How sanctions affect Russia: from problems with payments to low profitability of the military-industrial complex

18:40, 07.06.2024

In early spring 2024, Russian buyers of dual-use technologies, equipment, and components faced significant difficulties in making payments. Biden's executive order at the end of 2023 greatly complicated financial transactions that allowed sanctions to be bypassed. As a result, the delivery time for orders crucial to the Russian military-industrial complex (MIC) has significantly increased. 

Due to fears of secondary sanctions, several major Chinese banks, such as Bank of China, China Construction Bank, and others, stopped accepting payments from Russian banks, rejecting transactions through settlement systems like SWIFT, SPFS, and CIPS. At one point, about 80% of trade settlements between the two countries were suspended. Additionally, key financial institutions in Turkey, the UAE, and Mongolia followed suit. 

According to Matthew Axelrod, Assistant Secretary for Export Enforcement at the U.S. Department of Commerce, "the Russian government is paying twice as much for microelectronics and semiconductors as before the war." 

What caused the price increase? Now, when organizing international transfers for companies from Russia or its allied countries, the compliance service of financial institutions is required to verify: 

  • The purchased goods are not dual-use or under sanctions. 
  • The cargo will be delivered to the buyer's country, not to Russia. 
  • The documents are correct (export declarations and routing documents). 

Funds are processed by the bank of the counterparty's country and can be held up for a month, two, or even longer. Previously, a shipment ordered in China for Kazakhstan or Belarus could transit through Russia and get lost along the way. Now companies are forced to spend extra money on actual delivery to the country specified in the documents, customs clearance there, reselling to another intermediary company, and only then sending the goods to Russia. Market players increasingly report situations where purchased equipment stands at the factory for several months because the supplier could not ship it due to the client's inability to pay. 

Additionally, if previously lathe buyers used incorrect product codes to get payments through, now, due to increased control by financial institutions, opportunities for deception have decreased. 

Currently, Russian companies in the MIC sector are using their reserves, but a significant shortage of electronic parts and other components is expected to grow in the summer or later. Further trade disruptions could affect weapon production volumes and undermine the strength of Russia's military machine. 

Delays in payments and deliveries, as well as rising import costs, lead to a decrease in the profitability of military production in Russia. In an interview with RBC, Sergei Chemezov, CEO of Rostec, stated that the profitability of factories fulfilling most orders from the Russian Ministry of Defense does not exceed 2.28%. 

The decrease in profitability means that Russia has fewer funds to reinvest in the development of the MIC and research and development. This negatively impacts the defense sector and the country's economy as a whole. The inability to quickly and effectively make payments and deliver components means further disruptions in weapon production and could undermine the strength of Russia's military machine in the near future.