Commentary: Germany's Nord Stream 2 suspension shows sanctions on Russia haven't worked

BRUSSELS: Well, that was a surprise. German Chancellor Olaf Scholz’s decision on Tuesday (Feb 22) to suspend the Nord Stream 2 gas pipeline project was the first sign that Berlin might get serious in opposing Russia’s aggressions against Ukraine.

It remains to be seen whether Germany, hitherto Russian President Vladimir Putin’s most reliable heavy-hitting friend in the European Union, has stopped Nord Stream 2 for good or just hit pause to see how the situation evolves. 

The first-round package of sanctions that the EU is collectively planning reaches farther than many had expected, including asset freezes and travel bans on Putin’s Defence Minister and Chief of Staff. 

But by continuing mainly to focus narrowly on banks and individuals connected to the incursion, the sanctions suggest that the EU may not fully recognise the weakness of its efforts at punishing Putin’s 2014 annexation of Crimea and incursions into eastern Ukraine.

If Nord Stream 2 is cancelled, it won’t be an immediate economic blow to Russia, which already has the Nord Stream 1 and Yamal gas pipelines to Europe. 

The significance is rather that Germany might finally be signalling that it is prepared to absorb substantial economic and political pain as a cost of isolating Putin’s regime. The United Kingdom, because of the impact on London as a financial centre or, more likely, on the Conservative party, has manifestly failed the same test.

RUSSIA'S ABILITY TO RECOVER FROM DAMAGE OF ECONOMIC SANCTIONS

Russia isn’t intrinsically economically resilient to sanctions. It’s got a small and stunted economy — its gross domestic product is about the size of Spain’s at market prices — heavily dependent on exports of fossil fuels and other commodities and which imports a lot of food and consumer goods. Its oligarch business class holds huge amounts of assets abroad.

But it has a proven ability to absorb a considerable amount of economic damage even when, perhaps particularly when, directed at households.

The supposedly state-of-the-art 2014 sanctions were coordinated between allies including the United States, EU, Australia, Canada and Japan. 

Inevitably designated “smart”, they were aimed at pressure points including individuals involved in fighting in Ukraine and companies operating in Crimea while shielding EU companies dependent on imports from Russia.

The Russian economy suffered in the years following, going into the longest recession in twenty years in 2014 and 2015. But most of that reflected the fall in the global oil price. 

The International Monetary Fund (IMF) reckons that from 2014 to 2018, the oil price had a negative impact three times larger than the sanctions. When world oil prices recovered, so did Russian GDP.

IMPACT ON VLADIMIR PUTIN'S PUBLIC POPULARITY?

Nor did sanctions effectively constrain the activities or loyalty of many of the Russian oligarchs regarded as close to Putin. Their activities are typically concentrated in energy and energy-dependent commodities — fertiliser, steel — on which western European companies rely. 

Even when they did have an impact, it did not turn them against the regime. Oleg Deripaska, one of the highest-profile targets, took a personal financial hit over being forced to divest from the aluminium giant Rusal, but he is still regarded as a Putin ally. He is also still a billionaire.

If the sanctions were supposed to undermine Putin’s standing with the public or the oligarchs in the short term, they failed.

His personal popularity soared after the invasion, and he was confident enough to inflict a whole lot more pain on the Russian public by blocking imports from the EU in retaliation.

Around 75 per cent of Russian consumer goods are imported, and before 2014, Russia was heavily dependent on food from abroad. Russia’s own trade sanctions didn’t do much lasting damage to EU exporters, who found other markets. 

But together with a sharp drop in the rouble, they drove inflation in Russia to double digits in 2015, cutting into household incomes. 

Even when the oil price recovered, Russia’s government decided to use the bonanza to buy some expensive insurance against future sanctions by running up foreign exchange reserves rather than allowing the benefit to flow to consumers.

Certainly, there is public discontent in Russia over stagnant living standards. But it doesn’t seem to be at a level that directly threatens Putin’s power or prevents further military adventures. 

The president’s approval ratings have dropped from 80 per cent plus levels after the crisis, but have generally held above 60 per cent since mid-2018.

Similarly, if the EU’s sanctions on individuals who are active in Crimea were intended to breed mass discontent by inducing economic stagnation through keeping out competent administrators and business people, they haven’t succeeded yet.

EUROPE'S DEPENDENCY ON RUSSIAN GAS

This is why gas is important. Despite Russia’s new pipeline to China, sales to Europe are a source of income it cannot currently do without. Russia has a fair degree of monopoly power there, but as a major customer, Europe has some monopsony power to balance it. 

Of course, the cost to western Europe of actually ending dependency would be high, including having to import expensive liquefied natural gas from elsewhere, a point made by Putin conduit and former National Russian President Dmitry Medvedev. 

An excellent time to do so would have been 10 or 15 years ago, when oil and gas prices were low. But it’s still a burden worth incurring now. It’s hard to put effective sanctions on a country that’s prepared to let its own public suffer without taking on some costs yourself.

To be grimly realistic, it might already be too late for sanctions to restrain Putin’s attempt to carve two vassal republics out of Ukraine. He’s got some insulation from short-term risks through foreign exchange reserves and appears to be getting more rather than less reckless. 

But Germany’s announcement on Nord Stream 2 is at least a signal that Berlin knows what is required.