The West Has Expanded the Sanctions: What Shocks Should the Lukashenka Regime Expect?

• 19.08.2021, 13:22

Coming shocks may become a trigger for a change in the situation in Belarus.

Recently, the United States announced a large-scale package of sanctions against the official Minsk. The UK, Canada, and Switzerland also announced new restrictions. Experts Lev Lvovsky and Dmitry Kruk will tell how the expansion of sanctions from the West can affect the general state of the economy of Belarus, what consequences await private business, and when they will develop in full force, Belarusians and Rynok reports.

This summer, official Minsk is increasingly feeling pressure from the West. On June 3, the United States announced the resumption of sanctions against a number of enterprises of the Belarusian petrochemical complex. A few weeks later, on June 21, the European Union approved sectoral economic sanctions that could affect power-related businesses in trade and logistics, as well as the truck industry. On the same day, the EU, USA, Great Britain, and Canada synchronously updated the "black lists" in Belarus, which included more than 40 individuals and 13 organizations.

On August 9, a year after the elections in Belarus, the Joe Biden administration announced even larger sanctions against Belarus. Restrictions have been introduced for 23 citizens and 21 legal entities - these are construction, tobacco, energy, and transport companies.

The expansion of sanctions on August 9-11 was also reported by the UK, Canada, and Switzerland. The restrictions will affect the financial sector, insurance, the supply of petroleum products, and potash products.

Experts in their comments to probusiness.io draw attention to the fact that it is only possible to speak about the scale of economic losses after the extension of sanctions, with a lot of reservations. If we imagine a negative scenario, when the authorities are not trying to counteract the wave of "export shock," we may expect a decrease in GDP by 10-13% in the coming years. This situation cannot but affect the exchange rate in the country and the financial position of many borrowers, as well as private business, income/employment of the population, and other important economic indicators.

- Why US sanctions are called "the most ambitious" in history for Belarus?

Lev Lvovsky:

- It is important to clarify that the White House actually issued two separate documents on August 9. The first one renews and expands the old sanctions, it mentions a number of individuals, as well as large Belarusian companies and banks, such as Belaruskali, Belneftegaz, Belkaztrans, Belkazatrans Ukraine, Energo-Oil, Inter Tobacco, Absolutbank, and others.

The second document, signed by President Biden, describes how the US government should work on the sanctions and what they should be. Since this decree describes the general nature and type of future sanctions, it contains rather vague wording than specific legal details.

But already now we see that the United States, which joined the sanctions pressure later than the EU, is very serious.

The document specifically emphasizes the intention to strike at the defense sector, energy, potash production, tobacco products, construction, and the transport industry.

How large-scale the consequences of these decisions will turn out to be, in my opinion, depends on whether the mechanism of "secondary sanctions" will be applied on the model of Iran or Nord Stream-2. If the "secondary sanctions" work, then any company doing business with the "sanctioned" one will be subject to the same restrictions. Thus, most of the methods for circumventing sanctions are almost completely excluded, whether it be offset deliveries of petroleum products (for example, if we supplied petroleum products to the Russian Federation, and it sold its petroleum products to the EU) or the creation of an infinite number of gasket firms.

I suppose that the toxicity mechanism with the imposition of US sanctions will take place one way or another, although we do not yet know if it will be minimal or will turn on at full capacity. International practice shows that large global companies are trying to distance themselves from US sanctions, even if they are not in any legal threat.

- If the company is included in the US "sanctions list," what is the threat?

Dmitry Kruk:

- The listing of individuals and companies on the US Treasury Office of Foreign Assets Control (OFAC SDN) sanctions list is comparable to a black mark on the global market. American residents will avoid entering into transactions with unsanctioned companies, and if they have assets of such companies at their disposal, they will help to block them.

Another tangible consequence may be the inaccessibility of settlements in dollars for such companies. Let me explain how it works. Among the American residents for whom the implementation of the sanctions provisions is mandatory, there are banks. And settlements in dollars at any of the stages will necessarily go either through an American bank or through a bank that has direct access to the US financial market. In compliance with the sanctions provisions, they will have to immediately block the relevant dollar transaction and freeze the funds.

As for the "secondary sanctions," so far I do not see in the published documents that this mechanism for Belarus has been formalized. But very often counterparties of sanctioned companies from other countries, as reinsurance, independently make decisions about refusing to cooperate with them.

Often there is no time or it is too expensive to understand what the legal implications may be, so it is easier to simply refuse questionable cooperation.

All of the above means that for companies and individuals who are on the SDN list, the consequences will be very tangible. It is clear that, with the help of a number of schemes, some companies may attempt to circumvent the restrictions. Accordingly, the negative impact on the financial result will vary. For this reason, today it is difficult to assess what the macro-effect of the pinpoint component of the sanctions will be.

- How will the US sectoral sanctions affect the economy?

Dmitry Kruk:

- Biden's new decree contains a sectoral sanctions component. In addition to the inclusion of specific companies in the SDN list, it says that the sanctions will apply to the Belarusian financial and energy sector, the production of potash fertilizers, construction, and tobacco production, etc.

There is still a significant element of uncertainty in how this will work, a kind of backlash in the possible consequences. Without the introduction of a formalized mechanism for residents from third countries, the rejection of transactions with goods of Belarusian origin will probably not be total.

Where transactions for the counterparty of the Belarusian side are economically significant or where there are other considerations in addition to commercial ones, I think business relations will continue. For example, I doubt that US sanctions will be a reason for Chinese and Indian counterparties to refuse to buy Belarusian potash. I also do not think that Russian banks will refuse to lend to their Belarusian subsidiaries or other Belarusian counterparties.

But the dangers can await the Belarusian side from different sides. A problem may arise with counterparties in the supply chain.

For example, the task of delivering potash fertilizers to the end consumer will become difficult and very expensive, since foreign intermediaries will not want to provide such services.

All this suggests that the introduction of sectoral sanctions by the United States will be followed by a decline in exports. This will primarily affect the export of sectors that are directly stipulated in the Biden decree.

Based on the theoretical model, it can be simplified to say that every 1% decline in exports within 2-3 quarters will lead to a drop in GDP by about 0.6% with a comparable drop in real incomes and wages. In a longer period - 7-10 quarters - due to the special role of the energy and potash sectors, these losses can reach a ratio of almost 1 to 1, that is, every percentage of the decline in exports will be fraught with a comparable drop in output and income.

- In addition to the EU and the US, the sanctions are expanded by the UK, Canada, Switzerland. Does it matter?

Lev Lvovsky:

- The very fact that other countries join the US and EU sanctions is important. The fact is that Great Britain, like Switzerland, was an important potential "loophole" for Minsk to circumvent the sanctions. Many international transactions for the resale of minerals take place with the participation of companies from these two countries.

Previously, Great Britain enjoyed an ambiguous image, sometimes hiding in its jurisdiction capital of dubious origin and persons of ambiguous reputation.

By joining the sanctions against Belarus and separately mentioning Mikhail Gutseriyev (a Russian businessman who is supposed to be a longtime associate of Aliaksandr Lukashenka. - commentary by Pro Business), Great Britain closed the "loophole" and showed the seriousness of its intentions in defending the principles common to Europe and the United States.

Dmitry Kruk:

- According to statistics, it is to the UK that almost half of all exports of Belarusian petroleum products are delivered, or rather, it is through this country that they are cleared, although the end buyers may be in other countries. Even with this caveat in mind, the UK sanctions could mean a near-total blockage of the route for supplies of Belarusian oil products to Western markets.

Before the UK joined the sanctions, EU restrictions could affect about 17% of the export of Belarusian oil products. Now we can talk about the fact that all supplies of petroleum products to Western markets (which is over 60% of exports of petroleum products) will be blocked. The above will significantly change the aggregate potential scale of the export shock that Belarus will face.

The role of the sanctions of Switzerland and Canada is many times more modest in terms of potential losses. But, firstly, these countries generate a powerful negative informational effect. Secondly, they also close the potential different workarounds for previously adopted sanctions.

In June, the research company InComeIn published calculations on the impact of EU and US sanctions on the Belarusian economy. Losses from the already adopted restrictions were estimated at up to 7% of GDP. According to experts, the sanctions imposed by the US and the EU will directly or indirectly affect almost all spheres of the Belarusian economy.

- How Western sanctions, including the fourth EU package, will affect the economy of Belarus?

Dmitry Kruk:

- EU sanctions affect (depending on the interpretation in terms of potash fertilizers) from 3.5 to 7% of all Belarusian exports. According to the mechanism that I described above, this is fraught with rapid GDP losses from 2.1 to 4.2%. Over a longer time period, due to the subsidence of other industries (suppliers and consumers of sanctioned enterprises), production losses may grow to a range of 3.5-7%.

If we add to this the UK sanctions, then the initial size of the shock can be estimated at 10-13.5% of all exports. This is fraught with rapid GDP losses of 6-8.1%, and over a longer period - 10-13.5%.

US sanctions, which are more difficult to measure in terms of export and output drawdowns, make the above potential losses all the more likely de facto.

It is important to note that in the above estimates, I deliberately use the term "potential losses." They will happen if an export shock of this magnitude occurs, and the authorities do not oppose it (except for the standard mechanisms of monetary and fiscal policy).

Imagine seeing a threat and assessing its magnitude. Realizing that this is unacceptable to you, you will try to mitigate the consequences. The situation with sanctions is similar.

The authorities can potentially deflect and mitigate the threat in two ways: “at the entrance” - that is, try to limit the initial shock (for example, directing the “released” volume of exports to other geographic directions) and “at the exit,” that is, using additional mitigation tools.

But now the official Minsk has limited room for maneuver in both directions. Redirecting export flows, especially in the case of petroleum products, is difficult and fraught with a sharp decline in profitability. It's even harder to think about it in light of US sanctions. Of the mitigation tools, external borrowing seems to be the most obvious, although access to them is very limited, and it is dangerous to take new sovereign loans due to the high debt burden.

I suppose that some measures of counteraction by the authorities will certainly be taken. If not, then the sanctions are fraught with a whole set of tangible consequences for the Belarusian economy - a drop in GDP and incomes of the population, problems with employment, etc.

- What will be the losses for private businesses and when will we feel them?

Lev Lvovsky:

- The reputation of the enterprises included in the sanctions lists, unfortunately, will also extend to innocent private enterprises, since some of the counterparties will have no time to understand the intricacies of the sanctions legislation, and they will prefer not to deal with Belarus at all.

Since large state-owned enterprises will fall under the sanctions, a decrease in profits along the chain will undoubtedly affect private businesses through a decrease in effective demand. The sanctions do not operate in an airless space, and their effect will be imposed on the already negative internal conjuncture, counter-sanctions, and pressure on private business as part of the political struggle within Belarus.

Usually, 3-6 months pass between the issuance of the US presidential decree and the entry into force of the sanctions developed on its basis, so Belarus will be able to see the real scale of the consequences only in 2022.

In addition to the losses from the sanctions, we can also expect the effect of Belarusian counter-sanctions, which is often as painful for the economy as the original reason.

Dmitry Kruk:

- Private businesses will definitely suffer, and, unfortunately, I do not have universal recommendations on how to prepare entrepreneurs for the consequences of the sanctions. Of course, it's always good to have some kind of airbag that can help you ride out bad times. But when there is no clear understanding of how bad these times can be and how long they will last, it is difficult to talk about the presence of a "conditionally correct strategy." Moreover, any action in an attempt to anticipate possible shocks at the macro level can in itself become a trigger for the worsening of the situation.