The mysterious middlemen helping Russia’s war machine

RUSSIA IS PLANNING for decades of Western sanctions, a senior foreign-ministry official, Dmitry Birichevsky, said last week. The evidence suggests that might not be too much of a problem. The economy is growing smartly, at an annualised rate of 4% in the second quarter, after a whopping 5.4% the quarter before, despite one of the toughest regimes ever imposed. Trade continues to flourish. How come?

For a clue, look at Kazakhstan. Last year, the Central Asian republic’s tech industry appeared to pull off a triumph. Since the war in Ukraine began, European firms have been banned from selling most products in Russia; they were previously the country’s biggest tech suppliers. But Kazakhstan’s tiny tech industry, some 50 firms with a production capacity of $100m in 2021, seemed to have filled the gap. Its exports to Russia rose from $40m in 2021 to $298m in 2023. Of course, all was not as it seemed. Electronic imports from Europe also increased, from €250m ($273m) to €709m. Did Kazakh firms magically expand, or had Russian firms found a roundabout route to their old European suppliers? You be the judge.

Kazakhstan is one of several countries where trade with Russia and Europe has been mysteriously booming since Ukraine’s invasion. Others include Armenia, Azerbaijan, Georgia, Turkey and the other four countries of Central Asia. Exports from the European Union to these countries increased by €46bn in 2023, up 50% from 2021. That was equivalent to three-quarters of the drop in Europe’s exports to Russia from 2021 to 2023.

Along with military aid, sanctions are the West’s main contribution to Ukraine’s war effort, but unlike long-range rockets, they have so far failed to deal much of a blow. Two and a half years in, Russia’s economy is holding up well. It is hard to tell which European firms are simply adjusting well to the new restrictions and which are circumventing sanctions. But as it happens the biggest boosts in trade flowing through third countries have been among products that are now heavily restricted. European policymakers are desperate to close the leaks, but that means getting tough on the governments of some of Europe’s most prickly neighbours.

Three strands lie behind the boom in intermediated trade. The first is trade in banned goods, which openly flouts sanctions. The EU has adopted 14 packages of sanctions, most recently on June 24th. They ban firms making anything that could be used on a battlefield from exporting to Russia. That includes semiconductors and drones, but also ball-bearings and microwave ovens. Even so, more than half of the battlefield equipment that Russia acquired between February and August 2022 contains components made in Europe or America, according to the Royal United Services Institute, a think-tank in London.

For example, the most rapid growth in exports from the EU to Kazakhstan and Armenia has been in chemicals, electronics and machinery, all product groups under heavy sanctions. Machinery exports to Kazakhstan from the EU doubled from 2021 to 2022, and then rose another 23% in 2023 to reach €6.4bn. Armenia imported twice the chemicals, five times the IT hardware and four times the electronics from Europe in 2023 as it did in 2021. Then there are the goods that are smuggled across borders, which fall outside the official trade statistics.

Shipments can pass through several middlemen on their way to Russia. Some exporters in Turkey and Central Asia genuinely have no idea where the goods they are shipping came from. But others know very well. Last year America imposed sanctions on a network of European firms organised by Mayak, a Russian conglomerate, to transport forbidden equipment through Uzbekistan and Armenia. In June, it uncovered two different networks of European toolmakers shipping to Russia, one via Turkey for Ostec, a Russian state-owned company, and one via Kyrgyzstan for Newton-ITM, a Russian aerospace firm.

The second reason for rising indirect trade is that Russia has barred lorries from entering directly from the EU since 2022. The EU allows the export of some products to Russia, such as agricultural goods, but they must now take circuitous routes. The EU is not too worried about this: it makes transport more costly, which discourages trade with Russia but lets firms that heavily depend on it survive. Agricultural products flowing from Europe into Kazakhstan doubled from 2021 to 2023, official numbers show.

The third trend is the hardest for Europe to stop. It comes from a manufacturing boom in third countries. Third-country firms import some materials and parts from Europe, which does not necessarily break the rules. Sanctioneers have yet to touch some exports, such as textiles, raw iron and raw steel.

But even where trade is allowed, getting paid without breaking financial sanctions is a problem. Almost every transaction with a state-owned Russian firm is banned. European banks are barred from interacting with most Russian ones. Major Russian banks are locked out of SWIFT, the network that banks use to communicate with one another. Firms must avoid doing business with 2,200 firms and financiers who are blacklisted by the EU.

Turkey was one of the biggest suppliers of household appliances to Europe before the war started. America reckons Turkish firms are now making drones and microelectronics for Russia. Metals for some munitions may be smelted in Europe, according to a Turkish foreign-ministry official. Kazakhstan’s imports of office machinery from Europe tripled to almost $1bn from 2021 to 2023. That was probably partly due to a surge of new offices and factories. Investment in Kazakhstan rose by 11% in 2023, buoyed by Russian firms.

The economies of Central Asia and the Caucasus seem to be benefiting from the war. Collectively, the economies of the five Central Asian republics grew by 6% in 2023, up from 4% in 2022, while Armenia’s economy expanded by 8%, up from 5% in 2022. A booming logistics sector has cropped up overnight, and cargo is growing by 20% each year.

For Europe’s policymakers, this is all bad news. “We expected some leakage,” says one official, “but not on the scale we now know about.” In December, the EU’s 12th round of restrictions targeted firms in Armenia and Uzbekistan for the first time. Bureaucrats have since threatened more sanctions on third countries and Europeans exporting to them, but have taken action only against a few firms. For each firm added to the blacklist, another is registered elsewhere.

A real solution would require enlisting the help of the governments of the Caucasus and Central Asia. That is a tall order. Regional politicians value their closeness to Russia and often profit personally from rule-breaking. Still, the Europeans could offer them goodies. Armenia recently started to shut down firms trading with Russia, after the EU awarded it €270m in aid, loans and contracts.

Alternatively, Europe could use sticks rather than carrots. It could extend export bans to third countries or restrict their banks. That could anger Europe’s remaining sources of gas in Azerbaijan and hurt European firms. The question is whether the EU thinks that the benefit to Ukraine of a tighter sanctions regime is worth it. Its current approach suggests it doesn’t.

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