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How Ukraine Can Use Sanctions to Counter Russia’s Aggression

by | March 24th, 2014 | 02:05 pm
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With its annexation of Crimea, Russia has become a rogue state in international affairs. Russia appears certain to cause Ukraine great suffering, well beyond the annexation of Crimea, but Ukraine can also impose significant economic damage on Russia.

Sanctions against Russia are wholly justified legally because the Crimea annexation violated the United Nations Charter, the Helsinki Final Act, the Treaty on the Dissolution of the Soviet Union of Almaty December 1991, the Budapest Memorandum on Ukraine’s denuclearization of December 1994, the Russia-Ukraine Friendship Treaty of 1997, and the Sevastopol Naval Base Treaty of 1997. The two most obvious precedents—Iraq’s annexation of Kuwait in 1990 and Nazi Germany’s annexation of Austria in 1938—lead us to the right ballpark of international law. The actual state of affairs between Russian and Ukraine is war. A rethinking of how to deal with Russia economically and financially derives from that fact.

The Russia-Ukrainian gas trade is a case in point. Until the end of last year, Ukraine paid $400 per 1000 million cubic meters (mcm) of gas. On December 17, President Vladimir Putin cut that price to $269 per mcm for the first quarter of 2014, which approximates a normal market price in this region. After the new democratic government was formed in Kiev, Gazprom Chairman Alexei Miller announced that it would no longer maintain the discount because of Ukraine’s $1.8 billion in arrears to Gazprom , so the price would go back up to $380 per mcm.

Yet, on March 21, Putin’s spokesman Dmitri Peskov announced that the price would rise to $480 per mcm from April 1. Ukraine, he maintained, had received a “discount” of $100 per mcm in return for President Yanukovych prolonging Russia’s lease of the Sevastopol Naval Base for 25 years until 2042. He did so in an agreement in Kharkiv in April 2010. On March 22, the day of Russia’s formal annexation of Crimea, Peskov explained that after Crimea had become part of Russia, “a concept such as discount for gas for Ukraine for the Black Sea base no longer exist[s].” In other words, since Russia illegally seized the Sevastopol Naval Base, it no longer had to pay rent for it. Prime Minister Arseniy Yatseniuk noted that Ukraine could purchase gas from Europe at a price $150 per mcm cheaper.

On March 22, Prime Minister Dmitri Medvedev, to whom Putin delegates his most obnoxious statements about Ukraine, claimed that Ukraine owes Russia $16 billion, of which $3 billion is in eurobonds (i.e. bonds sold in Europe, usually denominated in US dollars) from December and $2 billion debt to the state-controlled energy company, Gazprom. Incredibly, the remaining $11 billion was calculated as lost future benefits until 2042 for Russia, since it no longer needs to lease the Sevastopol Navy Base but owns it! This is the ultimate chutzpah, like leasing a car and demanding earlier payments back because you have stolen it. Such assertions cannot be taken seriously.

Meanwhile the Crimean authorities—that is, Russia—have confiscated vast Ukrainian state assets, including those possessed by the oil and gas company Chernomorneftegaz. These assets are worth many billions of dollars. Both the speed of aggression and the lawlessness are impressive.

Conversely, both Russia and Crimea are freezing or confiscating assets belonging to big Ukrainian businessmen who cooperate with the new rulers in Kiev. Thus, Russia has frozen accounts of $80 million of Petro Poroshenko’s company Roshen in Russia, and Crimeans have confiscated his car shop in Crimea. Russia has taken the Russian part of Ukrainian Privatbank under administration, while the Crimean government has confiscated Privatbank in Crimea. Its main owner is the newly-appointed governor in Dnepropetrovsk.

These steps have turned a tragedy into a theater of the absurd. The Ukrainian government needs to adopt a rigorous policy toward Russian financial claims, and the international community should offer full legal, political, and financial support.

First, Ukraine should refuse to serve any of its debts to Russia and its state entities, including Russian state banks. A country does not owe anything to an aggressor who has violated every international law. On the contrary, Ukraine is entitled to war reparations. Such reparations can only be settled at an eventual peace agreement. My colleague Anna Gelpern had argued that the $3 billion Russian bond purchase in December 2013 should be considered “odious debt” from the outset and be disowned outright. International financing must not be used to pay Russia or Gazprom.

Second, Ukraine needs to alter its whole gas policy instantly. Given Gazprom’s politicized behavior, the Ukrainian government should revoke the dysfunctional agreement between Gazprom and Naftogaz, the Ukrainian national oil and gas company, of January 2009. In order to rid itself of the pervasive corruption in the gas sector of arbitrage between low state-controlled prices and high free-market prices, the government should raise gas prices to a market-conforming level. Half of the cut in subsidies could be given to the needy as direct social compensation from the state budget. With higher gas prices, Ukraine’s high energy intensity would soon decline. In the long term, Ukraine can easily produce enough gas for its own needs. In the short and medium term, it can import gas from Slovakia, Poland, and Hungary.

Ukraine should cease to import gas from Gazprom, since Gazprom acts like an organized crime syndicate poisoning Ukraine with its corruption. Gazprom still needs Ukraine’s gas transit system for half of its exports to Europe. Considering its business habits, Ukraine should only allow such transit if Gazprom prepays for the transit. As a member of the European Energy Community, Ukraine can also lean on the European Union in its legal defense. Gazprom is entitled to take a case against Ukraine to the Stockholm Arbitration Court, but such cases are usually brought by others, and Gazprom persistently loses big.

Third, in war, the confiscation of the enemy’s state property is commonplace. If Russia continues with its confiscation of Ukrainian private assets in both Russia and Crimea, the Ukrainian government needs to consider the nationalization of the four Russian state banks in Ukraine, which hold about 15 percent of all Ukrainian banking assets.

On March 21, Prime Minister Yatseniuk stated that his government was preparing lawsuits to be brought against Russia in international courts. “It was Russia that [in] using weapons committed a holdup of Ukraine’s state-owned facilities.” Consequently, Ukraine is calling for many billions of dollars of damages.

After all, Russia accounts for only 2 percent of global GDP, and it is far too poor and vulnerable to launch a full-fledged war.