How are Sanctions Sidestepped?

By: Arjun Goyal

Trade sanctions have become a popular policing tool in international trade, and is many countries’ blocking access to vital goods. Some countries have found creative ways to sidestep these barriers.

Trade protection measures seem to be in vogue in the international trade markets. Between the US-China tariff war and the sanctions on Russia for election interference, trade barriers are on the rise. Measures like tariffs and quotas make it expensive to conduct trade with a particular country, while sanctions prevent this trade altogether. But certain countries have found a loophole to eke goods through.

Economic sanctions essentially prevent a particular country, or group of countries, from conducting trade in a particular good, or group of goods. These could be imposed by another country or by international consensus (typically through the United Nations or the European Union). The rationale behind imposing sanctions is to reprimand a country for engaging in certain activities, and economically incentivize them to disengage from these activities.

How do they work in practice? Let’s assume the United States wants to impose sanctions on a target country. The simplest implementation would be for the US to simply suspend trade with the target country. This would work well if the US is a key trade counterparty for that country (like China for example). Alternatively, organizations like the EU or the United Nations could prevent its member countries from engaging in trade with the target country (either for a particular good(s), or a complete cut-off).

An increasingly used tactic is where sanction enforcers prevent the target country from engaging in any transactions with the enforcer’s domestic businesses. Going back to our example of the US, this method not only prevents any US trade with the target country, but it also cuts off any borrowing from US financial institutions. This prevents the target country from having access to additional US dollars, with which it can conduct trading transactions.

Since the US Dollar is such a pervasive foreign currency, and the basis of almost all international trade, such a measure (if imposed by the US) makes it very difficult for the target country to engage in any trade with the rest of the world. The euro is also becoming a popular currency for trade, and such sanctions from the EU can have the same effect as US sanctions on target countries (though to a lesser extent).

Sanctions have been used as  international policing instruments for a while now. However, as international relations among major global powers like the United States, China and Russia have become strained, the number of sanctions imposed in the recent past have increased dramatically. Enigma Labs made a global map that tracked these sanctions since 1994. The comparison between global sanctions in 2000 and 2019, shows the extent of this explosion.

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While the intention of these sanctions is to curb increasing narcotics trafficking and terrorism funding, they put a huge economic burden on other countries that rely on these sanctioned countries for vital resources.

Take India for example. Even though it widely endowed with a bounty of natural resources, it has close to no oil, and definitely not enough to support its booming economy. As a result, it relies on Iran for its oil demand through imports. However, when the US imposed export sanctions on Iran in 2013, India felt the bite of the cut off supply and experienced soaring fuel prices and higher inflation projections. The reimposition of these sanctions in April will lift prices up once again.

Countries have struggled to find ways around these sanctions previously. However, desperation for essential resources have forced these nations, like India, to find creative solutions.

As stated before, the main issue that sanctions pose to third-parties is the inability to use the enforcer’s currency. With most key sanctions in the recent past coming from the US, inability to use the US dollar makes it difficult to conduct any international trade. For example, if India wants to buy oil from Russia (which is currently being sanctioned by the US), and it cannot use US dollars, how would it pay the oil companies? Russian Roubles? Indian Rupees? Thai Bahts?

A person with no background in international trade would wonder why the bilateral trade couldn’t just be conducted in the local currency. The issue with using local currency lies in its name: ‘local’ currencies can only be used for domestic transactions. Russia can get a fair payment for oil in Indian Rupee, but they would only be able to spend this money in India. Unlike other local currencies, the US Dollar may be local but it also international and accepted for trade transactions globally. A payment in dollars allows Russia to use the proceeds from the oil sale and buy chocolate from Belgium or wine from France.

Another issue with using local currency is faced by financial institutions that would actually conduct the trade transactions. Since local currencies like the Indian Rupee and Russian Rouble are not as pervasive as the dollar, they have lower liquidity in currency markets. This opens up FX risk (change in value of holdings because of sudden market movements) for financial institutions holding these currencies, which becomes expensive to hedge. Overall, it is more efficient and economical to use the dollar rather than a local currency.

But with sanctions in place, countries have no choice but to use these local currency or stop trade altogether. Perhaps turning back clocks may help provide another solution.

If countries are not allowed to use US Dollars to conduct trade, they have the option of reverting back to the earliest payment system: bartering. In this method, countries would not exchange goods for money, but exchange it for other goods of equal value.

Indonesia and Russia entered into a deal where they would exchange weapons for commodities like palm oil and coffee, effectively getting around US sanctions. India and Venezuela also got around US sanctions by swapping oil for rice and pharmaceuticals. While historically the barter system died out because of the ‘double coincidence of wants’ (where both buyer and seller needed to have demand for each other’s goods), countries have been forced into bartering when their preferred currencies has no longer become an option.

Some countries have combined bartering with the use of local currency. India has tried to enter into a modified version of the barter system with Iran, where it buys Iranian oil in Indian rupees, which cannot be withdrawn by Iran but used to buy an equivalent value of Indian goods. This is effectively conducting trade in Indian rupees, and could be mimicked by any pair of countries, provided they have overlapping wants.

Sanctions can throw a wrench in the works for many third-parties, and so it has become a priority for them to get around them. In addition to the strategies above, some other payment means have also been used.

Certain businesses have tried to route payments through other countries like Turkey and other underground channels. However, even if these methods work for a while, they are not sustainable. The scale of international trade is massive, and reliance on the dollar is high.

European Union representatives have tried to come up with strategies to electronically wire money to Iranian oil producers directly from the central banks, so as to not expose private financial institutions to US penalties. The EU has also set up the Instrument in Support of Trade Exchanges, or Instex, as a channel through which local currency denominated bartering can occur between the EU and Iran.

Russia has tried to adopt a far more radical strategy: forfeit the dollar as the transaction currency altogether and make the Rouble a global transaction currency. However, given Russia’s reliance on oil and gas as its main export, which is a deeply dollar market, this move is not likely to be successful.

While there is no clear win-win solution in this dilemma, it is evident that countries suffering with sanctioned trading partners need a solution which does not involve waiting for mercy from the penalizer. A new global trade currency could be an answer, but which one will we choose? Euro? Rouble? Yuan? Bitcoin? That decision is difficult to make. Till the day we make that decision, countries will have to continue to be creative skirting sanctions to get what they want.

Works Cited:

Image Source: https://www.insurancejournal.com/news/international/2019/08/06/535028.htm.

England, A. (2019, February 21). Iranian businesses devise creative ways to evade Trump sanctions. Retrieved from https://www.ft.com/content/c3edcca4-3378-11e9-bd3a-8b2a211d90d5.

Enigma Labs: Sanctions Tracker. Retrieved from https://labs.enigma.com/sanctions-tracker/.

Fouriezos, N. (2019, February 14). To Avoid Trump’s Sanctions, Countries Turn to Stone Age Bartering. Retrieved from https://www.ozy.com/fast-forward/to-avoid-trumps-sanctions-countries-turn-to-stone-age-bartering/91467/.

Foy, H. (2018, October 3). Can Russia stop using the US dollar? Retrieved from https://www.ft.com/content/a5187880-c553-11e8-8670-c5353379f7c2.

Lederman, J., & Luce, D. D. (2018, September 4). How Europe plans to skirt Trump’s sanctions and keep doing business with Iran. Retrieved from https://www.nbcnews.com/politics/national-security/how-europe-plans-skirt-trump-s-sanctions-keep-doing-business-n906161.

Welle, D. (2019, January 31). INSTEX: Europe sets up transactions channel with Iran: DW: 31.01.2019. Retrieved from https://www.dw.com/en/instex-europe-sets-up-transactions-channel-with-iran/a-47303580.