Russia after Sanctions: Pirate or Mafia State?
By Alexander Kupatadze
Russia is now the most sanctioned economy in the world. These unprecedented sanctions open new frontiers of illegal activity. The likely outcome is the expansion of illicit supply chains for delivering regulated/prohibited goods (e.g., luxury goods, machinery and technology) and foreign currency cash to Russia. The fungibility of the gold reserves that Russia owns and hopes to use as an economic lifeline, also depends on shadow and illicit gold markets. As the commercial entities in neighbouring countries and Russia’s trade partners shy away from direct complicity in sanctions-busting fearing secondary sanctions from the West, Russian intelligence agencies, private companies and illicit proxies of Russian state e.g., Russian organised crime networks are the best candidates for picking up the slack. Depending on the longevity of sanctions the Russian economy may become widely dependent on illicit supply chains and associated criminal networks.
Elsewhere in the sanctioned countries, we have seen growing criminalisation of the economy. Russian economy has already entered ‘the state of permanent illegality’ long time before the Ukraine invasion. The era of chaotic privatisation and illicit deal-making over public procurement contracts, that gave birth to oligarchic system, did not evolve into modern, legal economic edifice. It is difficult to find a large business structure in contemporary Russia without the history of insider deals in the process of privatisation, contract killings and links to organised crime. Essentially, no business has been immune from illicit practices similar to what BBC recently found in the case of Roman Abramovich’s acquisition of Sibneft in 1995.
More worryingly despite some improvement in institutional environment in the 2000s and 2010s, this murky business structures failed to transform into something entirely licit and continued using semi-legal and illegal methods to secure and expand their interests including blackmail and corporate raiding. The enablers in the West, having few qualms over these practices, eagerly helped Russia-based entrepreneurs to launder their money, primarily to Europe and North America. Russian oligarchs are using complex ownership structures registered in secrecy jurisdictions that complicates the process of identifying and targeting their assets. Sanctions do not necessarily prevent them from acquiring new assets either. For example Arkady and Boris Rotenberg, two brothers close to Vladimir Putin, successfully exploited the opaqueness of art market and acquired high-value art hiding behind a shell company even after they came under US sanctions in 2014. They also successfully took stakes in seven companies using European offshore tax havens. In the latter case the divergence in the US and EU approaches has been successfully exploited as a regulatory loophole. New sanctions face the same challenge. For example, Oleg Deripaska has been blacklisted by US (since April 2018) and UK (March 2022) but not by the EU.
The extensive use of shell companies is also problematic in achieving compliance regarding Russia-related trade restrictions. Many legitimate goods are now banned to enter or leave Russia and hence the related supply chains are illegal only because they are linked to Russia. However, Russia’s involvement in moving goods can be successfully masked by using entities registered in offshore jurisdictions. North Korea has successfully used similar schemes. Moreover, sanctions create incentives for illicit trade schemes and trade-based money laundering involving myriad of illicit methods. This may range from the use of transhipment, whereby Russian exporters send their produce via a non-restricted third country for eventual re-export (after some processing or re-packaging) to a sanctioning country; to Russian importers over-invoicing the value of imports so that misrepresented value can be moved offshore. Also Russian ships have been noticed to be turning off their tracking systems double of the normal weekly rate, another indication of possible sanctions-evasion involving the widely-used method.
Use of cryptocurrencies to circumvent new rules is another ‘new frontier’ and sanctioned countries have resorted to this method before. However there are indications that cryptocurrency dealers would hesitate to knowingly help, given the willingness of the West to police the issue.
In a nutshell the longer sanctions continue the more methods of evasion would emerge; and more severe the sanctions get; more extensive role illicit supply chains will play. The reports from Russia suggest that the prices on many consumer goods have skyrocketed. Apple products are now priced 142 percent above their valuation. This establishes clear incentives for smuggling these products. Russian government has passed a law legalizing ‘parallel imports’ basically allowing Russian importers of foreign products to bring commodities to Russia without the consent of the licensed producer. This equals to legalising infringement of copyrights but also encourages Russian firms to engage in sanctions-busting.
Better news is that unlike other sanctioned countries, one should expect more stringent enforcement by a very determined Western alliance. However unlike other sanctioned countries Russian state has links to one of the most globally-networked organised crime that it has already used for various tasks. Russian criminal networks have excelled in the provision of illicit services internationally and has a capacity of transporting goods over long distances as well as laundering money through well-elaborate schemes. Moreover, it already is an experienced actor in sanctions-busting
Russian criminal networks and private companies are likely to play a prominent role in smuggling various legal products but some commodities, especially arms and the spare parts for military industry is likely to fall under the mandate of Russian intelligence agencies. The representatives of these agencies have shown readiness and capacity to transport dangerous commodities across borders themselves (e.g. nerve agents and/or polonium) and/or enlist semi-independent networks to smuggle arms internationally. If the past is any guide, the illicit supply chains of arms and militarily-usable technology and machinery will involve various hybrids comprising representatives of Russian deep state, organised crime and private sector. Importantly, one needs to distinguish between different types of organised crime in Russia and it needs to be acknowledged that illicit trade networks and mafia networks do not always overlap in post-soviet context, but post-Soviet underworld is still likely to be at the forefront of organising transnational smuggling operations due to its well-networked structure spanning borders of ex-Soviet independent countries. Many bosses of mafia network dubbed as Brother’s Circle by US treasury and headquartered in Moscow, hail from Georgia, Armenia, Kyrgyzstan and Uzbekistan.
Outside of Russia, commercial entities in Turkey, UAE ad China are ‘usual suspects’ due to their record of helping Iran, Venezuela and North Korea in evading sanctions as well as the refusal of their host countries to join sanctions against Russia. Ex-Soviet Union countries, especially in South Caucasus and Central Asia, are also at the risk to be implicated. Deriving inspiration from covid-19 vaccination tours Russian touristic companies started advertising ‘credit card tours’ in Uzbekistan where Russian citizens can travel to get international Visa and Master cards. There are concerns in Georgia, where some banks are offering banking services to Russian citizens and entities without conducting proper due diligence. In the past there were concerns over Iranian entities using Georgia for evading sanctions. Ukrainian military intelligence has recently claimed that Russia is organising arms smuggling schemes via Georgian territory. Even though no hard evidence exists at the moment of writing, the risk remains high given the close links between Georgian and Russian smuggling networks and the unwillingness of official Tbilisi to join the sanctions.
Venezuelisation or Iranisation would not be good descriptors of the situation in Russia. The scale of the economy, sheer size of the country and specific context described above point to vastly different calibre of a problem. Enforcing the sanctions means a long battle against sophisticated schemes designed by experienced actors. Depending on the longevity and severity of sanctions this may well evolve into near-full dependency of Russian economy and industry on illicit supply chains and smuggling networks.