The past two years have seen a marked downturn in Russia-EU trade, as well as diminishing prospects for future economic cooperation. The impact of sanctions has been felt especially hard in Russia, which has also suffered from falling oil and gas prices.

'No entry' sign in front of EU government building. Photo: Legion-Media

Less than two years have now passed since the EU introduced its anti-Russian sanctions and Moscow answered symmetrically with counter-sanctions against the EU member states. Judging from the statistical data, it has been a period of unprecedented economic collapse in EU-Russia relations.

Trade flows have decreased dramatically in the sectors affected directly by the sanctions, as well as in related areas as a result of the economic multiplier effect. There has also been a crisis of confidence, as concerned investors did not hurry with the launch of new projects, while simultaneously freezing ongoing ones. The significant decline in the relationship has had a painful impact on the economies of both sides and probably will be felt for a long time.

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A brief look at Russia-EU trade turnover

Over the past five years, trade relations between the EU and Russia have been unstable, largely dependent on the pace of economic growth in Russia. The slowdown in EU-Russia trade had already started in 2013, when the Russian economy first started to show signs of weakness.

However, the aggravation of the political situation and sanctions in 2014, in conjunction with the fall of oil prices and growing economic tensions in Russia, have transformed this process into an avalanche, leading to a dramatic trade decline in a number of industries. However, a potential recovery and further growth may occur due to the weakening of the Russian currency, which has decreased the cost of labor and made domestic products more competitive.

Source: Eurostat

The ongoing events in Russia-EU relations are reflected most prominently in the trade statistics on agricultural goods, which have been directly affected by the administrative barriers that arose as a result of Russian counter-sanctions. One of the main results of the "sanctions war" has been a more than 50 percent reduction of agricultural exports from the EU to Russia in 2015 compared with the level of 2013. At the same time, there was a reduction of the negative balance of trade between Russia and the EU in this category. This, however, can hardly be called a success of the Russian economy.

Source: Eurostat

Hydrocarbons, which are the main Russian export to the EU, as well as the main "culprit" of Russia’s permanent substantial trade surplus with the EU, suffered the most. At the end of 2015 the fall of Russian hydrocarbon exports to the EU compared to the peak in 2012 was about 42 percent. In this case, a purely economic factor played the defining role. The main reason for the reduced exports was the fall of oil prices; even as the amount delivered remained the same, the value was falling rapidly.

Source: Eurostat

The picture for Russian suppliers looks better in two other industries contributing significantly to the EU-Russia trade structure: chemicals and engineering. For example, the downturn on the Russian side in the chemical industry has been minimal: in 2014 there was slight growth, and in 2015 there was a drop of 15 percent, which turns into a significant increase adjusted for the Russian currency exchange rate. Shipments from the EU decreased slightly (in 2015 they fell by 22 percent, while in 2014 they almost retained their 2013 peak).

Source: Eurostat

In engineering, the sanctions war has seen a sharp decline in Russia's trade deficit, achieved mainly due to the collapse of the supply of engineering products from the EU (down 44 percent in 2015 compared to 2013). At the same time, the reduction of supply can not be attributed to sanctions only or to the deterioration of purchasing power in Russia due to the ruble depreciation. In fact, the decline in the supply of engineering products began in 2013, when they fell by 8 percent. In comparison, there was a 15 percent growth rate in 2012.

It is noteworthy that during the period of sanctions there has been an increase in the supply of Russian engineering products in terms of value (even taking into account the fall of the ruble).

Source: Eurostat

Services have also become a victim of the general economic situation in Russia and the growing tensions between Russia and the EU. A steady growth of trade on both sides, reported in the period leading up to 2013, was reversed in 2014. Exports from the Russian side dipped a little stronger than from the EU side: 12 percent for Russia compared to 7 percent for the EU. Since 2012, the trade balance has remained virtually unchanged.

Source: Eurostat


Investment activity has also undergone a serious decline as a result of sanctions. According to the Central Bank of Russia, EU foreign direct investment (FDI) in Russia's economy shrank in 2014 by 44 percent and Russian FDI in the EU fell by 21 percent.

The falling investment activity was due, primarily, to lower investor risk appetite that resulted because of the sanctions, the fall in oil prices and ruble instability. However, as the situation was becoming more stable in 2015, capital returned and frozen projects started to recover. The 2014 decline is likely to be played out a little at the end of 2015 (according to data for 10 months of 2015 investment is almost on par with the 2014 level).

From the Russian side, the activity in the EU countries was aimed at the energy sector primarily. For example, in 2014-2015, Rosneft purchased 16 percent of the Total refinery in Germany. Furthermore, acquisitions were made in the pharmaceutical, construction and nuclear sectors. Assets were sold off in the oil and gas sector, as Gazprom sold off shares in gas distribution companies in Latvia and Lithuania and Lukoil sold off its gas station network in the Czech Republic, Slovakia, Hungary and Estonia.

Source: Russian Central Bank

Joint projects, especially long-term ones with a significant amount of investment, are traditionally considered to be the most stable form of economic interaction. However, the current crisis in Russia-EU relations led to a number of closed or frozen long-term projects: the South Stream project was stopped and the Total and Lukoil joint venture for the development of the Bazhenov shale formation was frozen. In addition, the Italian firm Eni declined to participate in the Arctic shelf development and Royal Dutch Shell was forced to cease cooperation with Gazpromneft in a shale oil development project.

However, the majority of ongoing projects are still working. They can be found in the energy sector. For example, Royal Dutch Shell signed a long-term contract with Novatek in 2015 for LNG supplies as part of the Yamal LNG project.

However, most of the ongoing joint projects that have not felt the impact of sanctions can be found in industries such as mechanical engineering, nuclear power, chemicals and retail. Companies from the EU launched new production in Russia in 2015 (Henkel, Bayer, Rohde & Schwarz), increased the capacities of existing ones (Sanofi), or raised their stakes in Russian assets (Renault-Nissan, Daimler).

It is due to several reasons that the EU companies are preserving contacts and even increasing the cooperation rate with their Russian counterparts under the difficult economic conditions and against the backdrop of a declining market.

First, the European partners are strategically focused on the Russian market and have experience working there in difficult times (e.g. Unilever came to Russia starting in the beginning of the 1990s).

Second, in terms of Russia's "pivot to the East" and intensifying competition for markets in the globalized world, investors from the EU do not want to burn bridges under the pressure of variable market conditions because of the fear of losing the Russian market in the long run.

Third, the situation with the Russian ruble exchange rate opens up new possibilities for export-oriented industries in Russia. A number of producers from the countries of the EU such as Candy and Ehrmann have already taken advantage of this trend.

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Estimates of losses and future prospects

The Russian economy is significantly affected by the Western sanctions, and its losses can be seen in the economic results of the past two years.

The losses induced by the financial sanctions have become the most painful factor for the Russian economy, reducing the prospects for investment and development. The structure of capital export was dominated by repayment of external debt.

By the end of 2015, the net foreign debt of the Russian banking sector decreased by $56.6 billion, compared to 2013, when the same figure rose by $13.7 billion. Russia's total foreign debt for 2014-2015 fell by more than $200 billion, or 30 percent. Given that about 90 percent of Russian foreign debt is owned by corporations, one can speak about an unprecedented weakening of the investment position of Russian big business.

Another problem that has arisen as a result of European sanctions is possible difficulties with oil exploration, especially in the fields close to depletion and shale deposits. The full effect on the Russian economy will emerge in the medium term. According to estimates, the decline in oil and gas production in Russia as a result of the EU and U.S. sanctions may amount to 3-5 percent.

It is even more difficult to assess the impact of the sanctions imposed against the military-industrial complex and the prohibition of dual-use goods supply as well as cooperation with Russian companies in the respective industries. Undoubtedly, they will deprive Russia of many opportunities to modernize its economy and slow down any efforts at overcoming the current structural crisis.

Assessing the contribution of sanctions in the deterioration of the economic situation in Russia, it’s possible to conclude that they were responsible for approximately one-third of the total decline. The rest came from domestic structural problems and the situation in the world energy markets.

The losses to EU countries due to Russian counter-sanctions were immeasurably less just because the exports to Russia that were targeted by the sanctions played a negligible role in most EU economies.

Statistics show that during less than two years of counter-sanctions, most EU countries have seen their total agricultural exports grow. This is especially true for the largest economies: exports from the UK and Spain grew in 2015 by 15 percent compared to 2013, while exports from the Netherlands and Germany grew by 10 percent.

The only victims were the Baltic states (decline in Estonia, Latvia and Lithuania in 2015 compared to 2013 was 22, 25 and 33 percent, respectively), Finland (down 39 percent) and Poland (2 percent). These countries are experiencing the greatest difficulty in finding alternative markets for their products. This is indicated by the accelerating rate of decline of exports in 2015 compared to 2014. Finland found a way out of this situation using the opportunity to transfer part of its dairy products production to Russian territory, strengthening existing production capacities.

Source: Eurostat

What are the future prospects of Russia-EU trade?

Summing up two years of life under sanctions, one can conclude that the victims were both economies, but the damage to Russia turned out to be significanly bigger both in quantitative and qualitative terms. Moreover, the losses from a series of measures taken by the EU have delayed effects, and may only manifest themselves in a few years with a force that is difficult to predict. The EU, in turn, was affected by the Russian counter-sanctions unevenly, but eventually managed to (at least partially) to redirect their trade flows in accordance with the new circumstances.

Sanctions did not become a turning point in the economic relationship between the EU and Russia. They were supposed to accelerate the developments that started at the end of 2012: the decline in the Russian domestic market, the reduction of the supply of oil and other raw materials as a result of Russia’s pivot to the East, and the termination or suspension of a series of investment projects.

The current crisis has highlighted the existing problems in relations between the EU and Russia, but at the same time, has demonstrated a real degree of interdependence of their economies. In short, the crisis has provided an opportunity to start building new cross-border value chains.

In the near future, one can expect further reduction of traditional ways of economic cooperation between Russia and the EU, a restructuring of the Russia-EU trade relationship, and the emergence of new relationships beween corporations in Russia and Europe.