West's Sanctions Playbook Faces Challenge With Russia Over Ukraine

By Jay Solomon and Marcus Walker 

The U.S. and Europe made good this week on their threats to start penalizing broader sections of Russia's economy in a bid to force President Vladimir Putin to end his support for separatist rebels in Ukraine.

But recent history of the use of financial sanctions by Washington and Brussels--including against Iran, North Korea and Syria--suggests that significantly more pervasive penalties, particularly against Moscow's energy sector, would be needed to change the Kremlin's calculations, said current and former U.S. officials and sanctions experts.

Even then, it is uncertain whether Mr. Putin values Russia's economy more than his influence over Ukraine.

The Obama administration has viewed the ongoing financial squeeze on Iran as a model: The country's oil exports have been cut in half over the past three years and its banks largely hived off from the global financial system. This prompted Tehran, the White House argues, to engage for the first time in serious negotiations aimed at capping its nuclear program.

American and European officials who crafted this strategy, however, stress that it took more than a decade of steadily increasing sanctions to achieve those results.

The U.S. and European Union also had to be prepared to weather potential economic blowback, in the form of oil price spikes. Such risks could be even bigger in an economic campaign against Russia.

"Russia is a very different animal than the places where we've had sanctions before," said Victor Comras, who led U.S. sanctions efforts under U.S. Secretary of State Madeline Albright in the late 1990s.

Russia's economy is more integrated into Europe's through energy infrastructure, trade and finance channels. It also has a much larger share of the global economy: nearly 3% versus Iran's 0.5%.

With nearly $500 billion in foreign exchange reserves--roughly 23% of its gross domestic product--Russia also has a bigger cushion than Iran, whose $68 billion represents around 19% of the country's GDP.

But the two countries pose similar foreign policy challenges, said backers of the Iran sanctions policy.

"The situation with Russia is similar to the situation with Iran in that you've got a foreign policy and national security problem in which just talking with them is not going to work...so diplomacy without leverage is not going to work," said Stuart Levey, who spearheaded the Treasury Department's Iran sanction efforts for seven years, and now serves as chief legal officer for HSBC Holdings PLC.

The corporate world is watching warily, with auto makers and energy giants already moving to limit Russian risks to their businesses. French oil giant Total SA said it has stopped increasing its stake in Russian natural gas producer OAO Novatek.

Mass-volume car makers such as Volkswagen AG, Ford Motor Co. and General Motors Co.'s Opel unit are expected to suffer most from the sanctions, said Ferdinand Dudenhoeffer, director of the Center for Automotive Research at the University of Duisburg-Essen.

"The more this looks like the administration is using pages from the Iranian financial sanctions playbook, the greater the likelihood that market players will voluntarily cut their business ties to stay ahead of potential penalties," said Mark Dubowitz of the Foundation for Defense of Democracies, who advises Congress.

Russia reacted with defiance. Mr. Putin didn't publicly respond to the EU and U.S. moves Wednesday, but his Foreign Ministry denounced the sanctions as "crazy and irresponsible" and warned that the U.S. and Europe would suffer as well.

The penalties included a ban on medium- and long-term financing for three of Russia's largest state-owned banks-- VTB Bank, Bank of Moscow and Russian Agricultural Bank. They also included measures to ban the sale of military items to Moscow and to deny the Russian oil industry access to Western technologies needed for deep-sea drilling and the extraction of shale oil.

For the first time, the EU this week also hit members of Mr. Putin's inner circle with visa bans and asset freezes. The U.S. has done so in its previous rounds of sanctions.

"Russia has not changed course" in Ukraine and has continued to escalate the conflict there, in defiance of international demands and its own commitments, the Group of Seven leading countries said in a separate statement Wednesday.

The immediate economic impact of the new sanctions is expected to be limited. The Russian stock market and the ruble gained a bit Wednesday, optimism that masks deeper risks, officials and analysts say. It isn't clear whether those risks are enough to change the Kremlin's calculus.

"The sanctions rolled out by the EU/U.S. this week do not really threaten an immediate and brutal hit to the Russian economy, but rather offer the prospect of further isolation, stagnation and decline for Russia," said Standard Bank economist Timothy Ash. "The question is whether Putin understands or really cares about this."

Restrictions on Russian banks' access to EU financial markets is expected to be the main source of near-term economic pain. But the measures leave out Russia's main business with the West: the sale of natural gas and oil to EU countries.

EU leaders including German Chancellor Angela Merkel have said the sanctions can be scaled back if Moscow becomes more cooperative--or scaled up if it continues to support pro-Russia rebels in Ukraine's east.

But few in Europe can imagine steps such as a boycott of Russian gas, which flowed to the West continuously even at the height of Cold War enmity. Many countries across the Continent have no way of replacing Russian gas quickly or affordably.

"If you really restrict Russian energy exports, then you hurt the EU as much as Russia," said Stefan Lehne, a scholar at Carnegie Europe, a nonpartisan Brussels think tank.

A sanctions regime limited to secondary economic ties such as banking, specialized engineering and arms highlights the constraints facing the West. Still, U.S. Treasury officials said they're plotting new measures against the Kremlin. "We have made it very clear that we can and will continue to increase pressure if Russia does not change course," said a senior U.S. official.

Current and former U.S. officials cited two actions against Iran that had the most crippling impact in recent years.

The first was the passage of legislation in 2009 that sanctioned any firm, foreign or American, that continued doing business with sanctioned Iranian banks and companies. The law gave the U.S. Treasury extraterritorial reach and essentially forced foreign firms to choose between doing business with the U.S. or with Iran.

The second action was the White House's sanctioning in 2012 of Iran's central bank, through which virtually all of Tehran's oil exports are conducted. The blacklisting served as a de facto oil embargo on Tehran and was followed by the EU's formal banning of any Iranian oil imports.

U.S. and European officials said it remains unclear how far the Obama administration and EU are willing to go. But officials involved in the debate said Washington and Brussels needed to make clear to the Kremlin that further pain is coming.

Mr. Dubowitz said Treasury should be considering steps to target Russian banks for their suspected money-laundering activities and ban them from global banking systems, which are vital to routine business. Congress and the White House should also consider legislation blacklisting companies that deal with blacklisted Russian entities.

"Sanctions are as much about psychology as legalities," he said.

Ian Talley,

Gregory L. White

, Laurence Norman, Géraldine Amiel and Matthew Dalton contributed to this article.

Write to Jay Solomon at [e-mail] and Marcus Walker at [e-mail]