Russian technology imports at pre-war levels, tougher export controls needed – Bruegel

Russia’s imports of Western technology have reached pre-war levels and the export control regime to stop the trade is full of holes. Tougher rules, enforcement and bigger fines are needed to curb the trade, according to a report from the Brussels-based Bruegel think-tank released on April 30.

“Russian imports of battlefield goods that are subject to export controls, including from Western producers, have surged since mid-2022 and reached levels close to those prior to Russia’s full-scale invasion of Ukraine. Russia thus continues to be able to acquire critical foreign components that it needs for its military industry,” Benjamin Hilgenstock and Anna Vlasyuk of the Kyiv School of Economics (KSE) Institute, together with Elina Ribakova of Bruegel, said in the report.

Russia continues to be able to buy critical foreign components used in military production and industry from partners in China, Hong Kong, Turkey and the United Arab Emirates, as well as friendly countries such as Armenia, Georgia, Kazakhstan and the Kyrgyz Republic that are facilitating the trade and have seen massive increases in imports from the EU over the last two years.

“The implementation and enforcement of export controls faces major challenges, which are multifaceted and centre around complex supply chains, lack of transparency in documentation and opaque financial structures,” the authors said, suggesting that the West take a leaf out of the existing anti-money laundering practices to better enforce the sanctions regime, as well as incentivising manufacturers to do better due diligence on where their goods will eventually end up after they leave the factory gate:

–      financial institutions could be tasked to play a role in the monitoring of the trade in export-controlled goods and the blocking of illicit transactions, building on their experience with due diligence in financial transactions;

–      non-financial companies could learn from banks’ efforts in the AML/CFT sphere to implement proper due-diligence procedures and to ensure export controls compliance; and

–      public-sector investigations and appropriate fines are critical to increase the incentives for firms to act.

“Technology sanctions are going to be part of the economic statecraft toolbox for the foreseeable future. The Russia case will test their effectiveness and credibility, or lack thereof,” the authors recommend.

The nature of export controls has changed dramatically since the war in Ukraine started. One of the main challenges is that unlike the Soviet Union, after three decades of independence Russia has become well integrated into global markets. The problem of banning the exports of some goods is complicated by Putin’s big bet on the Global South Century, where Russia has plenty of friends and markets that are not participating in the sanctions regime.

Research by KSE found that Russia acquired $12.5bn of technology goods in 2023 – only 2% lower in monetary terms than what it imported in 2021. However, given Russia is now forced to pay significant mark-ups for technology, imports have probably fallen modestly in volume terms, the authors say.

Within this trade, the goods of greatest concern, classed tier one military-use goods that Russia can’t make, accounted for $2.3bn, or 18% of the total technology trade, according to Bruegel’s report.

Tier two products – electronic items for which Russia may have some domestic production capability – made up another $2.4bn (19%).

Russian imports of battlefield goods

Friendly countries to the rescue

China has played a leading role in helping Russia replace missing electronic components. While Beijing, afraid of bringing down secondary sanctions on itself, has avoided exporting military equipment to Russia, exports of dual-use goods in a grey zone and essential equipment and machinery have soared. But a large share – 40.3% of the total in 2023 – is still being indirectly bought and imported from manufacturers based in coalition countries, Bruegel says.

China has been an important source of alternative technology to the now hard-to-get Western versions, but the authors suggest that the prevalence of Western components in Russian weapons is so high that it could be that it is so easy to get Western tech, the Kremlin has simply not bothered to ask China for replacements.

“Evidence from the battlefield shows that Western components still dominate as far as actual weapons production is concerned: 95% of all foreign parts identified were sourced from producers in coalition countries, with 72% accounted for by US-based companies alone. This could mean that Russia is not able to easily replace Western components with substitutes from, for instance, China,” the authors said. “However, it could also mean that Russia has not been required to substitute Western products in weapons because access to such imports remains in place despite export controls.”

While a lot of the technology Russia is buying is from Western brands, it appears that Russia has been buying this tech from their factories based in third countries and using its friendly country partners to send it to Moscow.

Direct shipping from the West to Russia accounted for only 5.7% of Russian imports in 2023, down from 50.9% in 2021, while the same trade share with China rose to 56.3% in 2023, up from 27.2% in 2021. Likewise, the shares for Hong Kong was 19.3% (14.4%), Turkey 5.7% (0.2%) and UAE 4.2% (0.4%) respectively. And these changes are not limited to these countries; similar changes in trade volumes are seen in most of the members of the Eurasian Economic Union (EEU).

Flows of battlefield goods to Russia in 2023

Russian imports of battlefield goods by location of shipment

Exports to Armenia, Georgia, Kazakhstan and the Kyrgyz Republic

“These trade dynamics, and the evidence from the battlefield, show that Russia has not been able to substitute certain high-technology Western goods and that export controls therefore remain a powerful tool of economic statecraft. However, it is also clear that enforcement needs improvements urgently, because critical technology still reaches Russia,” the authors said.

Bruegel suggests beefing up export controls by turning to the banks handling the trade payments as well as better incentivising the manufacturers to do more thorough due diligence on their customers. Banks are especially important, as money laundering laws give them more tools to demand more information than companies are required to do.

“Gaps in the legal framework make it difficult [for companies] to trace export control-related transactions, and regulations do not require the same level of diligence that banks have become accustomed to in areas such as anti-money laundering,” the authors said. “More broadly, the credibility of sanctions regimes and enforcement agencies is at risk of being undermined if the private sector learns that new and increasingly comprehensive measures of economic statecraft cannot be policed.”

There is a relatively short list of about 20 Western manufacturers that are seeing their goods turn up in Russian weapons coming down in Ukraine’s wheatfields.

Russian imports of battlefield goods in 2023 by producer

The $12.5bn in Russian high-priority goods imports in 2023 was made up of more than 1mn individual transactions. For companies there is little incentive to investigate further downstream distribution, as long as their direct buyers are not subject to the export restriction. And an increase in sales to a specific country is not itself a reason to start an investigation.

Tracing distribution networks is particularly difficult if the item in question is small, like semiconductors, and can be shipped in simple packages. The authors recommend manufacturers be asked to exercise greater vigilance coupled with a system of bigger fines to incentivise them. However, the banking system offers better prospects for policing export controls, as banks are already set up to do extensive due diligence and money trails are easier to follow than the shipment of physical goods.

“The most important element of such due-diligence efforts is to properly understand who one is conducting business with. In the financial industry, this is known as ‘know your client’ (KYC) and has been expanded over time to also involve a partners’ subsequent business relationships. Export-control regimes would be much more effective if non-financial companies were required to do this as well,” the authors said.

Fighter jets next

Russia’s ability to import electronics and chips is having a notable effect on the battlefield. In the early days of the war Ukraine’s innovation of using cheap commercial drones to drop Soviet-era grenades on guns and troops had a devastating effect, but after two years of fighting Russia learnt its lesson and has overtaken Ukraine by producing ever more sophisticated drones and developing effective electronic countermeasures to nullify the effectiveness of Ukraine’s drones.

The war has gone into a third phase, a drone war that came into its own at the start of this year. Ukraine has developed long-range drones that are hitting Russian oil refineries deep in its own territory. Russia has countered with swarms of drones that have proved lethal against Nato hardware and overwhelmed the Leopard and Abrams main battle tanks, which have been removed from the battlefield as a result.

The fourth phase of the war is imminent, awaiting the arrival of the long-overdue F-16 jet fighters, the first of which will reportedly be delivered this summer. And Russia is getting ready for the dogfights to come.

Despite ongoing international sanctions, Russia continues to procure the 2,000 components needed by military aircraft from over 200 companies across 22 countries, according to a recent analysis by the Independent Anti-Corruption Commission (NAKO), Ukrayinska Pravda reports.

An investigation found that in 2023 the Russia spent at least $4bn on electronics for military applications, notably in the maintenance and production of fighter aircraft such as the MіG-31I, Su-27SM3, Su-30SM, Su-34, Su-35S and Su-57.

The research highlighted that the majority of these components still originate from Western countries, with 244 companies from regions including the United States, Japan, Switzerland, Germany, France, the United Kingdom, Taiwan and the Netherlands contributing to the supply chain. Notably, the United States is the largest provider, accounting for 64% of the components imported by Russia.

Conversely, Russia sources fighter aircraft components from only 13 Chinese companies.

Once again, US companies play a crucial role in providing Russia’s military with otherwise hard-to-find parts. Key suppliers to Russia include high-profile firms such as Texas Instruments, Murata Manufacturing, Analogue Devices, Kemet, Micron, Maxim, IDT, AVX, Holt Integrated Circuits, Linear Technology, CIC and ON Semiconductor, according to the report.

In 2023, Russia’s expenditure on parts from these manufacturers totalled $962.6mn, marking a 19.7% decrease from 2022 but a significant 69.69% increase from 2021.

The survey also noted that at least 58 of Russia’s largest companies predominantly import goods through third countries. Networks facilitating the supply of Western electronics to Russian industries often involve intermediaries based in Hungary, Cyprus, Turkey, China and Russia itself, Ukrayinska Pravda reports.

Oil sanctions also failing to have an effect

The Bruegel report comes as similar criticism is made of the oil sanctions regime. The oil price cap on Russian oil is becoming increasingly unenforceable, according to the International Group of P&I Clubs, or so-called Mutual Insurance Clubs.

Russia’s oil revenues are rising, up 79% in the first three months of this year, according to figures released by Russia’s Ministry of Finance (MinFin) in April.

Russian oil export revenues surged to $17.2bn in March 2024, driven by higher global oil prices and increased crude export volumes, according to the April ‘Russian Oil Tracker’ by KSE Institute, which is calling for the oil sanctions regime on Russia to be tightened. As reported by bne IntelliNews, the oil sanctions are a spent cannon and have largely failed starve the Kremlin of the funds it needs to run its war in Ukraine.

The oil sanctions have not ended Europe’s Russian oil imports, just sent them round a longer route. Britain has increased its oil purchases from India, China and Turkey fivefold. Compared to 2022, Germany has purchased 1,100% more oil from India. Fuel exports from India to Europe grew by 124% compared to January. Russia has expanded its exports of liquefied natural gas (LNG) to Europe by 37% compared to 2021.

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