Despite the imposition of one of the toughest sanctions regimes ever on Russia by the West, its economy is displaying surprising resilience. The economy is growing steadily, with an annualized rate of 4% in the second quarter, following a remarkable 5.4% growth in the previous quarter. This growth is occurring despite the severe sanctions, and trade continues to flourish. How is this possible? The answer may lie in countries like Kazakhstan, which appear to be filling the gap left by European firms barred from selling products in Russia.
Kazakhstan’s tech industry, consisting of only 50 companies, seemingly expanded its exports to Russia from $40 million in 2021 to $298 million in 2023. However, this seemingly miraculous growth is deceptive. Electronic imports from Europe to Kazakhstan have also surged from €250 million to €709 million, suggesting a workaround route for Russian firms to access European suppliers. This pattern is not unique to Kazakhstan, but also observed in other countries like Armenia, Azerbaijan, Georgia, Turkey, and the Central Asian republics. Exports from the European Union to these countries have increased by €46 billion in 2023, a 50% rise from 2021, effectively offsetting three-quarters of the drop in European exports to Russia during the same period.
The sanctions, while a significant contribution to Ukraine’s war effort, have not yet inflicted a substantial blow on Russia’s economy. This raises questions about the effectiveness of the sanctions and the extent to which European firms are genuinely adapting to the new restrictions or simply finding ways to circumvent them. Notably, the most significant increases in trade flowing through third countries involve products now heavily restricted under sanctions. European policymakers are actively seeking to close these loopholes, which could lead to confrontations with their already sensitive neighbors.
The booming trade through third countries is driven by three key factors. First, there is the trade in banned goods, which openly violates the sanctions. The EU has implemented 14 packages of sanctions, including restrictions on the export of battlefield equipment like semiconductors, drones, ball bearings, and even microwave ovens. Yet, evidence suggests that over half of the battlefield equipment acquired by Russia between February and August 2022 contained components manufactured in Europe or the United States. This is reflected in the surge of chemical, electronic, and machinery exports from the EU to Kazakhstan and Armenia. Machinery exports to Kazakhstan doubled from 2021 to 2022 and further increased by 23% in 2023, reaching €6.4 billion. Similarly, Armenia imported twice the chemicals, five times the IT hardware, and four times the electronics from Europe in 2023 compared to 2021.
Second, goods are smuggled across borders, rendering them invisible to official trade statistics. Shipments can pass through multiple intermediaries before reaching Russia, with some exporters in Turkey and Central Asia genuinely unaware of the goods’ origin. However, others are fully aware of the illicit activities. Last year, America imposed sanctions on a network of European firms organized by Mayak, a Russian conglomerate, for transporting forbidden equipment through Uzbekistan and Armenia. Further investigations uncovered two networks of European toolmakers shipping to Russia, one via Turkey for Ostec, a Russian state-owned company, and another via Kyrgyzstan for Newton-ITM, a Russian aerospace firm.
The third factor driving indirect trade is the ban on Russian lorries from entering the EU directly since 2022, forcing goods to take longer routes. While this increase in transportation costs discourages trade, it allows firms heavily reliant on Russia to survive. Official numbers show that agricultural products flowing from Europe into Kazakhstan doubled from 2021 to 2023.
The most challenging aspect for Europe to address is the manufacturing boom in third countries. These countries import materials and parts from Europe, a process that does not necessarily violate the sanctions. However, the payment aspect presents a significant challenge, as almost all transactions with state-owned Russian firms are prohibited. European banks are barred from interacting with most Russian banks, major Russian banks are locked out of SWIFT, and firms must avoid dealing with 2,200 blacklisted entities.
Concerns are growing about the potential use of third countries as fronts for Russian activities. America believes Turkish firms are now manufacturing drones and microelectronics for Russia. A Turkish foreign ministry official stated that metals for some munitions might be smelted in Europe. Kazakhstan’s imports of office machinery from Europe tripled to almost $1 billion from 2021 to 2023, likely driven by a surge in new offices and factories, fueled by Russian firms investing in Kazakhstan, leading to an 11% increase in investment in 2023.
The economies of Central Asia and the Caucasus seem to be reaping benefits from the war. The combined economies of the five Central Asian republics grew by 6% in 2023, an increase from 4% in 2022, while Armenia’s economy expanded by 8%, up from 5% in 2022. This growth is accompanied by a rapid expansion in the logistics sector, with cargo volumes growing by 20% annually.
This situation presents a significant challenge for European policymakers, who have acknowledged the scale of the leakages in sanctions. In December, the EU’s 12th round of restrictions targeted firms in Armenia and Uzbekistan for the first time. While officials have threatened further sanctions on third countries and European exporters to them, only a few firms have faced action. For every firm blacklisted, another emerges elsewhere.
A truly effective solution requires collaboration with the governments of the Caucasus and Central Asia, a challenging proposition. Regional politicians prioritize their close ties with Russia and often profit from rule-breaking. To encourage cooperation, Europe could offer incentives like the €270 million in aid, loans, and contracts granted to Armenia, which subsequently initiated measures to crack down on firms trading with Russia. Alternatively, Europe could employ stricter measures, like extending export bans to third countries or restricting their banks. However, such actions could strain relations with crucial gas suppliers like Azerbaijan and negatively impact European businesses.
The question remains: does the EU believe that tightening the sanctions regime, even at the cost of strained relations and potential economic repercussions, is worth the benefit to Ukraine? The current approach suggests otherwise.
