Fortune Hunting: Russia and Sanctions Evasion

Fortune Hunting: Russia and Sanctions Evasion

. 8 min read

As with any war, Russia's missile supply has been a crucial component of its strategy throughout the more than two years of its full-scale invasion of Ukraine. Given the sheer volume of missiles fired into Ukraine, many experts and military analysts have speculated that Russia soon would run out of missiles. This assumption sounds logical, as heavy international sanctions and export restrictions were expected to disrupt Russia's ability to produce new munitions. However, despite these predictions, reports suggest that Russia has maintained a steady supply.

In his evening address to the country on October 20, President Zelensky said that since January 2024, Russia has launched 6,130 Shahed-type drones. Additionally, adding up all daily reports of the Ukrainian Air Forces, Russia also fired around 1,500 missiles during these ten months.

This statistic raises the question: how has Russia maintained military production despite the heavy sanctions targeting its arms industry?

Remarkably, despite defense expenditures of only US$109.45 billion in 2023 and a GDP of US$2 trillion (2023), Russia has out-produced the United States and NATO allies in ammunition, rockets, and tanks. Russia’s resources contrast starkly with the combined NATO defense spending of US$1.29 trillion in 2023 and a combined GDP of approximately US$51.5 trillion (2023).

Before 2022, most of the arms manufacturing in Russia was done in partnership with other countries, such as collaboration with the Taiwan Semiconductor Manufacturing Company (TSMC) on microchip production and the import of machinery, vehicles, and other technical equipment from the European Union. Therefore, imposed sanctions should have reduced imports in a way that decreased Russia’s military production. However, as Ukrainian officials have noted, foreign components remain prevalent in Russian weaponry.

Sanctions Breakdown

Since February 2022, the United States, United Kingdom, European Union, and allies such as Canada, Japan, and Australia have imposed over 19,000 sanctions on Russia in response to its invasion of Ukraine, making it one of the most sanctioned countries in history. The sanctions have targeted Russia’s economy and ability to produce military supplies, aiming to weaken its war effort.

This approach contrasts with the international response to Russia’s annexation of Crimea in 2014. Then, EU sanctions were relatively limited and largely symbolic. They included travel bans and asset freezes targeting 151 individuals and 37 entities, mostly Russian. The aim was to apply pressure without disrupting broader economic relations, allowing the trade flows.

Therefore, cognizant of past mistakes, NATO allies imposed harsher measures in 2022. The new sanctions have been more comprehensive and target different crucial sectors. Financial sanctions froze central bank reserves and disconnected major Russian banks from the Society for Worldwide Interbank Financial Telecommunication (SWIFT) system, cutting off potential sources of war funding. Export restrictions were placed on crucial technologies, including advanced electronics and precision components needed for weapons and missile production. Energy sanctions, by capping oil and gas revenues, also aimed to reduce funds flowing into Russia's defense sector. Additionally, sanctions targeted influential individuals, oligarchs, and state-owned companies—freezing their assets, banning business dealings, and limiting access to many foreign properties—to apply political pressure on the Kremlin.

Despite these wide-reaching efforts, Russia has managed to maintain its arms supply and increase military production. Reports show that foreign components are still being used in Russian weaponry, suggesting that while the sanctions have had an impact, they have not fully thwarted Russia’s access to materials vital for missiles, rockets, and other military supplies.

Evasion Tactics

Third-Party Countries and Re-exporting

Although Moscow stopped publishing detailed monthly import statistics shortly after it launched an invasion of Ukraine, open sources still offer insights into current trends.

The Kyiv School of Economics Institute found that despite sanctions, countries imposing export controls on Russia were indirectly involved in 48.5 percent of battlefield goods imports from January to October 2023. The key point is that these goods were mostly shipped from outside of these countries. More specifically, over 50 percent of these re-exported goods arrived from China, Hong Kong, Turkey, and the United Arab Emirates. These four countries collectively represent 86.2 percent of total battlefield goods shipments and 78.6 percent of critical components shipments to Russia.

China has also become Russia's increasingly crucial trade partner, exporting many materials related to the war effort. For instance, China’s exports of vehicle spare parts have nearly tripled since 2021, rising from US$383 million to US$1.12 billion, with exports of heavy-duty trucks and other vehicle-related shipments also increasing. About 70 percent of machine tool imports and 90 percent of microelectronics imports to Russia arrive from China. China also exports over US$300 million in “dual-use” items—which can have non-military and military uses—to Russia monthly. Notably, trade between China and Russia increased by 64 percent from 2021 to 2023.

A similar increase in war-related trade is seen between Russia and its other neighbors. Armenian exports to Russia tripled in 2022, reaching US$2.4 billion; in 2023, they rose by 43.1 percent, hitting a historical high of US$3.4 billion. Armenia has also significantly increased its exports of electromechanical equipment, with 91 percent directed to Russia. Exports of nuclear reactors and mechanical devices soared tenfold, while exports of optical instruments and medical equipment grew fivefold. A similar situation is observed in Kazakhstan—2022 and 2023 were recorded years for economic cooperation with Russia as trade reached US$26 billion and US$27 billion, respectively, including the export of dual-use goods. Furthermore, 25 percent of the uranium production in Kazakhstan is now under Russian control, and energy interdependence is also growing, facilitating further economic cooperation.

Moreover, some nations effectively benefit from the sanctions by serving as intermediaries in the supply chain. For instance, the Maldives, which lacks a domestic chip industry, nonetheless recorded US$53 million in microchip shipments to Russia. Similarly, the United Arab Emirates has nearly quintupled its imports of EU-made aircraft parts, increasing them to 23.6 million euros (about US$26 million) after 2022. Interestingly, this increase coincided with Russia halting its imports of these parts from the European Union, demonstrating how EU-made parts are being funneled to Russia through friendly third-party countries, such as the United Arab Emirates. From March 2022 to March 2023, Russia imported over US$180 million in spare Boeing and Airbus aircraft parts, with over US$40 million worth from a Dubai-based company. However, the European Union’s 14th package of sanctions, passed in June 2024, aims to decrease these re-exporting activities.

Shell Companies

Moreover, intermediaries are not limited to countries acting as re-export hubs; they also include shell companies, which add another layer to sanction-bypassing networks. These businesses—though often legally registered and inactive in operations—mask the true flow of goods and finances involved in war-related trade, further complicating sanction enforcement efforts.

The New York Times recently published an investigation indicating that since 2022, nearly US$4 billion worth of restricted semiconductor chips have been funneled into Russia from over 6,000 companies, with many transactions occurring through a network of shell companies based in Hong Kong. US chipmakers—which are not legally obliged to track the destinations of their products—sell their chips to international distributors located in Hong Kong, Turkey, India, and Serbia, which, in turn, sell to Russia. This illicit trade in technology is very quick and evolving, and it is difficult for the US Department of Commerce's Bureau of Industry and Security (BIS) to keep up with the rapid appearance and transformation of shell companies.

A more famous Russian offshore scheme is called the “Cyprus Model.” It leverages Cyprus as a key transit point for Russian funds moving into Western financial systems. With the now-discontinued “golden visa” program—which allowed non-EU citizens to obtain permanent residency in Cyprus—2,869 Russian nationals received EU citizenship, allowing easier access to European markets. In March 2022, accounting firm PwC Cyprus facilitated the transfer of ownership of a significant Russian asset to a relative of a sanctioned individual just days after the sanctions were enacted.

In light of these established mechanisms, President Putin's recent legislative changes—which legalize cryptocurrency mining and allow its use in international transactions—suggest the potential for a new phase of cooperation between Russia and Cyprus-based entities engaged in the cryptocurrency sector. This shift is significant because the transfers in cryptocurrency are not connected to the identities of the individuals involved; instead, they utilize wallet addresses that can be created without revealing personal information. This level of anonymity complicates efforts to trace the origins and destinations of transactions, making cryptocurrency a useful way for Russian officials to engage in illicit financial activities.

In addition to cryptocurrency, many Russian companies and oligarchs use shell companies to conceal their assets. Russia accumulated US$80 billion in offshore cash, real estate, and investments in 2022. Additionally, Russia's long-term strategies have involved various international companies assisting in concealing its funds. For instance, the Pandora Papers indicated that prominent UK and US law firms aided Russian oligarchs, their families, and associated companies in navigating sanctions after 2014 and securing offshore schemes, which allowed the storage of enormous sums. Although the United States and EU countries froze many Russian assets, many offshore schemes involve anonymous shell companies, making it difficult to establish links to particular Russian individuals.

These methods—including shell companies and cryptocurrency—make it easier for Russian oligarchs and companies to hide their assets, which can support military operations and bolster the Russian economy. By working around sanctions, these illicit pathways undermine Western efforts to cut off the financial resources fueling Russia’s war activities. However, countries are working to control these schemes, with the European Union reforming legislation to combat money laundering and the United States starting to require beneficial ownership information for companies.

New Allies

In addition to sanction evasion tactics, Russia’s deepened alliances with China, Iran, and North Korea have provided significant economic and military benefits. Having already mentioned China, it is worth examining Iran and North Korea.

Russia turned to Iran nearly immediately, given its experience with dealing long-term with international economic sanctions. Their cooperation escalated in 2022, bringing significant economic benefits to the countries and resulting in a trade increase of 20 percent to US$4.9 billion. Over the past two years, the partnership has progressed beyond an economic arrangement, positioning Iran as a key supporter of Russia’s military campaign in Ukraine. Furthermore, as of 2023, plants in Alabuga, Russia, manufacture and assemble Iranian Shahed drones. The production rate of these drones at Alabuga has surged from fewer than 200 units in April 2023 to nearly 800 units by August 2024, which is concerning because approximately 14 out of 100 Shahed drones reach the target without being shot down. Moreover, despite all the warnings from the coalition countries, Iran has sent ballistic missiles—which are too fast and large for most air-defense systems—to Russia. These developments signify that Western allies should not underestimate the potential of cooperation between the world’s two most sanctioned countries.

Meanwhile, Russia’s cooperation with North Korea deepened after the invasion of Ukraine and is now escalating militarily. In a June 2024 agreement, the two countries agreed to assist each other if one were attacked, although they had already begun to cooperate militarily. North Korean short-range ballistic missiles have been found in Ukraine, and North Korea is expected to increase military exports to Russia. Between August 2023 and October 2024, North Korea sent over 13,000 containers of weapons to Russia. In the past year, North Korea has also sent Russia over eight million artillery shells, and at least 10,000 North Korean soldiers are currently fighting against Ukraine. As of May 2024, Russia was launching at least 10,000 artillery shells at Ukraine daily, demonstrating North Korea’s crucial role in providing ammunition to Russia.

Military cooperation among these countries significantly helps Russia maintain military production despite the heavy sanctions imposed by Western allies. This cooperation not only increases each country's military potential but also exposes the weaknesses of the US and EU foreign policy instruments intended to cripple Russia. These alliances also create the basis for an alternative global order that could destabilize Western democracy and liberalism.

Preventing Further Sanctions Evasion

Russia’s sanction evasion and tightening of global alliances pressure sanctioning nations to adopt more dynamic and proactive strategies. The current sanctions framework can be expanded and revised to enhance its impact. For example, the European Union continues to offer new packages of restrictions on economic cooperation with Russia. Moreover, secondary sanctions will become increasingly significant in motivating third-party, non-sanctioning countries to limit or end their backing of Russia's military activities. While evasion tactics can evolve, so too can international responses. This issue is extremely important to address because other countries, such as China, can learn from Russia’s evasion of Western sanctions, as Russia did with Iran. Therefore, the failure of sanctions in the case of Russia could embolden autocracies elsewhere.