Russia turns to Turkey, other trading partners to blunt sanctions’ impact

by Catherine Belton, Kareem Fahim
The Washington Post

Russia is turning to Turkey and other potential new trading partners as it tries to circumvent Western sanctions that are starting to bite even deeper into its economy following its invasion of Ukraine.

Russian President Vladimir Putin is set to meet his Turkish counterpart, Recep Tayyip Erdogan, in Sochi on Friday, and the meeting — the leaders’ second in just over two weeks — is setting off alarms that the Kremlin could strengthen economic ties with a NATO nation that has not joined in imposing sanctions on Moscow.

A Russian proposal intercepted ahead of the meeting indicates Russia hopes Turkey will agree to new channels to help it avoid those restrictions on its banking, energy and industrial sectors.

The proposal, which this week was shared with The Washington Post by Ukrainian intelligence, calls for Erdogan’s government to permit Russia to buy stakes in Turkish oil refineries, oil terminals and reservoirs — a move that economists say could help disguise the origin of its exports after the European Union’s oil embargo kicks in fully next year. Russia also is requesting that several state-owned Turkish banks allow correspondent accounts for Russia’s biggest banks, which economists and sanctions experts say would be a flagrant breach of Western sanctions, and that Russian industrial producers be allowed to operate out of free economic zones in Turkey.

There is no indication that Turkey would support these arrangements since they would leave the country’s own banks and companies at risk of secondary sanctions and cut off their access to Western markets. Kremlin spokesman Dmitry Peskov did not respond to requests for comment. The Kremlin previously described the Putin-Erdogan meeting as focused on military-technical cooperation.

A senior Turkish official, in response to questions about the Russian proposal, did not address its details but said the country remains “committed to Ukraine’s independence and sovereignty.” He added that Turkey “as a matter of principle…exclusively joins sanctions that are imposed by the United Nations.”

The official, who spoke on the condition of anonymity to discuss a sensitive diplomatic meeting, noted that Turkey is “the only NATO ally that both Ukraine and Russia speak with and trust. That is why no other country has been able to bring together the two foreign ministers or official delegations.”

Western government officials, also speaking on the condition of anonymity because of the sensitivity of the situation, told The Post that they were not aware of the intercepted proposal but knew Russia is seeking ways to circumvent the war-related sanctions and their growing economic damage. Russian officials are traveling the world trying to find people who would be willing to do business with their financial institutions, they said, noting that Turkey is among a group of jurisdictions being approached because of their lax regard to enforcement.

With Russia cut off from much of the global economy, such overtures are a sign of the regime’s increasing worries, those Western officials and economists say. Putin has derided Western sanctions as a failure — a steady stream of revenue from energy sales have propped up the Russian ruble and the country’s financial system — and the International Monetary Fund now forecasts Russia’s economy to fall only 6 percent this year.

But economists say headline numbers mask a collapse across a large swath of Russian manufacturing and call the banking sector a “zombie system,” with withdrawal of hard-currency deposits banned. Though Russia has sought to divert trade flows through countries like India and China, the Western-imposed block on imports of high-tech components has brought some industries to a standstill.

“The situation will be darker next year,” said Sergei Guriev, professor at France’s Sciences Po and former chief economist at the European Bank for Reconstruction and Development. “No one knows how things are going to function when the European oil embargo kicks in. We’re in unchartered territory.”

New figures released last week by Russia’s state statistics agency Rosstat show how hard some sectors have been hit. Car production, the industry most dependent on foreign components, was down 89 percent in June year on year, while production of computers and semiconductors was down 40 percent year on year and that of washing machines nearly 59 percent lower.

“It’s clear things are going to get tougher and tougher,” said Maxim Mironov, professor of finance at the IE Business School in Madrid. The announcement this week that one of the main auto plants of state-owned AvtoVAZ would reduce its workforce signals a lack of other options for the company — and the government, he noted. “Cutbacks are beginning and it could lead to social tension.”

Other high-tech sectors such as pharmaceutical production are also floundering. A Central Bank of Russia survey last month found that 40 percent of pharmaceutical producers had failed to find replacements for imports of ingredients and equipment. “Russia has been trying to onshore pharmaceutical production, but it clearly hasn’t been successful,” said Elina Ribakova, deputy chief economist at the Washington-based Institute of International Finance. “Sometimes the overall data doesn’t cover all the nuance,” she said, with aluminum producers facing choke points on vital chemical supplies.

Sergei Aleksashenko, a former deputy Central Bank chairman now in exile in the United States, said it’s imperative for Russia to find alternative financial channels for its banks. “It is a question of money,” he said, pointing out that Iran, with help from Russia and Turkey, had previously managed to get around Western sanctions. “If you pay a lot, there will be some banks ready to take the risk.”

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The Putin regime had previously hoped to bypass the current sanctions by creating alternative payment systems through Chinese banks, according to a well-connected Russian state official, speaking on the condition of anonymity because of fear of retribution. Yet Chinese banks have balked at taking on that role because of the risk of secondary sanctions. And despite the country’s increasing imports of Russian oil and gas, it cannot replace all of Russia’s equipment needs.

A study by the Green Finance & Development Center at Shanghai’s Fudan University concluded that sanctions fears prompted China to abandon new investments in Russia this year as part of its Belt and Road initiative. The Western officials said it had become clear that China was not an adequate channel for Russia to mitigate the impact of sanctions, forcing the Kremlin to desperately look for other partners.

In Erdogan’s complicated relationship with Putin — marked by periods of conflict and cooperation — Russia had significant past leverage and showed its displeasure by cutting off the flow of tourists to Turkey or banning the import of Turkish agricultural products. Since the start of the Ukrainian war, Turkey has positioned itself as a mediator between Moscow and Kyiv — a role that appeared to pay dividends last month when Turkey and the United Nations brokered an agreement to resume grain shipments from blockaded Ukrainian ports.

Erdogan wants Putin’s acquiescence for a planned Turkish military operation against Kurdish forces in northern Syria. Russia maintains troops in the area as part of its support for Syrian President Bashar al-Assad.

According to two Moscow businessmen, retail supply chains are already being rebuilt in Russia with Turkey’s help. The owner of a major retail chain said his outlets had completely reorganized supplies through new hubs in Turkey, Israel, China and Azerbaijan. Recent trade data from Turkish Statistical Institute, Ankara’s statistics office also known as Turkstat, shows monthly Turkish exports to Russia surged by about $400 million between February and June.

But consumer goods aside, sanctions experts and Western officials doubt Turkey could become a hub for vitally needed equipment supplies without facing the risk of crippling secondary sanctions. Those officials said the country now has to make a choice, knowing that any business it does with Russia risks casting a pall over its economy and financial sector and will make it harder to do business with the rest of the world.