February 18, 2015
With the potential unraveling of the second ceasefire agreement between Ukraine and Russian-backed separatists, U.S. and EU policymakers are searching for new ways to convince Russia to cease its destabilizing activities in the former Soviet Republic. While in recent weeks the focus has been on providing the Ukrainian military with lethal aid, analysts are now considering more powerful economic sanctions as a way to punish Moscow and deter it from continuing its support of the Ukrainian rebels.
One such idea gaining traction is to cut Russian financial institutions off from the Society for Worldwide Interbank Financial Telecommunication, or SWIFT. As noted by Fareed Zakaria in a recent Washington Post op-ed, severing Russian banks’ connection to SWIFT, a European organization that facilitates global interconnection of financial institutions by providing standardized means of communicating financial information, would seriously damage the Russian economy. But while causing Russia substantial economic pain, cutting the country’s banks off from SWIFT would be a short-sighted and ultimately dangerous move, as it would likely collapse the Russian economy, severely damage U.S. and European business interests, and accelerate the shift away from dollar-denominated transactions and Western financial markets.
This failure to properly understand and consider the consequences of preventing Russia from accessing the Western financial system is indicative of a larger, troubling trend; since policymakers began increasingly relying on financial sanctions as tools of first resort in dealing with foreign policy crises, they have not adequately taken into account the second order effects these sanctions can often cause. Instead of simply focusing on the economic pain these measures can bring to bear, policymakers must do a better job thinking through what impact these sanctions will have on the target state, U.S. and its allies’ interests, and the future of the international financial system.
The desire to ratchet up the pressure on Russia is understandable. Since Ukraine and Russian-backed separatists signed a second ceasefire agreement last week, the nearly year-long conflict has escalated, not cooled down. In an attempt to grab new territory and consolidate gains, the Russian military has actively intervened in the conflict, sending troops, tanks, and artillery units deep into Ukrainian territory. This brazen violation of Ukraine’s sovereignty demands a response, and policymakers are now searching for new ways to punish Russian President Vladimir Putin and his government for its continued assault on Ukraine if the ceasefire does not hold.
One option on the table is to force SWIFT to cease any services it provides to Russian financial institutions. SWIFT facilitates international financial transactions by transmitting more than five billion bank-to-bank messages annually. The organization, which aided financial institutions process trillions of dollars last year, provides a standardized template that helps these institutions easily transfer funds. Denying Russian banks the ability to use SWIFT, which was previously considered but shelved because it seemed too drastic, has received renewed attention in recent days, as the United States and the European Union have struggled to find ways to counter Russia’s aggression.
Taking such action would likely crater an already-suffering Russian economy. Since March 2014, inflation in Russia has risen to 11.4 percent and the Ruble has weakened by approximately 45 percent against the dollar. In 2015, the economy is predicted to shrink by 3.6 percent. Making it more difficult—if not impossible—for Russian banks to conduct financial transfers would inflict significantly greater damage on the economy. Russian banks are tightly connected with European financial institutions and sources have reported that more than 90 percent of transactions involving these banks cross borders.
A non-functioning financial system would freeze economic activity in the country, including simple transactions that underpin everyday economic life. The inability to access Western financial markets would likely cause another run on the Ruble, which consequently would further the economic downturn. FDI into the country, which has slowed substantially in the past year, and, along with energy exports, is the lifeblood of the economy, would almost certainly dry up.
Too Much Pain
If the United States and the European Union want to increase the pain on Russia for its activities in Ukraine, cutting it off from SWIFT would achieve that goal. But targeting Russian banks’ access to SWIFT would likely collapse the Russian economy and lead to a number of unintended and destructive consequences.
This economic collapse, instead of convincing Russia to reduce its support for Ukrainian separatists and pull out of Crimea, would likely make the country more dangerous. Russia has one of the most sophisticated and effective militaries in the world. With a cratered economy, it may be significantly more willing to use that military against its neighbors, especially since many of those neighbors possess large amounts of valuable natural resources. In effect, imposing these sanctions could have the opposite impact; instead of persuading Russia to cease its belligerent activities, it could give the country a reason to act more aggressively.
Such a collapse would also seriously damage Western economic interests. Russian companies are heavily invested in Europe, and U.S. and European firms have significant operations in—and conduct substantial trade with—Russia. Undercutting the Russian economy, which according to the World Bank is the sixth largest in the world, would have significant negative effects not only on those companies directly invested in Russia, but also on the economic health of the European Union more generally. A debilitated Russia could easily lead to a European, and indeed global, recession.
Using SWIFT to target Russia could also undermine the competitiveness of Western financial markets. The more that U.S. and EU policymakers use SWIFT as a political tool, the more likely other countries will be to develop their own mechanisms for facilitating financial transactions. Not wanting to be subject to the political whims of Washington and Brussels, Russia and China have already begun developing alternatives to SWIFT. In the medium and long terms, these new systems will make non-Western financial markets more attractive, and will hurt U.S. and European financial sectors.
Thinking Sanctions Through
This drive to inflict harsh financial punishment on Russia is understandable, as policymakers are struggling to find the best set of tools for dealing with an intractable foreign policy crisis. Unfortunately, resorting to powerful economic measures—without properly understanding and considering their potential negative consequences—has become all too common. Whether it is attempting to impose severe, Iran-like sanctions on Russia or ratcheting up the pressure on rogue actors without thinking through how to unwind these forces, policymakers have not sufficiently focused on the potential unintended impacts of employing these forms of coercive diplomacy. Particularly in a financially interconnected world, utilizing such sanctions is bound to have second order effects, and until this point policymakers have not done a good job appreciating what these might be.
Rather than seeing economic sanctions as the best tool for imposing immediate and significant pain on aggressive states, policymakers should more carefully understand what these sanctions can achieve—and what the unanticipated downsides of relying on them are. Doing so will increase the likelihood that these sanctions will be an effective part of a coordinated strategy to change the behavior of Russia, Iran, and other targets, while minimizing the risk that these sanctions have unintended and catastrophic consequences for Western interests.
More from CNAS
Putin’s Forever War
More than a year after Russia’s invasion of Ukraine, a grim reality has settled in: the war will not end soon. Despite the heavy fighting in and around the eastern city of Bak...
By Andrea Kendall-Taylor & Erica Frantz
China's leader Xi Jinping arrives in Moscow
Andrea Kendall-Taylor appears in Reuters to discuss the broader implications of Xi Jinping's visit to Moscow, and the future of the Sino-Russian relationship. Watch the full ...
By Andrea Kendall-Taylor
The Battle of Bakhmut
In this episode of MWI’s Urban Warfare Project Podcast, John Spencer is joined again by Michael Kofman, director of the Russia Studies Program at CNA. He researches Russia and...
By Michael Kofman
How to Think About Bakhmut and a Ukrainian Spring Offensive
Fresh back from his research trip to Ukraine, Mike Kofman joins Ryan for a discussion about what he learned. They discuss the battle for Bakhmut, munitions shortages and force...
By Michael Kofman