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Beware the risks of severe sanctions on Russia

After recent summits, Washington and Brussels are a bit more optimistic about the Ukraine-Russia-U.S.-EU stalemate. But economic tremors have only begun.

Recently, Russian President Vladimir Putin met Ukraine's newly-elected president, Petro Poroshenko, at a D-Day event in France. Brussels saw the meeting as a "good sign" and a "de facto recognition" of Ukraine's new, pro-Western leader.


Russian President Vladimir Putin talks during a meeting with State Duma and Council of the Federation members on April 28, 2014 in Pertozavodsk, Karelia region, Russia.
Sasha Mordovets | Getty Images
Russian President Vladimir Putin talks during a meeting with State Duma and Council of the Federation members on April 28, 2014 in Pertozavodsk, Karelia region, Russia.

Moscow saw things differently. But so did Washington. "We will have to see what Mr. Putin does over the next three or four weeks, and if Russia continues on its current course," said President Obama, "then we've already indicated the kind of measures [economic sanctions] we're prepared to take."

Last Friday, European Commission chief Manuel Barroso and President Putin agreed on new Russia talks. Meanwhile, Russian tanks and artillery were crossing into Ukraine, according to the U.S. State Department.

Read MoreRussia demands upfront Ukraine gas payments

The proposed EU-Ukraine free-trade treaty is to be signed in Brussels on June 27. The EU and the U.S. promise to impose new economic sanctions on Moscow if it does not de-escalate by the end of June.

But how far is the White House willing to go? And does President Obama expect the post-election Brussels to follow?

Return of Novorossiya — or the Eurasian Union

Washington believes that President Vladimir Putin's ultimate objective is not just Ukraine, but "Novorossiya"; the territory conquered by Imperial Russia from the declining Ottomans in the 18th century.

In this narrative, Putin seeks to bring the contested Ukrainian provinces under Russian domination, through annexation or a new federation.

Without effective economic and strategic intervention by the U.S., Washington expects Ukraine to be dismembered, or that parts of it would be brought back into Russia's sphere of influence within months. That would destabilize the borders of Romania and Moldova.

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In such a scenario, Ukraine could lose almost half of its population and two-thirds of its economy, even without an overt Russian intervention.

In late May, Putin, along with the leaders of Kazakhstan and Belarus, signed a historic treaty establishing the Eurasian Economic Union (EEU). It will create a common market of 170 million people and a combined GDP valued at $2.7 trillion — more than that of France.

Ever since the postwar era, America has had concerns about "Eurasian challengers" that could threaten U.S. global pre-eminence, as Zbigniew Brzezinski has put it.

Ukraine's life support, Russia's economic angst

In Washington, hawks demand tougher economic sanctions, which would sharply reduce Russia's oil and gas exports and revenues, decimate foreign investment and severely destabilize Russian growth. They would also like to boost U.S. and NATO forces near Polish borders, Baltic republics and northeast Romania — dramatically.

President Obama's recent $1 billion "European reassurance initiative," which was designed to reaffirm U.S. commitment to security and democracy in Eastern Europe, is the first step to this direction. But it is not exactly a show of force. It represents barely 0.15 percent of U.S. military spending in 2013.

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Nevertheless, a truly severe sanctions scenario would escalate the current regional stalemate into a large-scale crisis with global implications. It would significantly weaken U.S. pivot to Asia. It could also prove another U.S. confrontation without exit strategy, as Henry Kissinger has warned.

Ukraine is already on lifeline support. In 2014 alone, Kiev's sovereign financing needs will soar to $36 billion, which exceeds its total reserves by 2.4 times. Since the country would have defaulted without support, IMF created an $18 billion rescue package, while the EU has unveiled a $15.5 billion aid plan for Ukraine.

The West has made a huge bet on Ukraine's political stability, despite massive uncertainty and corruption.

What about Russia? In 2012, Russian GDP growth was still 3.4 percent, but it more than halved to 1.3 percent last year. In May, Putin's approval rating still soared to 83 percent, a six-year high. But the real question is how long Putin can sustain his strong domestic support amid a severe sanctions scenario.

Moscow's impending contraction would penalize growth by 0.8 percent, while capital outflows could climb to more than $100 billion. If inflation will exceed 8 percent in 2014, new rate hikes will deepen economic pain.

Impact on U.S. and Europe

The U.S. is not immune to a severe sanctions scenario. It would penalize the current optimistic consensus, which expects growth to accelerate to 2.8 percent in 2014 and 3 percent in 2015. But factor in a full-sanction scenario before the mid-term elections in fall 2014 and presidential elections in 2016 and all bets are off.

Europe can endure a short-term energy crisis, but if the crisis will prove longer, the region would suffer still another contraction. In particular, those economies that get 80 percent to 100 percent of their gas from Russia would be more exposed (Finland, Ukraine, Slovakia, Poland, and Hungary).

Moreover, in the post-election Europe, the right-wing protest seeks independence domestically, distance from the U.S., and rapprochement with Russia.

In France, Marine Le Pen would like to pull France out of NATO. Like Charles de Gaulle, she seeks independence from the U.S. Like her counterparts, she believes that old U.S.-led institutions such as the World Trade Organization, World Bank and International Monetary Fund have "expired."

Le Pen advocates a privileged partnership with Russia, which is necessitated by "obvious civilization and geostrategic factors" and "energy security interests." She supports cooperation with Russia within a "Eurasian alliance."

These ideas have unleashed great behind-the-facade concern in Washington, which had hoped to complete the EU-U.S. free-trade agreement (FTA) without further headaches.

What's worse, severe sanctions scenario could push the new and fractious Brussels and its euroskeptics even closer to Putin and further from the White House.

Fatal temptation

The absence of strategic trust between Washington and Moscow reflects more than a decade of erosion in bilateral ties.

Before the elections of 2014 and 2016, the severe-sanctions scenario is a tempting option to the critics of the White House, possibly even to President Obama. But as they say, beware what you wish for.

As senior policy makers like to say, sanctions are what you do when you don't know what do. Russia's recent actions could prove a textbook case.

Commentary by Dan Steinbock, a research director of International Business at India China and America Institute (USA), visiting fellow at Shanghai Institutes for International Studies (China) and in the EU-Center (Singapore). See also www.differencegroup.net.

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