a month since Russia invaded Ukraine. The longer the deadlock on energy sanctions continues, the likelier Russia will be to have the financial wherewithal to fight the West to the last Ukrainian.
Lukasz Rachel is a research fellow in economics at Princeton University. Moritz Schularick is a Professor of Economics at the University of Bonn and Sciences Po.