Since December 2023, the US administration has been intensifying its pressure on Russia's financial system with its so-called strangulation sanctions, making it progressively more difficult for the country to finance its imports.

Despite traders’ growing problems with getting paid, the new tougher financial sanctions have primarily hurt Russia’s small- and medium-sized enterprises (SMEs), while the big Chinese and Russian entities continue to find workarounds, and trade volumes between Russia and its partners have been largely unaffected, apart from outages that last for only a few months while new payment methods are found, OSW reported in a recent note.

According to the Central Bank of Russia (CBR), the value of imports for the first eight months of 2024 only fell by approximately 8% year on year, while exports saw a modest decline of more than 1%. Though these changes seem relatively contained, the rising cost of imported goods and longer delivery times have hurt as they are contributing to a persistent inflationary pressure, which has forced the CBR to hike the prime interest rates to 21% in October that is crushing growth and investment.

The US's escalation began with granting the Treasury Department authority in December 2023 to impose secondary sanctions on entities aiding Russia's military-industrial base. By restricting their access to the US financial market, Washington has targeted significant parts of the Russian financial sector, including major institutions like the Moscow Exchange (MOEX), the National Clearing Centre, and the National Payment Card System, which issues MIR bank cards. Additionally, sanctions were imposed on various banks, including the Shanghai branch of VTB, Gazprombank and the Russian Agricultural Bank. The knock-on effect lead to a number of Chinese and Turkish banks cutting ties to their Russian clients in April. Companies in China, Turkey and the UAE are increasingly being targeted by the US Office of Foreign Assets Control (OFAC), reflecting the widening net cast by the US and, more selectively, the EU.

"Foreign banks, primarily those from China, Turkey, Armenia and Kazakhstan, have increasingly refused to accept payments from Russia," OSW says.

The most severely affected sectors have included cars, electronics and Indian steel imports, with mounting challenges in processing payments. Most payments are reportedly being refunded to payers, yet the broader implications for trade remain. Notably, the CBR revealed that in June, 43% of Russia's imports were settled in rubles, closely followed by the yuan at 40%. The yuanisation of the Russian economy has led to a liquidity shortage of yuan on the Russian market in recent months, but analysts say this is temporary.

Chinese banks treading carefully

Chinese banks have exhibited a cautious approach to mitigating the risk of sanctions, driven by their relatively limited stake in the Russian market. The Bank of China, for instance, reduced its net assets in Russia by approximately 40% since April 2024. Following the Moscow Exchange's addition to the sanctions list, the Industrial and Commercial Bank of China (ICBC) stepped in to manage yuan clearing. However, its involvement could hinge on whether US licences allowing temporary cooperation expire on October 12. Similarly, China Construction Bank and Agricultural Bank of China have reportedly scaled back their operations with Russian entities, fearing potential secondary sanctions.

This caution from Chinese institutions has resulted in heightened vetting of cross-border transactions, significantly lengthening the clearing process. Some payments have not been processed at all, and many institutions are treating yuan passing through the Russian financial system as "dirty." Smaller banks, particularly those in border regions, have attempted to fill the void left by Beijing-controlled entities but face limitations in capacity and resources.

The reluctance of larger Chinese banks to deal with Russian financial institutions has created a two-tier system where only those businesses able to afford intermediary fees or establish subsidiaries in third countries can continue trading effectively. This dynamic has further exacerbated inequalities within the Russian economy, favouring larger enterprises at the expense of smaller ones.

Trade unaffected for now

Despite these obstacles, trade volumes have yet to show a significant contraction. The CBR data from the first eight months of 2024 show an 8% reduction in imports, while customs data reveal that imports from the largest suppliers to Russia have changed only marginally. However, this resilience has relied on increasingly creative solutions. One key method has been using third countries for registering subsidiaries, as well as intermediaries to facilitate payments, allowing businesses to circumvent direct exposure to Russian sanctions. Russia has also turned to platforms that connect importers with exporters holding "clean" yuan in China and, in more extreme cases, cash, cryptocurrencies and even barter arrangements have come into play.

For China, there have been benefits amidst these complications. As smaller Russian importers struggle to navigate the web of sanctions, larger Chinese businesses, such as Sinopec and Huawei, are well-positioned to capture a more significant market share. This has implications not only for the structure of Russia's import ecosystem but also for prices, as reduced competition could push up the costs of imported goods, says OSW. Furthermore, Chinese exporters have found new opportunities to leverage their financial connections in Southeast Asia and the Middle East to provide alternative channels for payments, thus reinforcing their influence in the region. In doing so, China has positioned itself as an indispensable partner for Russia, capable of bridging the gaps left by Western financial institutions.

The repercussions of these sanctions have also rippled through the logistical aspects of trade. Shipping costs for imports have increased, partly due to the reduced number of viable routes that avoid jurisdictions imposing sanctions. Delays at ports and border crossings have become more frequent as heightened scrutiny leads to longer inspection times. These logistical hurdles, coupled with increased payment processing times, have strained the supply chain for critical goods, from industrial machinery to consumer electronics.

Russian businesses have shown a remarkable ability to adapt by stockpiling inventories and adjusting their procurement strategies to mitigate these disruptions. For traders currently it’s a case of “what doesn’t kill you makes you stronger.”

While sanctions are undeniably straining Russia's economy, particularly its SMEs, analysts suggest that what is developing are new robust financial payment mechanisms outside the reach of sanctions for both Russia and China. Though payment issues have escalated since late July, and trade data for this period is not out yet, it seems that neither country is willing to let sanctions define the limits of their commerce. The evolving methods – from formal banking to barter – suggest a determination to maintain economic connectivity, even as global financial networks become increasingly fragmented. At the same time, the strangulation sanctions is driving innovation and at the recent BRICS summit in Kazakh in Russia all the members discussed setting up a BRICS Pay cryptocurrency that can be used to settle mutual trade deals independent of the dollar.

Game of whack-a-mole

The jury is still out on what the long-term consequences of these strategies and the effectiveness of the evolving financial sanctions. Sanctions on Russia remain a game of whack-a-mole and so far Russia has managed to successful evade both the oil price cap sanctions and technology sanctions that were supposed to bring the economy to its knees.

But there is a price to pay as the increased use of barter, cash and cryptocurrencies not only undermines the transparency of international trade but also increases the risk of corruption and inefficiencies. Moreover, the shifts in trade dynamics have political implications. Smaller nations, such as Armenia and Kazakhstan, are finding themselves increasingly caught between major powers, balancing the benefits of facilitating Russian trade against the potential repercussions from the West.

Furthermore, the focus on circumventing sanctions has led to the strengthening of economic ties with non-Western countries. The sanctions regime has driven Russia into the arms of not only China – probably a major strategic blunder by the US – but has also catalysed the development of major non-aligned organisations like the BRICS+ and the G20, which will only weaken the West’s influence in an increasingly fractured world.

It has also created unlikely beneficiaries. Central Asia is the big winner from the Ukraine war thanks to the windfall from not only amplified trade with Russia, but now there is an FDI and manufacturing boom underway that is lifting all boats in the region, which is also undermining the West’s influence in the region as it is not in the ‘Stans economic interests to adopt sanctions against Russia or cooperate in anyway with the Western campaign.

Russia's engagement with nations across Central Asia, the Middle East and Africa has intensified and has been met with enthusiasm, creating new opportunities for bilateral agreements and partnerships. Russian President Vladimir Putin’s message of anti-colonialism plays well in Africa where resentment to the colonial era remains strong. And the discounts offered to “friendly countries” buying Russian commodities, nuclear technology and arms are very attractive. On the flip side, the US aggressive lobbying of countries to adopt sanctions also goes down very badly.

Moreover, these alliances are not just economic; they represent a broader realignment of geopolitical loyalties, as Russia seeks to anchor its position outside the sphere of Western influence. Putin started the war in Ukraine specifically to keep Ukraine out of Nato, but more generally, he wanted to break up the unipolar hegemony of the US in geopolitics and replace it with a multipolar model. And in this he has been largely successful. The implications of these shifts are significant, potentially laying the foundation for a new set of international alliances and the end of the Pax Americana.

The continued adaptability of Russian and Chinese enterprises in finding solutions to maintain trade flows also highlights a broader trend of financial decoupling. As Western nations tighten restrictions, both Russia and China are increasingly investing in developing alternative financial systems, such as cross-border interbank payment systems that bypass SWIFT. The dollars dominance in global trade and reserves currencies gave it enormous power, not to mention the ability to borrow limitless amounts of money at all-but no cost. Undermining trust in the dollar could prove an extremely costly mistake and the dollar’s share in reserve currencies has already fallen below 50% in the last two years, although it will take decades for the dollar to lose its privileged position.